O'Shaughnessy v. C.I.R.

• Decision Date: 13 June 2003
• Docket Number: No. 02-1603.,No. 02-1532.,02-1532.,02-1603.
• Citation: 332 F.3d 1125
• Parties: Roger O'SHAUGHNESSY, as Tax Matters Person for Cardinal IG Company, Appellee, v. COMMISSIONER OF INTERNAL REVENUE, Appellant. Roger O'Shaughnessy, as Tax Matters Person for Cardinal IG Company, Appellant, v. Commissioner of Internal Revenue, Appellee.
• Court: U.S. Court of Appeals — Eighth Circuit

332 F.3d 1125

Roger O'SHAUGHNESSY, as Tax Matters Person for Cardinal IG Company, Appellee, v. COMMISSIONER OF INTERNAL REVENUE, Appellant.

Roger O'Shaughnessy, as Tax Matters Person for Cardinal IG Company, Appellant, v. Commissioner of Internal Revenue, Appellee.

No. 02-1532.

No. 02-1603.

United States Court of Appeals, Eighth Circuit.

Submitted: February 14, 2003.

Filed: June 13, 2003.

Paula Speck, Tax Division, DOJ, argued, Washington, DC (Kenneth L. Greene, on the brief), for appellant.

Steven Z. Kaplan, argued, Minneapolis, MN (Emily E. Duke and Dulce J. Foster, on the brief), for appellee.

Before WOLLMAN, HEANEY, and MELLOY, Circuit Judges.

WOLLMAN, Circuit Judge.

Roger O'Shaughnessy, as tax matters person for Cardinal IG Company (Cardinal), a subchapter S corporation, initiated this action against the Internal Revenue Service (IRS) under 26 U.S.C. § 6226, contesting the IRS's readjustments of partnership items filed by Cardinal during tax years 1994 and 1995. The IRS appeals the district court's grant of partial summary judgment that Cardinal was entitled to depreciate under the provisions of 26 U.S.C. §§ 167, 168 molten tin used to manufacture flat glass. Cardinal cross-appeals the district court's grant of partial summary judgment in favor of the IRS on the issue of whether the IRS's reallocation of certain of Cardinal's assets from one defined asset grouping to another constituted a change in Cardinal's method of depreciation accounting under 26 U.S.C. § 446(e). We affirm in part and reverse in part.

I. Background

Cardinal has manufactured flat glass at its plant in Menomonie, Wisconsin, since its purchase from AFG Industries, Incorporated (AFG) in 1992. Cardinal manufactures glass using the "float" process, in which limestone, sand, soda ash, and other materials are melted to yield liquid glass, which then is "floated" across the surface of molten tin in a structure referred to as a "tin bath." There must be a predetermined volume of molten tin in the bath for the system to operate. In the bath, the liquid glass forms a continuous sheet or ribbon. This ribbon then flows out of the tin bath, entering an "annealing lehr," in which it cools and hardens into glass. Once cooled, the glass is cut and shipped elsewhere for processing and assembly into insulated glass units, which Cardinal sells to window manufacturers.

While the liquid glass is in the tin bath, the molten tin reacts with oxygen, sulfur, iron, and other elements and compounds in the glass to yield tin oxide and tin sulfide. These by-products are impurities referred to as "dross" and must be removed periodically from the tin bath to prevent damage to or clouding of the glass. The presence of impurities in the tin bath accelerates the degradation of the tin: "specifically, sulfur impurities cause vaporization of tin that is eventually exhausted from the tin bath during blow-down of condensed compounds of tin[;] oxygen impurities cause diffusion of tin into the glass that is transported out of the tin bath by the moving ribbon of float glass." The volume of tin in the bath is reduced by these reactions, by general evaporation, as well as by the removal of the dross from the bath. When Cardinal began operations at the Menomonie plant in 1992, it placed approximately 168 tons of tin into the bath. Cardinal estimates that, to maintain the necessary volume of tin therein, it added approximately sixty-two tons, or between one and one and one-half tons per month, of new molten tin into the bath between 1992 and the filing of this case in 1997.

Cardinal treated the initial volume of 168 tons of tin as a depreciable capital asset with a basis of $1,720,808.00 on its federal income tax returns filed from 1992 to 1995. Pursuant to § 168, Cardinal has used the modified accelerated cost recovery system (MACRS) to depreciate tangible assets, including the initial installation of tin. On its 1994 and 1995 tax returns Cardinal also deducted as repair and maintenance expenses under 26 U.S.C. § 162 the costs of tin added to the bath to maintain the necessary volume. The IRS determined that Cardinal should not have depreciated the 168 tons of tin initially placed in the bath because under Revenue Ruling 74-491, molten tin, as used in glass manufacturing, is not a depreciable asset. The district court granted summary judgment in favor of Cardinal on this issue, allowing the depreciation deductions.

