                    130 T.C. No. 11



               UNITED STATES TAX COURT



 CAPITAL ONE FINANCIAL CORPORATION AND SUBSIDIARIES,
                    Petitioners v.
    COMMISSIONER OF INTERNAL REVENUE, Respondent



Docket Nos. 19519-05, 24260-05.   Filed May 22, 2008.



     Ps’ subsidiaries, Capital One Bank (COB) and
Capital One, F.S.B. (FSB), issuers of Visa and
MasterCard credit cards, earn income from late fees
charged to cardholders who do not timely pay at least
their minimum monthly payment due. From 1995 to 1997
COB and FSB included the late fees in income when the
fees were charged to cardholders; i.e., when they
accrued under the all events test.

     On Aug. 5, 1997, Congress enacted the Taxpayer
Relief Act of 1997, Pub. L. 105-34, sec. 1004, 111
Stat. 911, which codified sec. 1272(a)(6)(C)(iii),
I.R.C. This provision allows taxpayers who maintain a
pool of debt instruments, such as credit card loans, to
treat certain receivables related to that pool of debt
instruments as creating or increasing original issue
discount (OID).
                               -2-

          In 1998 R provided that a taxpayer could receive
     “automatic consent” to change its method of accounting
     in accordance with sec. 1272(a)(6)(C)(iii), I.R.C., by
     filing Form 3115, Application for Change in Accounting
     Method, with the taxpayer’s return. COB submitted Form
     3115 with Ps’ 1998 return. Ps treated certain credit
     card receivables as creating or increasing OID on their
     1998 and 1999 returns, but they continued to recognize
     COB’s and FSB’s late-fee income at the time the fee was
     charged to the cardholder.

          Through this proceeding Ps seek to retroactively
     treat COB’s and FSB’s 1998 and 1999 late-fee income
     under sec. 1272(a)(6)(C)(iii), I.R.C., thereby reducing
     their taxable income substantially.

          Held: COB and FSB were required to obtain consent
     to change their treatment of credit card receivables to
     comply with sec. 1272(a)(6)(C)(iii), I.R.C.

          Held, further: Neither COB nor FSB received
     consent to change its treatment of late-fee income on
     Ps’ 1998 or 1999 return.

          Held, further: Ps may not retroactively change
     their treatment of COB’s and FSB’s 1998 and 1999 late-
     fee income because the requested change is a change in
     the treatment of a material item and is therefore an
     impermissible change in method of accounting under sec.
     446(e), I.R.C., and sec. 1.446-1(e)(2)(ii)(a), Income
     Tax Regs.

          Held, further: Ps’ motion for partial summary
     judgment on the late fees issue will be denied, and R’s
     motion for partial summary judgment will be granted.



     Jean Ann Pawlow, Elizabeth A. Erickson, Holly K. Hemphill,

Kevin Spencer, and Robin L. Greenhouse, for petitioners.

     Gary D. Kallevang, James Hill, and Alan R. Peregoy, for

respondent.
                                -3-

                              OPINION


     HAINES, Judge:   This case is before the Court on the

parties’ cross-motions for partial summary judgment filed

pursuant to Rule 121.1   The issue for decision is whether section

446(e) prohibits Capital One Bank (COB) and Capital One, F.S.B.

(FSB), from changing their treatment of late-fee income from the

current-inclusion method (when it accrued under the all events

test) to a method which allows late-fee income to create or

increase original issue discount (OID).2

                            Background

     The parties have stipulated the facts applicable to the

issue considered in this Opinion.     Capital One Financial Corp. is

a publicly held financial and bank holding company based in

McLean, Virginia.   Its principal subsidiaries, COB and FSB, are

among the world’s largest issuers of Visa and MasterCard credit

cards.

     During the years at issue COB and FSB earned various types

of income from their credit card business, including finance



     1
      Unless otherwise indicated, section references are to the
Internal Revenue Code (Code), as amended. Rule references are to
the Tax Court Rules of Practice and Procedure. Amounts are
rounded to the nearest dollar.
     2
      Petitioners’ motion applies only to COB because FSB, unlike
COB, did not file a Form 3115, Application for Change in
Accounting Method, with petitioners’ consolidated 1998 return.
Respondent’s motion applies to COB and FSB.
                                  -4-

charges when cardholders carried a balance on their cards, annual

fees, overlimit fees when cardholders exceeded their credit

limit, cash advance fees when cardholders accessed cash with

their cards, and interchange.3    Pertinent to these motions for

partial summary judgment, COB and FSB also earned income from

late fees charged when the cardholder was delinquent in making at

least the minimum payment due.     For the years 1995 through 1999,

COB and FSB recognized late-fee income at the time the fee was

charged to the cardholder for financial accounting purposes as

well as tax purposes.     Late-fee income was recognized in the

following amounts.

           COB                                    FSB

Year         Late-Fee Income            Year        Late-Fee Income

1995           $86,620,377              1995                -0-
1996           143,520,881              1996            $9,737,796
1997           287,400,477              1997            20,598,116
1998           510,017,513              1998            11,926,000
1999           722,277,703              1999            29,732,338
  Total      1,749,836,951                Total         71,994,250




       3
      In addition to the motions for partial summary judgment
addressed in this Opinion, petitioners filed a motion for partial
summary judgment as to the proper tax treatment of interchange.
Interchange is a fee (usually a percentage of the amount charged)
that is paid on every credit card transaction to the bank which
has issued the card. Petitioners contend that interchange
increases OID under sec. 1272(a)(6)(C)(iii) because the
cardholder bears the economic burden of paying interchange.
Respondent disagrees and contends that the merchant’s bank, not
the cardholder, is contractually responsible for paying
interchange to the bank which issued the card.
                                -5-

     On September 15, 1999, COB submitted Form 3115, Application

for Change in Accounting Method, to respondent by attaching it to

petitioners’ consolidated Federal income tax return for 1998.

COB stated on the Form 3115:

     Capital One Bank (COB), a domestic corporation,
     requests permission under Section 12.02 of Rev. Proc.
     98-60 to change its method of accounting for interest
     and original issue discount that are subject to the
     provisions of Section 1004 of the Tax Relief Act of
     1997.

     Petitioners did not treat late-fee income as OID under the

Taxpayer Relief Act of 1997 (TRA), Pub. L. 105-34, sec. 1004, 111

Stat. 911 (section 1272(a)(6)(C)(iii)) in 1998 or 1999.    They

continued to use the current-inclusion method for late-fee

income.   Petitioners did not attempt to amend their 1998 or 1999

return to treat late-fee income as increasing OID.   Petitioners

began to treat COB’s and FSB’s late-fee income as increasing OID

on their 2000 return.   Respondent has not conceded that

petitioners had consent under section 446(e) to make that change.

