                  T.C. Memo. 2003-75



                UNITED STATES TAX COURT



    GREEN FOREST MANUFACTURING INC., Petitioner v.
     COMMISSIONER OF INTERNAL REVENUE, Respondent



Docket No. 1596-01.               Filed March 14, 2003.



     P is engaged in the business of assembling,
manufacturing, and selling furniture. P depreciated
certain items of equipment used predominantly outside
the United States. In accordance with the modified
accelerated cost recovery system (MACRS), alternative
depreciation system rules, R reclassified certain items
of P’s equipment. The reclassification required a
change in recovery period for all of the reclassified
items of equipment, and a change in depreciation method
for some of the reclassified items of equipment. P
concedes that R’s reclassification is correct.

     R determined that reclassification of the items of
equipment is a change in P’s method of accounting that
requires an adjustment pursuant to sec. 481(a), I.R.C.

     Held: The change in MACRS classification of the
items of equipment is excluded from the definition of a
change in method of accounting, and an adjustment
pursuant to sec. 481(a), I.R.C., is not required.
                               - 2 -

     Commissioner v. Brookshire Bros. Holding, Inc. & Subs.,
     ___ F.3d ___ (5th Cir., Jan. 29, 2003), affg. T.C.
     Memo. 2001-150, followed.



     Robert J. Gumser, for petitioner.

     Yvonne M. Peters, for respondent.



             MEMORANDUM FINDINGS OF FACT AND OPINION


     NIMS, Judge:   Respondent determined Federal income tax

deficiencies for petitioner’s tax fiscal years ended in August

1996, August 1997, and August 1998, in the amounts of $147,277,

$31,983, and $46,729, respectively.    At trial, petitioner

conceded that the modified accelerated cost recovery system

(MACRS), alternative depreciation system rules, in accordance

with section 168(g)(1), required petitioner to use a 10-year

recovery period and the straight-line method of depreciation for

items of petitioner’s equipment that were placed in service after

1986 and used predominantly outside of the United States.     The

issue for decision is whether a change in MACRS classification

that results in a change in depreciation method and recovery

period is a change in method of accounting for purposes of an

adjustment pursuant to section 481(a).
                                - 3 -

      Unless otherwise indicated, all section references are to

sections of the Internal Revenue Code in effect for the years at

issue, and all Rule references are to the Tax Court Rules of

Practice and Procedure.

                          FINDINGS OF FACT

      Some of the facts have been stipulated and are so found.1

The stipulations of the parties, with accompanying exhibits, are

incorporated herein by this reference.   At the time the petition

was filed, petitioner’s principal office was located in San

Diego, California.

I.   Petitioner’s Operations

      Petitioner is engaged in the business of assembling,

manufacturing, and selling furniture.    The dispute in this case

relates to the depreciation of several items of equipment

(Equipment) owned by petitioner.   Each item of the Equipment was

placed in service after 1986.   For each year petitioner owned the

Equipment, the number of days each item of the Equipment was

physically located outside the United States exceeded the number



      1
        The parties stipulated various facts relating to the
equipment at issue in this case. Paragraphs 4, 7, and 10 of the
“STIPULATION OF FACTS” describe the equipment at issue in this
case. In referring to the paragraphs describing the equipment at
issue in this case, the parties mistakenly refer to paragraphs 4,
7, and 9. Paragraph 9 does not describe any equipment at issue
in this case. The references to paragraph 9 appear to be a
repeated typographic error. As such, references in the
“STIPULATION OF FACTS” to paragraph 9 will be treated as if the
references were to paragraph 10.
                                - 4 -

of days that each item was physically located within the United

States.   During the time petitioner owned the Equipment, it was

used to assemble or manufacture furniture.    The foreign business

using the Equipment was not subject to U.S. Federal income tax.

Petitioner sold the furniture that was manufactured using the

Equipment.

II.   Petitioner’s Accounting

      For all relevant years, petitioner used the accrual method

of accounting.   On its Form 1120, U.S. Corporation Income Tax

Return, for each of the relevant years, petitioner depreciated

each item of the Equipment using either the double-declining

balance method or the straight line method.   For each item

petitioner depreciated using the double-declining balance method,

petitioner used either a 3-year or a 5-year recovery period.     For

each item petitioner depreciated using the straight line method,

petitioner used a 5-year recovery period.

