King Solarman, Inc. v. Comm'r
| Decision Date | 19 August 2019 |
| Docket Number | T.C. Memo. 2019-103,Docket No. 19969-17. |
| Parties | KING SOLARMAN, INC., Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent |
| Court | U.S. Tax Court |
Steve Mather and Lydia B. Turanchik, for petitioner.
Cassidy B. Collins and Christine A. Fukushima, for respondent.
LAUBER, Judge: With respect to petitioner's Federal income tax for its fiscal year ending April 30, 2015, the Internal Revenue Service (IRS or respondent) determined a deficiency of $1,929,212 and an accuracy-related penalty of $385,842. Petitioner manufactures and sells solar equipment. About 60% of the equipment it sold during the year at issue was sold in a single transaction for $7,938,000. Petitioner reported $2,268,814 in cash it received from that buyer during that year, but it excluded from its gross proceeds the balance of the purchase price, which took the form of a promissory note.
Petitioner contends that it used the cash method of accounting and that, under the cash method, it properly deferred the balance of the purchase price to future years when additional cash was received. Alternatively, petitioner contends that it should be permitted to report its sale proceeds using the installment method of accounting. See sec. 453.1
Respondent replies that petitioner elected the accrual method of accounting, that it actually used that method, and that it was required to use that method because it was "necessary to use an inventory." See sec. 1.446-1(c)(2)(i), Income Tax Regs. Under the accrual method, respondent contends, the entire sale price was immediately includible in petitioner's gross income consistently with the "all events" test. See sec. 1.451-1(a), Income Tax Regs. Respondent rejects petitioner's alternative theory, noting that the installment method cannot be used for a "disposition of personal property of a kind which is required to be included in the inventory of the taxpayer if on hand at the close of the taxable year." Sec. 453(b)(2)(B).
We conclude that respondent has the better side of these arguments. We will accordingly sustain the deficiency determined by the IRS after giving effect to a $125,554 concession by respondent.2 But we find that petitioner is not liable for the accuracy-related penalty.
Some facts have been stipulated and are so found. The stipulations of facts and the attached exhibits are incorporated by this reference. Petitioner had its principal place of business in California when it filed its petition.
Petitioner is a C corporation whose sole shareholder and chief executive officer (CEO) is Michael Cung. Mr. Cung is a Taiwanese national, and English is his second language. After getting his bachelor's degree Mr. Cung began working in the solar industry around 2007. He attended San Jose City College to learn more about the solar equipment business.
Mr. Cung incorporated King Solarman, Inc. (petitioner or KSI), in May 2011. KSI is principally engaged in the manufacture and sale of mobile solar-powered lighting units (solar towers). Each unit consisted of a wheeled cart containing a battery pack and a tower with an extendable solar-power panel. The panel would be exposed to the sun during the day, charging the battery to provide light-emitting diode (LED) illumination after dark. The units came in standard models (two- or four-wheeled carts incorporating lithium or lead-acid batteries). Customers had the option of adding certain accessories, such as security cameras or Wi-Fi/4G LTE access. The units were commonly used to provide lighting for parking lots, building and highway construction sites, and remote work locations.
Mr. Cung estimated that KSI since its inception has fabricated and sold about 900 solar towers. These units have many component parts, which KSI generally purchased from third parties. Components included trailers, batteries, battery gauges, secure battery boxes, solar panels, extendable masts, multiple antenna types (depending on signal and power required), LED light fixtures, circuit breakers, timers, inverters, control boxes, remote control and monitoring devices, electrical components, various metal items, and cabling. Optional accessory components included a mast assembly with an accompanying security camera (customers could choose among three available models) and LED floodlights.
KSI filed timely a Form 1120, U.S. Corporation Income Tax Return, for each relevant year. Schedule K, Other Information, of Form 1120 instructs the taxpayer to "[c]heck accounting method" and report its business activity. On its first return, for its fiscal year ending (FYE) April 30, 2012, KSI checked the box for "Accrual" and reported its business activity as "wholesale trade." It reported its business activity code as 423990, which identifies "Other Miscellaneous Durable Goods Merchant Wholesalers" in the North American Industry Classification System (NAICS). On its returns for FYE 2013, 2014, and 2015, KSI consistently stated that it was using the accrual method of accounting and reported the same business activity code and NAICS code. At no point did KSI file with the IRS Form 3115, Application for Change in Accounting Method.