     In response to respondent’s notice of deficiency with

respect to 1997, 1998, and 1999, petitioners timely filed a

petition with this Court.   Petitioners subsequently filed their

amended petition, claiming they are required to treat late-fee

income as increasing OID on their pool of credit card loans, thus

reducing their taxable income for 1998 and 1999 by $209,143,757
                                  -6-

and $216,698,486, respectively.4    On October 12, 2007, the

parties filed cross-motions for summary adjudication on the late

fees issue.   On December 7, 2007, the parties filed objections to

each other’s motions.    A hearing was held on the motions in

Washington, D.C., on January 24, 2008.

                              Discussion

I.   Change in the Law

     On August 5, 1997, Congress enacted TRA sec. 1004, which

added section 1272(a)(6)(C)(iii) to the Code.    Section

1272(a)(6)(C)(iii) has the effect, as explained below, of

requiring taxpayers to treat credit card receivables as creating

or increasing OID on the pool of credit card loans to which the

receivables relate.     Petitioners seek to change their treatment

of COB’s and FSB’s 1998 and 1999 late-fee income from the

current-inclusion method to a method based on section

1272(a)(6)(C)(iii).

     The parties have stipulated that if the Court finds that a

change in the treatment of late-fee income is permissible, then

such income may be treated as creating or increasing OID under

section 1272(a)(6)(C)(iii).    An understanding of that section and


     4
      Treating late-fee income as OID decreases petitioners’
taxable income because under the current-inclusion method
petitioners recognized late-fee income when a cardholder’s
liability for the fee accrued, whereas treating late-fee income
as OID allows recognition to be deferred; i.e., included in
increments over time on the basis of reasonable assumptions
regarding how long it will take a cardholder to pay off the debt.
                                -7-

its application to credit card receivables is helpful to an

understanding of the issues in this case.

     The holder of a debt instrument with OID generally accrues

and includes in gross income, as interest, the OID over the life

of the obligation, even though the interest may not be received

until the maturity of the instrument.    Sec. 1272(a)(1).   The

amount of OID with respect to a debt instrument is the excess of

the stated redemption price at maturity (SRPM) over the issue

price of the debt instrument.   Sec. 1273(a)(1).   The SRPM

includes all amounts payable at maturity.    Sec. 1273(a)(2).     In

order to compute the amount of OID and the portion of OID

allocable to a period, the SRPM and the time of maturity must be

known.   This presents a problem for debts such as credit card

loans and real estate mortgages that may be satisfied over a very

short or a very long period, thus making the time of maturity an

unknown at the inception of the debt.

     For this reason, special rules were created for determining

the amount of OID allocated to a period for certain instruments

that may be subject to prepayment.    In the case of (1) any

regular interest in a real estate mortgage investment conduit

(REMIC), (2) qualified mortgages held by a REMIC, or (3) any

other debt instrument if payments under the instrument may be

accelerated by reason of prepayments of other obligations

securing the instrument, the daily portions of the OID on such
                                  -8-

debt instruments are determined by taking into account an

assumption regarding the prepayment of principal for such

instruments.     Sec. 1272(a)(6)(C)(i) and (ii).

     Section 1272(a)(6)(C)(iii) applies this special OID rule to

any pool of debt instruments the payments on which may be

accelerated by reason of prepayments.     It is clear that section

1272(a)(6)(C)(iii) was intended to apply to credit card loans and

the related receivables.     See H. Conf. Rept. 105-220, at 522

(1997), 1997-4 C.B. (Vol. 2) 1457, 1992.     What was unclear at the

time of enactment and is still not fully resolved is which credit

card receivables increase OID under section 1272(a)(6)(C) and

which do not.5

     Rev. Proc. 98-60, app. sec. 12, 1998-2 C.B. 759, 786,

provides procedures by which taxpayers may receive “automatic

consent” to change their method of accounting for pools of credit

card receivables in accordance with section 1272(a)(6)(C).     Under

the revenue procedure, automatic consent is achieved by filing

Form 3115 with a taxpayer’s return.     Id. sec. 6.02, app. sec. 12,

1998-2 C.B. at 765, 786.

     When section 1272(a)(6)(C)(iii) was added to the Code,

credit card companies could be certain that grace period interest



     5
      Although the Commissioner has clarified the scope of sec.
1272(a)(6)(C)(iii) by revenue procedures and other published
guidance, issues still remain, such as whether interchange income
is properly treated as OID.
                                -9-

fell under the new rule.   See Rev. Proc. 98-60, app. sec. 12;

Staff of Joint Comm. on Taxation, Description and Analysis of

Certain Revenue-Raising Provisions Contained in the President’s

Fiscal Year 1998 Budget Proposal 31-34 (JCS-10-97) (J. Comm.

Print 1997).   Grace period interest is the interest that accrues

from the date of a credit card charge if the balance of a

cardholder’s account is not paid by the end of the grace period,

usually 30 days after the close of a monthly billing cycle.6     If

the cardholder pays the balance within those 30 days, no interest

is charged.

     The operation of section 1272(a)(6)(C)(iii) with respect to

grace period interest is best explained by the following example.

Assume the cardholders of a credit card company (a calendar year

taxpayer) incur $10 million of charges in December of year 1.

Grace period interest will be charged to the cardholders who do

not pay their balances in full by January 30 of year 2, the end

of their grace period.   Before enactment of section

1272(a)(6)(C)(iii), the taxpayer was not required to include any



     6
      Grace period interest is the equivalent of a finance
charge, and is distinct from a late fee. Assume a cardholder
with a zero balance at the beginning of a billing cycle charges
$1,000 during that cycle and the credit card company calculates a
minimum payment due of $100. If the cardholder timely pays $100,
he will be liable for grace period interest because the entire
balance was not paid in full. If the cardholder timely pays
$1,000, no grace period interest will be charged. If the
cardholder does not make a timely payment of at least the minimum
due, he will be liable for grace period interest and a late fee.
                              -10-

interest income in year 1 with respect to the December charges

because it was possible that all the cardholders would pay off

their balances by January 30, year 2.     Of course, not all

cardholders paid their balances within the grace period; thus the

taxpayer was permitted to defer grace period interest allocable

to December year 1, until year 2.