      Respondent examined petitioner’s returns for each of the

relevant years and issued a notice of deficiency with respect to

those years.   Therein, respondent determined that petitioner’s

deductions for depreciation of items of the Equipment for the

relevant years must be decreased because petitioner failed to

compute depreciation using the alternative depreciation system

for tangible property used predominantly outside the United

States, as required under section 168(g)(1)(A).   Respondent also
                                 - 5 -

determined that the change in deductions for depreciation was a

change in accounting method for which an adjustment pursuant to

section 481(a) was required for the tax year ended in 1996.

     At trial, petitioner conceded that respondent’s

determination relating to the deductions for depreciation is

correct.   Petitioner conceded that each item of the Equipment

should be reclassified under MACRS, alternative depreciation

system rules, in accordance with section 168(g)(1)(A), and

depreciated using the straight-line method and a 10-year recovery

period.

     Petitioner continues to challenge respondent’s determination

relating to the adjustment pursuant to section 481(a) on

multiple, alternative grounds.    First, petitioner claims that a

change in MACRS classification is not a change in method of

accounting for which section 481(a) requires an adjustment.

Second, petitioner claims that fairness should prevent an

adjustment under section 481(a) because respondent’s agent

reviewed and accepted petitioner’s method of depreciation and

accumulated depreciation during an examination of petitioner’s

tax years ended in 1992 and 1993.    Finally, on brief, petitioner

argues that respondent should not be allowed to assert an

adjustment pursuant to section 481(a) without considering and

applying section 481(b).
                                 - 6 -

                                OPINION

I.   General Rules

      A.   Depreciation Deductions

      Depreciation deductions are primarily governed by sections

167 and 168.    Section 168 describes a specific depreciation

system for tangible property.    As part of the Tax Reform Act of

1986, Pub. L. 99-514, secs. 201, 203, 100 Stat. 2122, 2143,

Congress replaced the accelerated cost recovery system with

MACRS, effective generally for property placed in service after

December 31, 1986, and section 168 was amended accordingly.     As

such, depreciation deductions for tangible property placed in

service after 1986 are generally determined under section 168.

Section 168 prescribes two systems for determining depreciation

deductions:    (1) The general depreciation system in section

168(a), and (2) the alternative depreciation system in section

168(g).    Taxpayers are required to use the alternative

depreciation system for “any tangible property which during the

taxable year is used predominantly outside the United States”.

Sec. 168(g)(1)(A).

      B.   Adjustments Pursuant to Section 481

      Section 481(a) provides for adjustments required by changes

in a taxpayer’s method of accounting.     If a taxpayer has changed

his method of accounting, the taxpayer must take “into account

those adjustments which are determined to be necessary solely by
                               - 7 -

reason of the change in order to prevent amounts from being

duplicated or omitted”.   Sec. 481(a)(2).    If there has been a

change in method of accounting, then section 481(a) applies and

adjustments are made thereunder to prevent the omission or

duplication of taxable income caused solely by the change in

method of accounting.   If there has not been a change in method

of accounting, then no adjustment pursuant to section 481(a) is

made.

     A change in method of accounting to which section 481(a)

applies includes “a change in the overall method of accounting

for gross income or deductions, or a change in the treatment of a

material item.”   Sec. 1.481-1(a)(1), Income Tax Regs.

     Regulations promulgated under section 481(a) incorporate the

rules of section 446(e) and section 1.446-1(e), Income Tax Regs.,

for determining when a change in method of accounting has

occurred.   Sec. 1.481-1(a)(1), Income Tax Regs.    A change in

method of accounting “includes a change in the overall plan of

accounting for gross income or deductions or a change in the

treatment of any material item used in such overall plan.”     Sec.

