MEMO TO: The Files
FROM:
SUBJECT:
DATE PREPARED: April, 23 2018
In Lawrence G. Humphrey and Karen G. Humphrey v. Commissioner there was a dispute over what items were allowable as deductions from business income for the taxable years 1985 and 1986. The disputed items were dental inventory, credit card chargebacks, discharged bankruptcy debts, and debt deemed owed by the bankruptcy court. The court ruled in favor for the IRS and Lawrence was not allowed any deductions for these items. The dental inventory deduction was denied due to lack of evidence, the chargebacks based on Section 1341 dealing with claim of right, and the debts were similarly disallowed for being incurred in a different tax year.
The claim of right doctrine in the Lawrence G. Humphrey case helps to showcase differences in book accounting and tax accounting. A company may set aside money in a claims reserve account where they may then use once claims against them have been settled. This reserve may not be deducted. The company would have to wait until the amount of liability has been decided as stated in Code Section 1341(a)(2).…show more content… Commissioner of Internal Revenue is about an inventory issue because the accounting method used did not “clearly reflected income” §1.471-2(a)(2), which made the tax liability lower. The regulations require taxpayers to value inventory for tax purposes at cost unless market value is lower. The taxpayer, which is a tool manufacturer, wrote down according to GAAP the excess goods, but continued to sell the goods at their original prices. Therefore, the taxpayer received more income than the actual reported for tax purposes. The write down exceeded the 1964 sales and produced a net operating loss for that year. The write down was disallowed the offset because it did not reflect income clearly for tax purposes. The commissioner disallowed the offset and the carryback for the net operating