Prior to Cardinal's purchase of the Menomonie, Wisconsin, manufacturing plant from AFG, AFG hired the accounting firm of Deloitte & Touche to perform a cost segregation study allocating the purchase price among plant assets in accordance with the MACRS method of depreciation accounting. Cardinal used the asset groups assigned by Deloitte & Touche to compute MACRS depreciation expenses on its income tax returns from 1992 through 1995.¹ The IRS disputed Cardinal's asset allocation on its 1994 and 1995 federal income tax returns and reallocated those assets from one asset group to another accordingly.² The IRS characterized the asset reallocation as a change of Cardinal's method of accounting, which requires Cardinal to submit an accounting adjustment under § 481. Cardinal does not dispute the asset reallocation, but challenges the district court's determination that the reallocation constituted a change in Cardinal's method of accounting under § 446(e).

II. Standard of Review

We review the district court's grant of summary judgment de novo. Brassard v. United States, 183 F.3d 909, 910 (8th Cir.1999) (citation omitted). A grant of summary judgment is appropriate when there is no genuine issue of material fact and the prevailing party is entitled to judgment as a matter of law. Id.; see Fed.R.Civ.P. 56(c). Because the parties do not dispute the material facts, we address, as a matter of law, whether Cardinal was entitled to depreciate molten tin used to manufacture flat glass under 26 U.S.C. §§ 167 and 168, and whether the IRS's reallocation of certain of Cardinal's assets from one defined asset grouping to another constituted a change in Cardinal's method of depreciation accounting under 26 U.S.C. § 446(e).

III. Appeal: Depreciation

A. Depreciability of Molten Tin

The IRS contends that Cardinal cannot claim a depreciation deduction for the cost of 168 tons of tin initially installed in the tin bath because the tin is not subject to exhaustion or wear and tear within the meaning of 26 U.S.C. § 167(a) and therefore does not constitute property for which a depreciation deduction may be taken. See 26 U.S.C. § 168 (providing applicable depreciation method for depreciation deduction authorized by § 167). The IRS argues that because the tin is consumed during the manufacturing process, its cost may be deducted instead under 26 U.S.C. § 162, as an expense of operation.

Section 167(a) of the Internal Revenue Code authorizes a depreciation deduction of a "reasonable allowance for the exhaustion, wear and tear ... of property used in the trade or business...." 26 U.S.C. § 167(a); Treas. Reg. § 1.167(a)-2. Unlike § 162, which provides a deduction for expenses that are "ordinary and necessary" and are "paid or incurred during the taxable year in carrying on any trade or business," the depreciation deduction authorized by § 167 encompasses only capital expenditures or assets, which are amortized and depreciated over time. INDOPCO, Inc. v. Comm'r, 503 U.S. 79, 83-84, 112 S.Ct. 1039, 117 L.Ed.2d 226 (1992).

[I]f a taxpayer can prove with reasonable accuracy that an asset used in the trade or business or held for the production of income has a value that wastes over an ascertainable period of time, that asset is depreciable under § 167.... "Whether or not ... a tangible asset, is depreciable for Federal income tax purposes depends upon the determination that the asset is actually exhausting, and that such exhaustion is susceptible of measurement."

Newark Morning Ledger Co. v. United States, 507 U.S. 546, 566, 113 S.Ct. 1670, 123 L.Ed.2d 288 (1993) (citing Rev. Rul. 68-483, 1968-2 Cum.Bull.91-92). Cardinal, therefore, must show only that the tin "was subject to exhaustion and wear and tear." Liddle v. Comm'r, 65 F.3d 329, 335 (3d Cir.1995); Simon v. Comm'r, 68 F.3d 41, 46 (2d Cir.1995) (holding that, for the purposes of § 168, "`property subject to the allowance for depreciation' means property that is subject to exhaustion, wear and tear, or obsolescence"). As the district court noted, the burden of demonstrating that an asset is depreciable is undemanding: "even imperceptible physical changes in or impact[s] upon the particular item of property during its usage [are] sufficient to qualify the property in question as depreciable." O'Shaughnessy v. Comm'r, 2001 WL 1640129, 2001 U.S. Dist. LEXIS 22738 at * 15 (D.Minn.2001) (citing, generally, Simon, 68 F.3d 41; Liddle, 65 F.3d 329); see also INDOPCO, 503 U.S. at 84, 112 S.Ct. 1039 (stating a presumption in favor of capitalization: "The notion that deductions are exceptions to the norm of capitalization finds support in various aspects of the Code.").

As indicated above, Cardinal initially installed 168 tons of tin in the tin bath in 1992. The quality and quantity of tin installed in the bath were diminished during the manufacturing process by evaporation and other chemical reactions, specifically the formation of tin oxide and tin sulfide. Accordingly, Cardinal added tin to the bath to maintain the volume required to keep the float glass manufacturing system functioning — approximately sixty-two tons during its first seven years of operation. The tin installed initially in the bath declined in volume and purity as a result of its use in the glass manufacturing process, undergoing "exhaustion, wear and tear" within the meaning of § 167. Because the tin as installed initially qualified as depreciable capital property, and because the property was placed in service after December 31, 1986, Cardinal appropriately...