Each of the four returns included a Schedule L, Balance Sheet per Books, with attached statements that reported (among other things) current assets and liabilities. For FYE 2015, the tax year at issue, petitioner's reporting included the following entries: Item Amount Opening accounts payable $202,454 Closing accounts payable 189,454 Opening credit card payable 9,283 Closing credit card payable 62,761 Closing accrued payroll 12,764 Closing payroll tax liabilities 1,436 Opening State tax payable 5,530 Closing State tax payable 27,283 Closing Federal tax payable 14,731
KSI's returns for the three previous years included Schedules L and attached statements that likewise reported accounts receivable, accounts payable, credit card payables, Federal tax payable, and State tax payable.
KSI attached to each return a Form 1125-A, Cost of Goods Sold. This form instructs the taxpayer to determine cost of goods sold (COGS) by listing its opening inventory; adding thereto its purchases, costs of labor, and other applicable costs; and subtracting its closing inventory from the total thus derived.
KSI did not prepare its Forms 1225-A consistently with these instructions. It listed no opening or closing inventory for any year. Although the inputs to its COGS should have included material and labor costs, it did not report either item accurately. For FYE 2013 it listed cost of labor as $2,739,994, left the other lines blank, and showed COGS in an amount equal to its cost of labor. For FYE 2012, 2014, and 2015, it listed purchases as $1,090,503, $3,332,621, and $5,665,900, respectively, left the other lines blank, and showed COGS in amounts equal to its purchases.
The COGS petitioner reported on Form 1125-A for FYE 2015 appears to be the sum of the following yearend general ledger accounts:
KSI excluded from its COGS all of the wages it paid the employees who worked on assembly of the solar towers. But it appears to have included those labor costs among its deductions. On line 13 of its Form 1120, KSI reported a deduction of $92,667 for salaries and wages. It included on line 26, among its other deductions, a deduction of $109,701 for outside services. The general ledger account for outside services shows 244 payments, mostly in amounts under $1,000, to at least 120 distinct individuals, who appear to have been laborers.
KSI's general ledger for FYE 2015 includes various entries that are consistent with its use of the accrual method of accounting. It had general ledger accounts for "accrued salaries," "accounts payable," "payroll taxes payable (Federal)," "payroll taxes payable (State)," "payroll tax payable (FUTA)," and "income tax payable." General ledger account 154, captioned "Equipment - Solar Light Tower," actually appears to capture inventory because it has no matching sub-account for accumulated depreciation. Its entries include "solar light tower," "solar trailer," and "solar panel." The general ledger total for that account, $1,062,241, was zeroed out on December 31, 2014, and "reclassif[ied] to cost."
During 2014 Mr. Cung negotiated a deal for the lease of 162 solar towers. Each tower had the same basic design and core components. The towers were capable of accepting optional accessories, such as an LED floodlight and a security camera with mast assembly. But KSI did not include these accessories on the 162 towers that were the subject of the lease.
On the advice of his accountant Mr. Cung structured his side of the transaction through a network of related entities. KSI executed a purchase agreement for the 162 units with Solarman (Indion) Fund I, LLC (Fund). The Fund was an investment vehicle in which income and expense items were initially allocated 99% to passive investors and 1% to King Solarman LLC, an entity wholly owned by Mr. Cung. The Fund immediately leased the towers to an intermediary company, which immediately subleased the towers to King Solarman LLC, which then subleased the towers to the end users. The transaction was apparently structured this way in order to transfer bonus depreciation and tax credits to the Fund's passive investors while minimizing their exposure to the economic risk of the leasing transaction.
The purchase agreement between KSI and the Fund was executed on December 29, 2014, with Mr. Cung signing for both parties. The total purchase price was $7,938,000, payable in two cash installments totaling $2,143,260 and a promissory note for the $5,794,740 balance. The note was secured by the solar towers and called for 240 monthly payments of...
To continue reading
Request your trial