1.446-1(e)(2)(ii)(a), Income Tax Regs.      A material item, in turn,

“is any item which involves the proper time for the inclusion of

the item in income or the taking of a deduction.”      Id.
                               - 8 -

     Regulations also detail certain types of adjustments, with

examples thereof, that are specifically excluded from

characterization as changes in method of accounting:

          A change in method of accounting does not include
     correction of mathematical or posting errors, or errors
     in the computation of tax liability * * *. Also, a
     change in method of accounting does not include
     adjustment of any item of income or deduction which
     does not involve the proper time for the inclusion of
     the item of income or the taking of a deduction. For
     example, corrections of items that are deducted as
     interest or salary, but which are in fact payments of
     dividends, and of items that are deducted as business
     expenses, but which are in fact personal expenses, are
     not changes in method of accounting. In addition, a
     change in the method of accounting does not include an
     adjustment with respect to the addition to a reserve
     for bad debts or an adjustment in the useful life of a
     depreciable asset. Although such adjustments may
     involve the question of the proper time for the taking
     of a deduction, such items are traditionally corrected
     by adjustments in the current and future years. * * *
     [Sec. 1.446-1(e)(2)(ii)(b), Income Tax Regs.]

     Thus, even though an adjustment in the useful life of a

depreciable asset may involve the question of the proper time for

the taking of a deduction, such an item is includable among those

that are traditionally corrected by adjustments in the current

and future years, and a change in accounting method is not

involved.   The regulation is totally consistent with the language

of section 481(a)(2) because the useful life adjustment is not a

change “necessary * * * to prevent amounts from being duplicated

or omitted”.   Therefore, section 481(a) is not implicated so as

to require an adjustment thereunder.
                                 - 9 -

II.    Contentions of the Parties

       As detailed above, petitioner has conceded that each item of

the Equipment should be reclassified and depreciated in

accordance with MACRS, alternative depreciation system rules.

The parties agree that according to those rules, each item of the

Equipment should be depreciated using the straight-line method

and a 10-year recovery period.

       Respondent argues that the reclassification is a change in

method of accounting because the term “useful life” is not

synonymous with the term “recovery period” for purposes of

section 1.446-1(e)(2)(ii), Income Tax Regs.    Petitioner, however,

relies on our holding in Brookshire Bros. Holding, Inc. & Subs.

v. Commissioner, T.C. Memo. 2001-150, affd. ___ F.3d ___ (5th

Cir., Jan. 29, 2003), to argue that the reclassification is not a

change in method of accounting.     In Brookshire Bros. Holding,

Inc. & Subs., we held that the taxpayer’s change in MACRS

classification of an asset, which resulted in a change in both

the depreciation method and the recovery period, was excluded

from the definition of a change in method of accounting by reason

of analogy to the useful life exception contained in section

1.446-1(e)(2)(ii)(b), Income Tax Regs.

III.    Analysis

       Petitioner did not alter its overall plan of accounting for

income and deductions.    Rather, respondent required that
                              - 10 -

petitioner reclassify each item of the Equipment in accordance

with MACRS, alternative depreciation system rules, as required

under section 168(g)(1)(A).   Such reclassification resulted in a

change in depreciation method and recovery period.   Even though

petitioner concedes that the reclassification is correct, it

argues that, under the rationale explicated in Brookshire Bros.

Holding, Inc. & Subs. v. Commissioner, supra, a reclassification

of property under MACRS is to be treated as synonymous with an

adjustment in useful life for purposes of a regulatory exception

contained in section 1.446-1(e)(2)(ii)(b), Income Tax Regs.

     Respondent argues that for purposes of section 1.446-

1(e)(2)(ii), Income Tax Regs., as interpreted by the

Commissioner, the term “useful life” is not synonymous with the

term “recovery period.”   Respondent cites Thomas Jefferson Univ.

v. Shalala, 512 U.S. 504 (1994), for the propositions that this

Court should “give substantial deference to an agency’s

interpretation of its own regulations”, and “must defer to an

agency’s interpretation unless an alternative reading is

compelled by the regulation’s plain language or by other

indications of the agency’s intent at the time the regulation is

promulgated.”   The weight accorded to an agency’s interpretation

depends on the thoroughness of the agency’s consideration,

validity of its reasoning, consistency with earlier and later

pronouncements, and other factors that give an interpretation the
                                - 11 -

power to persuade.    United States v. Mead Corp., 533 U.S. 218,

228 (2001) (citing Skidmore v. Swift & Co., 323 U.S. 134, 140

(1944)).