     Under section 1272(a)(6)(C)(iii), the taxpayer is required

to make a reasonable assumption as to what portion of the

December balances will not be paid off within the grace period

and is required to accrue interest income through the end of year

1 with respect to that portion.   The taxpayer then adjusts the

accrual in the following year to reflect the extent to which the

prepayment assumption reflected the actual payments received

before expiration of the grace period.7

     The application of section 1272(a)(6)(C)(iii) to grace

period interest causes a taxpayer to recognize income in a

taxable year which it previously had deferred to the following

year, thus increasing the tax due.   The application of section

1272(a)(6)(C)(iii) to other credit card receivables, such as

late-fee income, generally has the effect of deferring income to

later years which otherwise would be recognized in the year the

fee was charged to the cardholder.   See supra note 4.    Which



     7
      Petitioners treated COB’s and FSB’s 1998 and 1999 grace
period interest under sec. 1272(a)(6)(C)(iii).
                                   -11-

receivables are eligible for this treatment has been the subject

of contention.

       Respondent has conceded that cash advance fees generally

increase OID under section 1272(a)(6)(C)(iii).8      See Rev. Proc.

2005-47, 2005-2 C.B. 269.       When a cardholder repays the loan (the

amount of cash advanced), the cardholder will also pay the cash

advance fee.       Thus, the SRPM is the amount of the loan plus the

fee.       As the SRPM is greater than the issue price (the amount of

the loan), there is OID on the transaction.       Before 1998

petitioners treated COB’s and FSB’s cash advance fee income as

increasing OID.       For 1998 and 1999 petitioners continued to treat

cash advance fee income as increasing OID under section

1272(a)(6)(C)(iii).       Respondent concedes this treatment is

proper.

       Respondent has taken the position that overlimit fees paid

by a cardholder to a credit card company increase OID.       Tech.

Adv. Mem. 2005-33023 (Aug. 19, 2005).       Before 1998 petitioners

treated overlimit fees under the current-inclusion method.

Petitioners treated COB’s and FSB’s 1998 and 1999 overlimit fee




       8
      To treat cash advance fees as increasing OID, the taxpayer
must be able to demonstrate that the amount of the fee is
separately stated on the cardholder’s account and that the fee is
not charged for property or specific services performed by the
taxpayer for the benefit of the cardholder. Rev. Proc. 2005-47,
sec. 5, 2005-2 C.B. 269, 270.
                               -12-

income as increasing OID under section 1272(a)(6)(C)(iii).

Respondent concedes this treatment is proper.9

     In contrast to overlimit fees and cash advance fees, the

parties agree that annual fees may not be treated as increasing

OID under section 1272(a)(6)(C)(iii).   Annual fees are charged to

the cardholder for all of the benefits and services available

under the credit card agreement, and not for any specific

service.   Rev. Rul. 2004-52, 2004-1 C.B. 973.   Therefore, annual

fees are compensation for services and not for the use or

forbearance of money.   Thus, they are not interest and do not

increase OID.

     Whether interchange increases OID under section

1272(a)(6)(C)(iii) is the subject of petitioners’ separate motion

for partial summary judgment which is still before the Court.

Petitioners treated COB’s and FSB’s 1998 and 1999 interchange

income as increasing OID under section 1272(a)(6)(C)(iii).

Respondent has taken the position that interchange income does

not increase OID.   See Tech. Adv. Mem. 2005-33023 (Aug. 19,

2005).

     Respondent has conceded that as a general proposition credit

card late-fee income may be treated as increasing OID on the pool



     9
      Although respondent has conceded petitioners’ treatment of
cash advance fees and overlimit fees is proper, respondent has
not conceded that petitioners correctly calculated the amount
includable.
                                  -13-

of credit card loans to which the income relates.10     Rev. Proc.

2004-33, 2004-1 C.B 989.     From 1995 through 1999 petitioners

treated COB’s and FSB’s late-fee income under the current-

inclusion method.      The issue in these motions is whether section

446(e) prohibits a retroactive change in the treatment of the

1998 and 1999 late-fee income from the current-inclusion method

to a method based on section 1272(a)(6)(C)(iii).

II.   Section 446(e)

      Section 446(e), at issue in this case, provides:

           SEC. 446(e). Requirement Respecting Change of
      Accounting Method.--Except as otherwise expressly
      provided in this chapter, a taxpayer who changes the
      method of accounting on the basis of which he regularly
      computes his income in keeping his books shall, before
      computing his taxable income under the new method,
      secure the consent of the Secretary.

The purpose of the section 446(e) consent requirement is to

assure consistency in the method of accounting used for tax

purposes and thus prevent distortions of income which usually

accompany a change of accounting method and which could have an

adverse effect upon the revenue.     See Commissioner v. O.

Liquidating Corp., 292 F.2d 225, 231 (3d Cir. 1961), revg. T.C.




      10
      To treat late fees as increasing OID, the taxpayer must be
able to demonstrate that the amount of the late fee is separately
stated on the cardholder’s account and that the late fee is not
charged for property or specific services performed by the
taxpayer for the benefit of the cardholder. Rev. Proc. 2004-33,
sec. 5, 2004-1 C.B. 989, 990.
                                 -14-

Memo. 1960-29; Casey v. Commissioner, 38 T.C. 357, 386-387

(1962); Wright Contracting Co. v. Commissioner, 36 T.C.

620, 634 (1961), affd. 316 F.2d 249 (5th Cir. 1963); Advertisers

Exch., Inc. v. Commissioner, 25 T.C. 1086, 1092-1093 (1956),

affd. per curiam 240 F.2d 958 (2d Cir. 1957).      In part, the

consent requirement is also intended to lessen the Commissioner’s

burden of administering the Code.       See Lord v. United States, 296

F.2d 333, 335 (9th Cir. 1961); Casey v. Commissioner, supra at

386.    This Court identified the following as the policy reasons

served by section 446(e):    “‘(1) To protect against the loss of

revenues; (2) to prevent administrative burdens and inconvenience

in administering the tax laws; and (3) to promote consistent

accounting practice thereby securing uniformity in collection of

the revenue.’”     FPL Group, Inc. & Subs. v. Commissioner, 115 T.C.

554, 574 (2000) (quoting Barber v. Commissioner, 64 T.C. 314,

319-320 (1975)).

       By requiring the taxpayer to obtain the Commissioner’s

consent before changing its method of accounting, section 446(e)

gives the Commissioner authority to approve or disapprove such

changes prospectively.    This Court has stated that the

Commissioner also has discretion to accept or reject a request

for a retroactive change in a taxpayer’s choice between two

permissible methods of computing taxable income.      See Barber v.

Commissioner, supra at 318.
                                 -15-

        If the Commissioner, acting within his discretion, does not

consent to the taxpayer’s request to make a change in the

taxpayer’s method of computing taxable income, the taxpayer is

required to continue computing taxable income under the

taxpayer’s old method of accounting.     See, e.g., United States v.

Ekberg, 291 F.2d 913, 925 (8th Cir. 1961); Schram v. United

States, 118 F.2d 541, 543-544 (6th Cir. 1941); Drazen v.

