United States

Texas: Taxpayer Could Not Amend Reports to Change Election to Expense or Capitalize COGS

Apr 17, 2017
From KPMG TaxWatch

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A Texas Administrative Law Judge (ALJ) recently addressed whether a corporate taxpayer was allowed to amend its franchise tax reports to change its method of deducting Cost of Goods Sold (COGS). Under Texas law, a taxable entity that elects to deduct COGS and that is subject to Internal Revenue Code (IRC) sections 263A, 460, or 471 may choose, on an annual basis, to capitalize or expense its COGS. The election is made by filing the franchise tax report using one method or another. A taxable entity may file an amended report to correct a mathematical or other error, but under a Texas regulation the annual election to capitalize or expense COGS may not be changed after the due date of the report or the date the report is filed, whichever is later. The taxpayer at issue was audited for the 2009-2012 tax years. The auditor determined that, for three of the audited tax years, the taxpayer had changed its accounting methodology from the prior year and had not properly computed the COGS deduction. The auditor made certain adjustments to the COGS deduction to reflect what it determined to be the chosen method and assessed the taxpayer additional franchise tax. The taxpayer protested the adjustment, arguing that it had intended to use the capitalization method each year and that it should be allowed to amend its reports because the changes in accounting methodologies identified by the auditor were actually mathematical errors. The taxpayer also argued that, to the extent the ALJ determined that it had made accounting methods changes from year to year, the regulatory prohibition against amending returns was not supported by statute and exceeded the Comptroller’s authority. 

The ALJ first determined that the taxpayer’s computations and workpapers did not support its position that it intended to use the capitalization method each year and simply made computational and data input errors on its returns for certain of the years under audit. In the ALJ’s view, the taxpayer’s computations indicated it made a decision to use an expensing methodology for certain years. The ALJ next addressed the taxpayer’s position that there was no statutory authority for the regulation that prohibited it from changing its COGS accounting method on an amended return. The taxpayer observed that the same regulation allowed taxpayers to file amended reports changing their election to deduct COGS, compensation, or just pay based on 70 percent of total revenues and that the rule must be interpreted consistently. The ALJ again disagreed with the taxpayer, noting that the decision to expense or capitalize COGS affected not only a taxpayer’s current year COGS deduction, but also COGS deductions allowed in subsequent years. Thus, the regulatory limitation on changes to the COGS methodology was, in the ALJ’s view, necessary to address the accounting complexities associated with taxpayers changing their accounting methods. The ALJ concluded that the regulation promoted administrative convenience with respect to the administration and enforcement of the franchise tax and was a reasonable interpretation of the statute, both of which would require the regulation to be upheld. The fact that the same rule allowed amended reports changing the election to deduct COGS or compensation was not inconsistent, as the provisions addressed different aspects of franchise tax reporting. Please contact Doug Maziur at (713) 319-3866 with questions on this ALJ determination. 


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The following information is not intended to be "written advice concerning one or more federal tax matters" subject to the requirements of section 10.37(a)(2) of Treasury Department Circular 230.

The information contained herein is of a general nature and based on authorities that are subject to change. Applicability of the information to specific situations should be determined through consultation with your tax adviser.