     Respondent urges that the Commissioner’s interpretation of

section 1.446-1(e)(2)(ii), Income Tax Regs., is that a change in

recovery period or depreciation method in contrast to a change in

useful life is a change in method of accounting.

     As indicative of the Commissioner’s interpretation of

section 1.446-1(e)(2)(ii), Income Tax Regs., respondent cites

Internal Revenue Service Publication 538, which states:

“[C]hanges that are not changes in accounting methods and do not

require consent * * * [include an] adjustment in the useful life

of a depreciable asset.    You cannot change the recovery period

for ACRS or MACRS property”.    IRS Pub. 538, Accounting Periods

and Methods (1994).    Respondent also cites Rev. Proc. 96-31, sec.

2.01, 1996-1 C.B. 714, which provides that a “change from not

claiming the depreciation or amortization allowable * * * to

claiming the depreciation allowable is a change in method of

accounting”.

     The level of deference accorded to an agency’s

interpretation of its own regulation is based, in part, on the

thoroughness in the agency’s consideration and validity of its

reasoning.     United States v. Mead Corp., supra at 228.   Neither

Pub. 538 nor Rev. Proc. 96-31 provides any reason why a change in
                             - 12 -

MACRS classification should not be treated as analogous to a

change in useful life and, therefore, excluded from the

definition of a change in method of accounting.

     In Brookshire Bros. Holding, Inc. & Subs. v. Commissioner,

supra, we concluded:

     The similarities between a change in MACRS
     classification and a change in useful life are greater
     than the differences. Section 1.446-1(e)(2)(ii)(b),
     Income Tax Regs., was clearly intended to permit
     taxpayers to alter their depreciation schedules. The
     type of adjustment explicitly permitted--a change in
     useful life--would have resulted both in depreciation
     deductions over a longer or shorter period than
     originally contemplated and in an increased or
     decreased amount being deducted in any given period. A
     change in MACRS classification will have precisely
     these same two effects. Although a portion of the
     change in amount may be attributable to calculation
     method, as opposed to period length alone, such carries
     insufficient weight when balanced against severely
     limiting the intended relief. [Emphasis added.]

     In affirming the opinion of this Court, the U.S. Court of

Appeals for the Fifth Circuit stated:

     we fully agree with the Tax Court that the applicable
     regulations were meant to allow taxpayers to make
     temporal changes in their depreciation schedules * * *
     Clearly, doing so would produce changes in the length
     of time over which deductions are taken as well as
     concomitant changes in the amount of the deduction for
     any given tax year--and such a change under MACRS would
     produce exactly the same results. [Commissioner v.
     Brookshire Bros. Holding, Inc. & Subs., ___ F.3d ___
     (5th Cir., Jan. 29, 2003), affg. T.C. Memo. 2001-150.]

     Given our holding in Brookshire Bros. Holding, Inc. & Subs.

v. Commissioner, supra, and our statement therein as to agency

intent at the time the regulation was promulgated, we need not
                              - 13 -

defer to the agency’s interpretation as reflected in Pub. 538 and

Rev. Proc. 96-31.   Cf. Kurzet v. Commissioner, 222 F.3d 830 (10th

Cir. 2000)(giving deference to the Commissioner’s contrary

interpretation of section 1.446-1(e)(2)(ii)(b), Income Tax

Regs.), affg. in part, revg. in part, and remanding T.C. Memo.

1997-54 and an Oral Opinion of this Court.    Moreover, there is

nothing in the record to indicate the adjustments that respondent

made to reflect the change in classification of each item of the

Equipment or that the rationale of Brookshire Bros. Holding, Inc.

& Subs. is not appropriate to this case.

     For the foregoing reasons, we hold that the change in MACRS

classification of each item of the Equipment is not a change in

petitioner’s method of accounting.     Since there is no change in

method of accounting, an adjustment pursuant to section 481(a) is

not required.   Accordingly, we need not reach petitioner’s other

contentions regarding equitable relief or section 481(b).

     To reflect the foregoing and petitioner’s concessions,


                                           Decision will be entered

                                     under Rule 155.