Commissioner, 34 T.C. 1070, 1075-1076 (1960) (and the cases cited

thereat); Advertisers Exch., Inc. v. Commissioner, supra at 1092-

1093.     If the taxpayer changes the method of accounting used in

computing taxable income without first obtaining consent, the

Commissioner can assert section 446(e) and require the taxpayer

to abandon the new method of accounting and to report taxable

income using the old method of accounting.    See, e.g.,

Commissioner v. O. Liquidating Corp., supra; Drazen v.

Commissioner, supra at 1076; Advertisers Exch., Inc. v.

Commissioner, supra at 1093.

     In deciding whether to consent to a change of accounting

method, the Commissioner is invested with wide discretion.    See,

e.g., Commissioner v. O. Liquidating Corp., supra at 231; Capitol

Fed. Sav. & Loan Association & Sub. v. Commissioner, 96 T.C. 204,

213 (1991); Drazen v. Commissioner, supra at 1076.     In a case in

which the taxpayer has requested the Commissioner’s consent to

change methods of accounting, the Commissioner’s action in
                                -16-

refusing to give consent is reviewed under an abuse of discretion

standard.   See Schram v. United States, supra at 544; Capitol

Fed. Sav. & Loan Association & Sub. v. Commissioner, supra at

213; S. Pac. Transp. Co. v. Commissioner, 75 T.C. 497, 681

(1980).

     In a case in which the taxpayer does not first obtain the

Commissioner’s consent, such as where the taxpayer attempts in a

court proceeding to retroactively alter the manner in which the

taxpayer accounted for an item on its tax return, the question is

whether the change constitutes a change of accounting method that

is subject to section 446(e).   See S. Pac. Transp. Co. v.

Commissioner, supra at 682; Wright Contracting Co. v.

Commissioner, supra at 635-636; cf. Poorbaugh v. United States,

423 F.2d 157, 163 (3d Cir. 1970); Hackensack Water Co. v. United

States, 173 Ct. Cl. 606, 352 F.2d 807 (1965); FPL Group, Inc. &

Subs. v. Commissioner, supra at 573-575.   If the change

constitutes a change of accounting method that is subject to

section 446(e), then the taxpayer is foreclosed from making the

change by section 446(e) and the regulations promulgated

thereunder without regard to whether the new method would be

proper.   See S. Pac. Transp. Co. v. Commissioner, supra at 682;

Wright Contracting Co. v. Commissioner, supra at 635-636.
                                 -17-

III. Whether Consent Is Required Under Section 1272(a)(6)(C)(iii)

     As a preliminary matter, the Court must address whether

taxpayers are required to obtain consent in order to change their

method of accounting to comply with section 1272(a)(6)(C)(iii).

Petitioners argue that Congress provided that a taxpayer did not

need consent to change its method of accounting to comply with

section 1272(a)(6)(C)(iii).     TRA sec. 1004(b)(2) provides:

          (2)Change in method   of accounting.--In the case of
     any taxpayer required by   this section to change its
     method of accounting for   its first taxable year
     beginning after the date   of the enactment of this Act--

          (A) such change shall be treated as initiated by
     the taxpayer,

          (B) such change shall be treated as made with the
     consent of the Secretary of the Treasury, * * *

The Court must read this provision, which was not codified, with

section 446(e) and the regulations promulgated thereunder, which

require a taxpayer to secure consent before adopting a new method

of accounting by filing Form 3115 and setting forth the classes

of items that will be treated differently.11    Sec. 1.446-

1(e)(3)(i), Income Tax Regs.

     Section 446(e) begins with the qualification:    “Except as

otherwise expressly provided in this chapter”.    Nothing in

section 1272(a)(6)(C)(iii) expressly provides that a taxpayer is

not required to receive consent to change its method of


     11
      Petitioners have not challenged the validity of the sec.
446 regulations.
                                -18-

accounting.    TRA sec. 1004(b)(2) was not codified and therefore

does not qualify as an exception to section 446(e).

     Nevertheless, if that provision had been codified, taxpayers

would still be required to follow the applicable procedures in

order to effect a change in accounting method.    Language similar

to that of TRA sec. 1004(b)(2) has been used in other provisions

of the Code.    The manner in which taxpayers change their method

of accounting under those provisions informs the Court’s

interpretation of TRA.

     Section 448(a) bars C corporations and partnerships if one

or more partners is a C corporation from using the cash method of

accounting.    Exceptions apply to this prohibition.   See sec.

448(b).    For example, entities with annual gross receipts of $5

million or less may use the cash method.    Sec. 448(b)(3), (c).

If section 448 forces a taxpayer off the cash method, such as a C

corporation that no longer meets the gross receipts test, the

mandatory adoption of another method (presumably the accrual

method) is a change in method of accounting generally requiring

consent.    Section 448(d)(7) provides:

          (7) Coordination with section 481.-- In the case
     of any taxpayer required by this section to change its
     method of accounting for any taxable year--

                 (A) such change shall be treated as initiated
            by the taxpayer,

                 (B) such change shall be treated as made with
            the consent of the Secretary, * * *
                                 -19-

Nevertheless, a taxpayer forced to change its method of

accounting under section 448 must still file a Form 3115 with its

return for the year of change.     Sec. 1.448-1(h)(2), Income Tax

Regs.     If the Form 3115 is not filed timely, a taxpayer forced

off the cash method must comply with the requirements of section

1.446-1(e)(3), Income Tax Regs., in order to secure the consent

of the Commissioner.    Sec. 1.448-1(h)(4), Income Tax Regs.

Pursuant to section 1.446-1(e)(3), Income Tax Regs., a taxpayer

requesting to change its method of accounting is required to file

a Form 3115 during the year in which it intends to make the

change.    In effect, the filing of a Form 3115 is a request for a

ruling from the Commissioner.     Sunoco, Inc. & Subs. v.

Commissioner, T.C. Memo. 2004-29; see Capitol Fed. Sav. & Loan

Association & Sub. v. Commissioner, 96 T.C. at 211; sec.

601.204(c), Statement of Procedural Rules.    The issuance of such

a ruling is a matter within the Commissioner’s discretion.

Capitol Fed. Sav. & Loan Association & Sub. v. Commissioner,

supra at 212.

     Timely notification of an accounting method change prevents

the loss of tax revenue because the Commissioner may then ensure

that appropriate adjustments are made to the taxpayer’s taxable

income in accordance with section 481.    Without notification, the

Commissioner would be unaware that such adjustments are

necessary.    Furthermore, timely notification prevents
                               -20-

administrative burdens and inconvenience in administering the tax

laws and promotes consistent accounting practice, thereby

securing uniformity in collection of the revenue.   See FPL Group,

Inc. & Subs. v. Commissioner, 115 T.C. at 574.

