SCOTUS Reports

Tag: Inventory Method

  • Hewitt v. Commissioner, 1947 Tax Ct. Memo LEXIS 19 (T.C. 1947): Inventory Method and Capital Gains Treatment

    1947 Tax Ct. Memo LEXIS 19 (T.C. 1947)

    A securities dealer who uses the inventory method of accounting must obtain permission from the Commissioner of Internal Revenue before changing to a different method; otherwise, securities held in inventory are not considered capital assets, and profits from their sale are taxed as ordinary income.

    Summary

    The petitioners, partners in a securities firm, sought to treat profits from the sale of certain securities as capital gains. The Tax Court ruled against them, holding that because the securities had been inventoried by the partnership and no permission was obtained from the Commissioner to change from the inventory method, the securities were not capital assets. The court emphasized that the partnership continued to operate and report as such, making the inventory method applicable and precluding capital gains treatment.

    Facts

    Hewitt and Lauderdale were partners in a securities business. They used the inventory method to account for their securities. In 1942, Hewitt entered military service, and Warne became a partner to represent Hewitt on the Stock Exchange. The new partnership (Hewitt, Lauderdale, and Warne) continued to deal in securities, including those previously dealt with by the original partnership. The securities from the “old partnership” were held in an account labeled “old accounts.” The petitioners sold some of these securities in 1943 and sought to treat the profits as capital gains.

    Procedural History

    The Commissioner of Internal Revenue determined that the profits from the sale of the securities should be taxed as ordinary income, not capital gains. The taxpayers petitioned the Tax Court for a redetermination.

    Issue(s)

    Whether profits from the sale of securities, previously inventoried by a partnership, can be treated as capital gains when the partnership continues to operate and has not obtained permission from the Commissioner to change from the inventory method of accounting.

    Holding

    No, because the partnership continued to operate and report as such without obtaining permission to change from the inventory method, the securities remained part of the inventory and were not capital assets.

    Court’s Reasoning

    The court reasoned that the burden was on the petitioners to show that the securities were not inventory assets. The evidence indicated that the “old partnership” continued to exist, even after the formation of the new partnership with Warne. Partnership returns were filed reflecting the income of both partnerships. The court stated, “The intention as to continuation of the old partnership is plain. It was not dissolved. Its property was not distributed.” Because the partnership did not secure permission to change from the inventory method, as required by regulations, the securities could not be considered capital assets. The court cited Internal Revenue Code sections 117(a)(1) and 22(c), as well as Regulations 111, section 29.22(c)-5, emphasizing that assets properly includible in inventory are not capital assets. The court distinguished Vaughan v. Commissioner, noting that in that case, the activity in the stocks passed from Vaughan to a newly formed partnership, whereas here, the same entity continued to buy and sell.

    Practical Implications

    This case highlights the importance of adhering to accounting methods and obtaining proper authorization for changes. For securities dealers, it underscores the requirement to seek permission from the Commissioner before abandoning the inventory method. Failure to do so will result in the profits from the sale of securities being taxed as ordinary income rather than capital gains. The case also demonstrates that a mere intention to treat securities as investments is insufficient to overcome the statutory and regulatory requirements for changing accounting methods. Later cases will cite this to enforce consistent application of accounting methods unless explicit permission to change has been granted.

  • Hewitt v. Commissioner, 6 T.C. 1279 (1946): Inventory Method and Capital Gains for Securities Dealers

    6 T.C. 1279 (1946)

    A securities dealer who uses the inventory method of accounting must obtain permission from the Commissioner of Internal Revenue before changing to a non-inventory method to treat securities as capital assets.

    Summary

    Hewitt v. Commissioner addresses whether profits from the sale of securities by a partnership are taxable as ordinary income or capital gains. The Tax Court held that because the partnership had been dealing in securities, inventoried them, and did not obtain permission from the Commissioner to change from the inventory method, the securities were not capital assets when sold. The court emphasized the importance of consistent accounting methods and the requirement for prior approval to switch from inventory to a non-inventory method, rejecting the argument that the partners’ intent to treat the securities as investments was sufficient.

    Facts

    Petitioners Hewitt and Lauderdale were partners in a securities business. The partnership inventoried its securities. On June 30, 1942, Hewitt entered military service, and a new partnership agreement was formed including Warne. The new partnership continued dealing in securities, including those previously held by the old partnership. Securities held by the “old partnership” were maintained in an account labeled “old accounts.” Though some buying and selling occurred in this account, it was less extensive than the new partnership’s activities. These securities were not distributed to Hewitt and Lauderdale.

    Procedural History

    The Commissioner of Internal Revenue determined that profits from the sale of securities should be taxed as ordinary income. The taxpayers petitioned the Tax Court, arguing the securities should be treated as capital assets subject to capital gains rates. The Tax Court ruled in favor of the Commissioner, upholding the ordinary income tax treatment.

    Issue(s)

    Whether the securities sold by the partnership in 1943 were capital assets, eligible for capital gains treatment, or were properly includable in inventory, making them subject to ordinary income tax rates.

    Holding

    No, because the partnership had been dealing in securities, inventoried them, and did not obtain permission from the Commissioner to change from the inventory method, the securities were not capital assets.

    Court’s Reasoning

    The court reasoned that the securities remained the property of the partnership. The petitioners failed to demonstrate a dissolution of the old partnership. The court noted that partnership returns filed for 1942 and 1943 indicated a continuation of the original partnership, separate from the one including Warne. The court emphasized that the intention of the partners to treat the securities as investments was insufficient to override the requirement to obtain permission to change from the inventory method. The court stated: “A mere desire by the partners to regard certain securities as no longer inventory, but as investments, and themselves as no longer dealers, can not suffice to meet the statute.” The court cited the necessity of prior permission to change accounting methods, supporting its decision with Stokes v. Rothensies. The court concluded that the statutes and regulations mandated the stocks be treated as non-capital assets.

    Practical Implications

    This case highlights the importance of adhering to established accounting methods, particularly the inventory method for securities dealers, unless explicit permission is obtained from the IRS to change. This decision clarifies that a taxpayer’s intent alone is not sufficient to reclassify assets from inventory to investments for tax purposes. It emphasizes the need for formal compliance with IRS regulations regarding changes in accounting methods. Later cases applying this ruling underscore the IRS’s authority to ensure consistent and accurate income reporting and the requirement for taxpayers to follow prescribed procedures when altering accounting practices.