John Bullis: Duty of consistency doctrine
The Tax Court recently held that an S corporation that consistently reported income in the wrong tax year could not avoid tax by including the amount involved in the following year. The S corporation was a full service janitorial business and was a cash basis taxpayer (income realized when received and expenses realized when paid).
In January of 2009, PBS (the taxpayer) deposited checks for a total of $1.6 million that were most likely received in 2008. IRS argued that under the duty of consistency, the shareholders of the S corporation should be required to be taxable in their 2009 returns the $1.6 million received in 2008 (but not reported on the 2008 returns). Then in January of 2010, PBS deposited about $1.9 million of checks that were received in 2009. In January 2011, PBS deposited checks of about $2.3 million that were received in 2010. PBS tax returns used bank deposits as total income.
IRS said it was wrong to figure its gross receipts by excluding the checks that were received in the last quarter of each tax year at issue. IRS did not push back the $1.6 million of 2008 income to year 2008, but instead included in the 2009 gross receipts. IRS did correct the later years so income was as received each year, not using when it was deposited in the bank.
The shareholders said the $1.6 million should not be reported as 2009 income because it was actually received in 2008 and the statute of limitations had closed the 2008 returns. That would mean the $1.6 million would never be reported and taxed.
The duty of consistency is an equitable doctrine that prevents a taxpayer from benefiting in a later year from an error or omission in an earlier year which can not be corrected because the statute of limitations for the earlier year has closed or expired. The Ninth Circuit Court of Appeals (our circuit) has held that for the duty of consistency to apply three requirements must be met:
There is a representation or report (tax return) by the taxpayer
IRS relied on the representation or report
After the statute of limitations has run, the taxpayer attempts to change the previous representation in such a way as to harm IRS.
If all three elements are present, IRS may act as if the previous representation on which they relied continues to be true, even if it is not true.
The taxpayers admitted they filed 2008 return and IRS relied on it and allowed the statute of limitations to close on 2008 corporation and individual returns. But they said it would not be consistent with their previous reporting to include the $1.6 million received in 2008 to be taxed in 2009. The Court held PBS was bound by the duty of consistency doctrine, IRS won that case.
Did you hear? “In order to succeed you must fail, so you know what not to do next time.”
John Bullis is a certified public accountant, personal financial specialist and certified senior adviser who has served Carson City for 45 years. He is founder emeritus of Bullis and Company CPAs.