     Section 448 and the regulations promulgated thereunder

illustrate that when the law provides that a change is treated as

made with consent, the taxpayer must still comply with the

applicable procedures in order to effect the change.     If the

taxpayer does not file a timely Form 3115, automatic consent will

not be granted.   Sec. 1.448-1(h)(4), Income Tax Regs.    It follows

that if the taxpayer files an incomplete or otherwise deficient

Form 3115, automatic consent will not be granted.   This would be

especially true when the change in accounting method is more

complex than the change envisioned by section 448 (a change from

the overall cash method to the overall accrual method).

     In the light of the purposes for requiring notification to

the Commissioner of a taxpayer’s change in method of accounting,

the Court holds that petitioners were required to follow all

applicable procedures put in place by respondent in order to

receive consent to change their method of accounting to comply

with section 1272(a)(6)(C)(iii).   See Rev. Proc. 98-60, 1998-2

C.B. 759.   Failure to follow those procedures would negate

automatic consent to the proposed change.
                                -21-

IV.   The Meaning of “Item”

      The parties dispute the meaning of “item” as it is used in

section 1.446-1(e), Income Tax Regs.    Section 1.446-

1(e)(2)(ii)(a), Income Tax Regs., provides:

      A change in the 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. Although a method of
      accounting may exist under this definition without the
      necessity of a pattern of consistent treatment of an
      item, in most instances a method of accounting is not
      established for an item without such consistent
      treatment. A material item is any item which involves
      the proper time for the inclusion of the item in income
      or the taking of a deduction. * * *

      The dispute arises because COB requested permission to

change its method of accounting for “interest and OID that are

subject to the provisions of section 1004 of the Taxpayer Relief

Act of 1997.”   Petitioners contend that the relevant item is

interest, including OID, and by using that description COB

obtained consent to change its treatment of late-fee income, a

“component” of interest, including OID.    Respondent contends that

the relevant item is late-fee income.    Respondent further argues

that the description used by COB is ambiguous at best and that

because COB did not apply the OID rules to late-fee income on its

return for 1998 or 1999, COB did not obtain consent to change the

treatment of late-fee income.   See infra V.

      The meaning of “item” is also important to our discussion,

infra VI, regarding whether a change in the treatment of late-fee
                                  -22-

income is a change in the treatment of a material item.        See sec.

1.446-1(e)(2)(ii)(a), Income Tax Regs.     Whether an item is

material is a question of timing, but before determining

materiality we must know which item to address, interest or late-

fee income.

     Petitioners contend that the references to “item” throughout

section 1.446-1(e), Income Tax Regs., mean an “item of income or

deduction”.     “Items of income” are listed in section 61.    Under

petitioners’ theory, because item means item of income, under

Gitlitz v. Commissioner, 531 U.S. 206 (2001), the Court must look

to section 61 to determine what an item is.     Petitioners give the

Supreme Court’s holding in Gitlitz far too much weight.        Gitlitz

involved the effect of discharge of indebtedness income on the

basis of S corporation stock, not the ability of an entity to

change its method of accounting.     The Court addressed the

Commissioner’s argument that the discharge of indebtedness of an

insolvent S corporation was not an “item of income”.      Id. at 212.

To resolve the issue, the Court looked to section 61, which

provides that discharge of indebtedness is generally included in

gross income.     Id. at 213.   The Court did not address how narrow

an item of income may be or whether a specific type of discharge

of indebtedness is also an item under section 1.446-1(e), Income

Tax Regs.
                               -23-

     The regulations promulgated under section 446(e) make

frequent reference to the broad term “item” and the narrower term

“material item”.   “Material items” are necessarily a subset of

the broader group “items”.   Courts have identified a variety of

“material items”, all of which are narrower than the broad items

of income listed in section 61.   For example, courts have found

the following to be material items:   (1) Commissions from a

particular insurance company, Leonhart v. Commissioner, T.C.

Memo. 1968-98, affd. 414 F.2d 749 (4th Cir. 1969); (2) the

treatment of automated teller machine replacement modules,

Diebold, Inc. v. United States, 891 F.2d 1579, 1583 (Fed. Cir.

1989); (3) gain from sales of automotive inventory, Huffman v.

Commissioner, 126 T.C. 322, 343 (2006), affd. 578 F.3d 357 (6th

Cir. 2008); (4) the treatment of natural gas as “working gas”

(inventory) or “cushion gas” (capital asset), Pac. Enters. v.

Commissioner, 101 T.C. 1, 23 (1993); (5) the treatment of costs

as a repair expense or as depreciable, FPL Group, Inc. & Subs. v.

Commissioner, 115 T.C. 554 (2000); (6) a change in depreciation

method resulting from a change from section 1250 property to

section 1245 property, Standard Oil Co. (Indiana) v.

Commissioner, 77 T.C. 349, 410 (1981); and (7) overburden removal

costs under section 616(a), Sunoco, Inc. & Subs. v. Commissioner,

T.C. Memo. 2004-29.   See also sec. 1.446-1(e)(2)(iii), Example

(2), Income Tax Regs. (real estate taxes are a material item);
                                -24-

sec. 1.446-1(3)(2)(iii), Example (6), Income Tax Regs.

(allocation of overhead to value of inventory is a material

item).    The preceding examples fall within the narrow group

“material items” and therefore must also be “items”.

     An item under section 1.446-1(e), Income Tax Regs., may be

narrower than the broad items of income listed in section 61.

Whether particular income is an “item” under section 1.446-1(e),

Income Tax Regs., depends on all the facts and circumstances

surrounding that income.    COB and FSB earned most of their income

from interest and items deemed to be interest for Federal tax

purposes.

     A taxpayer is required to obtain the Commissioner’s consent

before making changes to the treatment of a material item used in

its overall plan of accounting.    Sec. 1.446-1(e)(2), Income Tax

Regs.    Under petitioners’ theory, because late-fee income, and

presumably other credit card receivables, are not “items”

themselves, but are merely components of the “item” of interest,

they would also not be “material items.”    Consequently,

petitioners could make changes to these “components” of interest

without first receiving respondent’s consent.

     Defining item in this way would severely undermine the

reasons for section 446(e).    In 1998 and 1999 COB and FSB earned

late-fee income of $521,943,513 and $752,010,041.    They earned

more in late-fee income than any other type of fee.    In 1998
                               -25-

COB’s and FSB’s late-fee income accounted for approximately 22

percent of the gross receipts and 15 percent of the total income

reported on petitioners’ consolidated return.     Late fees are

earned for reasons independent of the reasons other types of

income are earned, such as finance charges, overlimit fees,

interchange, and cash advance fees.   Late fees are a separate and

distinct item of income.   In this context, the Court holds that

the relevant item for purposes of section 1.446-1(e), Income Tax

Regs., is late-fee income.

V.   Whether COB Received Consent To Change Its Treatment of
     Late-Fee Income

     Having found that the relevant item is late-fee income, we

must determine whether COB received consent to change its

treatment of late-fee income by requesting permission to change

its treatment of “interest and OID that are subject to the

provisions of section 1004 of the Taxpayer Relief Act of 1997.”

Petitioners argue the description is sufficient to obtain consent

to change COB’s treatment of late-fee income.   Petitioners

further argue that since COB received consent, they may now fix

their error in failing to implement the change.     Respondent

argues COB’s description of the item to be changed was ambiguous

at best and that because COB did not apply the OID rules to late-

fee income on its 1998 or 1999 return, it did not obtain consent

to change its treatment of late-fee income.
                                -26-

     In response to the enactment of section 1272(a)(6)(C)(iii),

the Commissioner set forth the procedures by which consent would

be given to a taxpayer to change its method of accounting.       Rev.

Proc. 98-60, 1998-2 C.B. 759.     Specifically, a taxpayer was

required to file Form 3115 with its return.     Id.   COB filed a

Form 3115 which stated:

           Capital One Bank (COB), a domestic corporation,
     requests permission under Section 12.02 of Rev. Proc.
     98-60 to change its method of accounting for interest
     and original issue discount that are subject to the
     provisions of Section 1004 of the Tax Relief Act of
     1997.

Question 9 on Form 3115 states:

          If the applicant is not changing its overall
     method of accounting, attach a description of each of
     the following:

               a.   The item being changed.

               b.   The applicant’s present method for the
          item being changed. * * *

In response COB stated:

     Question 9a

          The taxpayer proposes to change its method of
     accounting for interest and original issue discount
     that are subject to the provisions of Section 1004 of
     the Taxpayer Relief Act of 1997 (Pub. L. 105-34).

     Question 9b

          Credit card obligations are not currently
     accounted for as required by section 1272(a)(6) of the
     Internal Revenue Code. The taxpayer’s present method
     of account[ing] for credit card obligations is to take
     into account the differences between issue price and
     stated principal amount upon origination in certain
                                 -27-

     cases. Cash advance fees are taken into account as
     original issue discount.

     In accordance with Rev. Proc. 98-60, app. sec. 12.02(a), COB

also stated:

     Additional Requirements

          Pursuant to Section 12.02 of Rev. Proc. 98-60, the
     taxpayer makes the following representations. The pool
     of debt instruments consists of all credit card
     receivables held by the taxpayer. The proposed method
     is to account for interest and OID as required by
     Section 1272(a)(6). The prepayment assumption on the
     pool is the actual rate at which payments occur on the
     whole pool in the succeeding months. The amount of
     grace period interest included is determined using the
     same assumption used for book purposes. Cash advance
     fees continue to be accounted for as original issue
     discount.

     The Form 3115 did not mention late fees.   On petitioners’

consolidated 1998 return filed with the Form 3115, they treated

COB’s income from overlimit fees, cash advance fees, and

interchange as increasing OID on its pool of credit card loans

under section 1272(a)(6)(C).   On their returns for 1998 and 1999

petitioners did not treat COB’s late-fee income as increasing OID

but instead continued to recognize late-fee income at the time it

was charged to the cardholder.

     As discussed previously, the relevant item in this context

is late-fee income.   Neither Rev. Proc. 98-60, supra, nor COB’s

Form 3115, nor petitioners’ 1998 or 1999 return gave any

indication that late-fee income would be treated as OID.     The

language used in COB’s application to change its method of
                                 -28-

accounting was ambiguous and vague.     The ambiguities in COB’s

description of the item to be changed were clarified by the

treatment of the respective fees on petitioners’ consolidated

returns.     The Court therefore finds that COB did not receive

consent to change its treatment of late-fee income for 1998 or

1999.     In fact, by failing to mention late fees or to account for

late fees as OID on the returns for those years, COB did not seek

consent for the change.12    Even though petitioners began to treat

late-fee income as increasing OID with their 2000 return, they

made no effort to change their treatment of late-fee income for

1998 and 1999 until they filed a motion to amend their petition

in May 2006.13


     12
      Petitioners contend that if respondent did not consent to
COB’s 1999 request to change its method of accounting for late-
fee income, then that refusal constituted an abuse of discretion.
Because COB did not make clear to respondent that it was
requesting permission to change its method of accounting for
late-fee income, petitioners’ contention is unpersuasive.
     13
      Even if COB had been given consent to change its
accounting method for late-fee income with its 1999 return, the
Court doubts that COB would be entitled to correct its error in
implementation. By failing to implement the change and
continuing to treat late-fee income under the current-inclusion
method for 1998 and 1999, COB did not adopt the OID method for
late-fee income. The “error” petitioners would be attempting to
correct would be a total failure to implement the accounting
method, not a mere correction of an adopted method. It is
doubtful that such a correction would be permissible under sec.
446. See Standard Oil Co. (Indiana) v. Commissioner, 77 T.C.
349, 383-384 (1981) (although sec. 446 is inapplicable where
certain intangible drilling costs are treated improperly, sec.
446 may be applicable where all intangible drilling costs are
treated improperly). A correction of that nature would likely be
                                                   (continued...)
                               -29-

VI.   Whether Recharacterization of Late-Fee Income as OID Is a
      Prohibited Change in Petitioners’ Method of Accounting

      Petitioners argue that if COB did not receive consent, it is

still entitled to change its treatment of late-fee income because

it is not changing its treatment of a material item and is

therefore not changing its method of accounting.14   See sec.

1.446-1(e)(2)(ii)(a), Income Tax Regs.    We have determined that

the relevant item is late-fee income; now we must determine

whether a change in the treatment of late-fee income would be

material as that term is used in section 1.446-1(e)(2)(ii)(a),

Income Tax Regs.   If the recharacterization of late-fee income is

material, petitioners will be foreclosed from making the change

by section 446(e) and the regulations promulgated thereunder

without regard to whether the new method would be proper.    See S.

Pac. Transp. Co. v. Commissioner, 75 T.C. at 682; Wright

Contracting Co. v. Commissioner, 36 T.C. at 635-636.

      A.   The Regulations

      Before a taxpayer changes its method of accounting, it must

secure the consent of the Commissioner.   Sec. 446(e); sec. 1.446-

1(e)(2)(i), Income Tax Regs.   The Code does not define the phrase



      13
      (...continued)
a prohibited change in method of accounting under sec. 1.446-
1(e), Income Tax Regs.
      14
      Petitioners’ motion applies only to COB, but their
argument on this subissue is equally applicable to FSB.
Respondent’s motion applies to both COB and FSB.
                               -30-

“method of accounting”.   The Court has held that the phrase

includes “the consistent treatment of any recurring, material

item, whether that treatment be correct or incorrect.”   See Bank

One Corp. v. Commissioner, 120 T.C. 174, 282 (2003), affd. in

part and vacated in part sub nom. J.P. Morgan Chase & Co. v.

Commissioner, 458 F.3d 564 (7th Cir. 2006); H.F. Campbell Co. v.

Commissioner, 53 T.C. 439, 447 (1969), affd. 443 F.2d 965 (6th

Cir. 1971).   The regulations promulgated under section 446 state:

“The term ‘method of accounting’ includes not only the over-all

method of accounting of the taxpayer but also the accounting

treatment of any item.”   Sec. 1.446-1(a)(1), Income Tax Regs.

Section 1.446-1(e)(2)(ii)(a), Income Tax Regs., provides the

following discussion of changes of accounting method:

     A change in the 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. Although a method of
     accounting may exist under this definition without the
     necessity of a pattern of consistent treatment of an
     item, in most instances a method of accounting is not
     established for an item without such consistent
     treatment. A material item is any item which involves
     the proper time for the inclusion of the item in income
     or the taking of a deduction. * * *

To determine whether late-fee income is an item “which involves

the proper time for the inclusion of the item in income” and,

hence, is material under the regulation, we must determine

whether a change in the treatment of late-fee income will change

the taxpayer’s lifetime income or will merely postpone or
                                -31-

accelerate the reporting of income.    See Wayne Bolt & Nut Co. v.

Commissioner, 93 T.C. 500, 510 (1989) (“When an accounting

practice merely postpones the reporting of income, rather than

permanently avoiding the reporting of income over the taxpayer’s

lifetime, it involves the proper time for reporting income.”).

     Petitioners seek to change COB’s and FSB’s treatment of

late-fee income from the current-inclusion method to a method

where late-fee income creates or increases OID on the pool of

credit card loans to which it relates.    Treatment as OID would

reduce petitioners’ 1998 and 1999 late-fee income considerably.15

The reductions would result in corresponding increases in later

years.    Petitioners would include all of the late-fee income

under either method; the only difference being whether the income

is recognized entirely in the year the fee is charged to the

cardholder or whether the recognition of income is spread to

subsequent years.    The difference is a matter of timing.

Therefore, the proposed method constitutes a change in a material

item in petitioners’ overall plan of accounting and is a change

in method of accounting.

     The regulations detail certain situations that are not

considered changes in method of accounting.    Section 1.446-

1(e)(2)(ii)(b), Income Tax Regs., provides:



     15
      Petitioners claim the reduction would be $209,143,757 and
$219,698,496 in 1998 and 1999, respectively.
                             -32-

     A change in method of accounting does not include
     correction of mathematical or posting errors, or errors
     in the computation of tax liability (such as errors in
     computation of the foreign tax credit, net operating
     loss, percentage depletion or investment credit).
     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. * * * A change in
     the method of accounting also does not include a change
     in treatment resulting from a change in underlying
     facts. On the other hand, for example, a correction to
     require depreciation in lieu of a deduction for the
     cost of a class of depreciable assets which had been
     consistently treated as an expense in the year of
     purchase involves the question of the proper timing of
     an item, and is to be treated as a change in method of
     accounting.

     The term “mathematical error” includes errors in arithmetic;

i.e., “‘an error in addition, subtraction, multiplication, or

division’”.   Huffman v. Commissioner, 126 T.C. at 344 (quoting

section 6213(g)); see also Repetti v. Jamison, 131 F. Supp. 626,

628 (N.D. Cal. 1955).   Whatever “error” petitioners made in

treating late-fee income under the current-inclusion method in

1998 and 1999, it was not a mathematical error.16


     16
      Petitioners argue that they made a mistake of law by
failing to treat late-fee income under sec. 1272(a)(6)(C)(iii),
and that a mistake of law which affects the computation of a
deduction under an established method of accounting, is
“‘tantamount to a mathematical error.’” Standard Oil Co.
(Indiana) v. Commissioner, 77 T.C. at 383 (quoting North Carolina
Granite Corp. v. Commissioner, 43 T.C. 149 (1964)). COB did not
establish the OID method of accounting for late-fee income.
                                                   (continued...)
                                  -33-

       The term “posting error” means an error in “‘the act of

transferring an original entry to a ledger.’”      Wayne Bolt & Nut

Co. v. Commissioner, supra at 510-511 (quoting Black’s Law

Dictionary 1050 (5th ed. 1979)).     In support of their position

that section 1.446-1(e)(2)(ii)(b), Income Tax Regs., should be

broadly construed, petitioners cite N. States Power Co. v. United

States, 151 F.3d 876 (8th Cir. 1998).     In that case, the court

held that the taxpayer’s failure to account for losses on nuclear

fuel contracts in the same way it accounted for coal and oil

losses was nothing more than a type of posting error.       Id. at

884.    The taxpayer, an energy company, was required by the

Federal Energy Regulatory Commission (FERC) to use a prescribed

method of accounting for book purposes.      Id.   The taxpayer’s tax

department was unaware that nuclear fuel losses were accounted

for as a portion of work order capital accounts under the method

prescribed by FERC.    Id.    Had the taxpayer’s tax department known

of the error, it would have been corrected; and nuclear fuel

losses would have been treated in the same way as losses from

other types of fuel.    Id.


       16
      (...continued)
Therefore, there were no mistakes made under that method.
Furthermore, the Court in Standard Oil did not hold that the
taxpayer’s mistake was tantamount to a mathematical error. The
Court did so in North Carolina Granite Corp., a case which
analyzed the regulations prior to the 1970 revisions, which gave
consistency and timing considerations an important role. See
Huffman v. Commissioner, 126 T.C. 322, 342-345 (2006), affd. 518
F.3d 357 (6th Cir. 2008).
                               -34-

     Petitioners’ error was not made in transferring late-fee

income from their financial accounting books to their tax books.

Petitioners were fully aware of the nature of late-fee income and

how it was accounted for under financial accounting principles.

Petitioners may not have been aware that late-fee income could be

treated as increasing OID under the new statutory provision, but

that is not akin to a posting error.

     Because petitioners made neither a mathematical nor a

posting error and because a change in the treatment of late-fee

income is a change in the treatment of a material item, this

issue appears to be resolved in respondent’s favor.   However, our

discussion cannot end here.

     B.   The Caselaw

     This Court has previously noted that there appears to be an

incongruity between section 1.446-1(e)(2)(ii)(b), Income Tax

Regs., and “the proposition * * * evidenced by a body of caselaw

(including cases of this Court), that a taxpayer does not change

its method of accounting when it does no more than conform to a

prior accounting election or some specific requirement of law.”

Huffman v. Commissioner, supra at 352.

     Petitioners use that body of caselaw to argue that a change

in the treatment of late-fee income is not a prohibited change in

method of accounting.   Petitioners cite numerous cases that were

decided before the 1970 revisions to section 1.446-1(e), Income
                                 -35-

Tax Regs.    E.g., Beacon Publg. Co. v. Commissioner, 218 F.2d 697

(10th Cir. 1955), revg. 21 T.C. 610 (1954); Potter v.

Commissioner, 44 T.C. 159 (1965); Wetherbee Elec. Co. v.

Commissioner, 73 F. Supp. 765 (W.D. Okla. 1947).    These cases do

not address the consistency and timing considerations emphasized

in section 1.446-1(e)(2)(ii), Income Tax Regs.    Therefore, their

weight is uncertain.    See Huffman v. Commissioner, supra at 347.

     The cases decided after 1970 on which petitioners rely are

Standard Oil Co. (Indiana) v. Commissioner, 77 T.C. 349 (1981),

and Gimbel Bros., Inc. v. United States, 210 Ct. Cl. 17, 535 F.2d

14 (1976).17    Petitioners equate the requirement of section

1272(a)(6)(C)(iii) with the elections made in those two cases, so

that deviation from the chosen method and subsequent adherence to

that method do not amount to changes in accounting method.

Petitioners’ argument fails for a number of reasons.    First,

unlike the taxpayers in those cases, neither COB nor FSB adopted

the OID method with respect to late-fee income.    Therefore, there

was no deviation from or subsequent adherence to the OID method.

     Second, these cases raise the issue of what “item” is being

corrected.     In Standard Oil and Gimbel Bros. the correction was



     17
      The Court notes that Gimbel Bros., Inc. v. United States,
210 Ct. Cl. 17, 535 F.2d 14 (1976), was decided by the Court of
Claims and is therefore not binding on this Court. Further, the
case analyzes and applies prior regulations in effect before
1970. The case is included because it was decided after issuance
of the regulations in effect in the instant case.
                                  -36-

made to a component of the material item, not to the item itself.

In Standard Oil, the relevant item was intangible drilling costs

(IDC).    The taxpayer, in error, failed to deduct certain

components of IDC, and this Court held that the retroactive

correction of that error was permissible.       Id.    The Court stated

the taxpayer’s “position constitutes an attempt to remedy its

failure to report similar items consistently under a fixed method

of accounting.”     Id. at 383.

     In Gimbel Bros., the taxpayer was a department store which

validly elected the installment method of accounting to report

its installment sales income.     The taxpayer applied the election

to all installment sales except revolving or rotating charge

accounts.    Id.   The taxpayer subsequently attempted to change its

treatment of revolving charge accounts.        Id.    The Court held that

revolving charge accounts were a component of installment sales

and that therefore the taxpayer was correcting its error rather

than changing an accounting method.      Id.

     Petitioners analogize the components of IDC and the

components of installment sales income with the components of OID

(late fees, cash advance fees, overlimit fees, and grace period

interest).18   Petitioners’ analogy falls short of the mark.        As

discussed above, late-fee income, not interest (including OID) is


     18
      Petitioners would also include interchange income as a
component of OID. Whether interchange income is properly treated
under sec. 1272(a)(6)(C)(iii) is still an issue before the Court.
                                    -37-

the relevant item.    Late fees are earned for a purpose

independent of the other components of COB’s and FSB’s OID.          The

same cannot be said about the “other costs” the taxpayer in

Standard Oil failed to deduct.       Those costs were expenses

incurred during the first phase of the construction of offshore

drilling platforms.        Id. at 361.   Costs for the other three

phases of construction and installation of the platforms were

deducted as IDC.     Id.    The four phases of construction and

installation were interdependent in a way that late-fee income

and the other types of credit card receivables are not.          The same

can be said about the installment sales income the taxpayer in

Gimbel Bros. failed to treat consistently with the rest of its

installment sales income.       All of the installment sales income

was earned in the same way, from the sale of goods on an

installment plan.

     Finally, more recent cases of this Court hold that a

taxpayer does change its method of accounting when it changes its

treatment of an item in order to adhere to a method adopted

pursuant to a prior accounting election.        These cases cast doubt

on Standard Oil Co. (Indiana) v. Commissioner, supra, and Gimbel

Bros. Inc. v. Commissioner, supra.         See Huffman v. Commissioner,

126 T.C. at 353 (“We question whether there is vitality to the

notion that a taxpayer conforming to a required but theretofore
                                 -38-

ignored method of accounting does not change its method of

accounting by so conforming.”).

     In Sunoco, Inc. & Subs. v. Commissioner, T.C. Memo. 2004-29,

this Court held that a retroactive attempt to change treatment of

certain mining expenses would be a change in method of

accounting, and not a correction of an error, where the taxpayer

had knowingly and consistently, albeit improperly, capitalized

and amortized expenses that should have been included in the

taxpayer’s cost of goods sold.    In First Natl. Bank of

Gainesville v. Commissioner, 88 T.C. 1069 (1987), a transferee

liability case, the transferee argued that the transferor’s

alteration of a LIFO inventory valuation procedure constituted

the correction of an accounting error and not a change in method

of accounting.    The Court held that, although the alteration in

question may have constituted the correction of an error, it also

constituted a change in method of accounting pursuant to section

472(e).   Id. at 1085.   The Court added:   “Where the correction of

an error results in a change in accounting method, the

requirements of section 446(e) are applicable.”     Id.

VII. Conclusion

     Neither COB nor FSB received consent to change its method of

accounting for late-fee income under section 446(e) in 1999.

They continued to treat late-fee income under the current-

inclusion method and did not deviate from that treatment until
                                 -39-

the submission of their 2000 return.     A retroactive change in the

treatment of 1998 and 1999 late-fee income is a change in the

treatment of a material item and is therefore a prohibited change

in method of accounting.   The “error” petitioners attempt to

correct is neither a posting error nor a mathematical error, and

petitioners are not entitled to correct that “error” with

retroactive effect for 1998 and 1999 because to do so would be a

prohibited change in method of accounting.     Accordingly, the

Court holds that petitioners’ requested recharacterization of

late-fee income is an impermissible change in method of

accounting under section 446(e).

     To reflect the foregoing,


                                        An order will be issued

                                 denying petitioners’ motion for

                                 partial summary judgment on the

                                 late fees issue and granting

                                 respondent’s motion for partial

                                 summary judgment.
