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An example in the regulations further supports our
interpretation. See sec. 1.1374-4(d)(2), Example (2), Income Tax
Regs. In the example, the taxpayer, who elected to convert to S
corporation status effective January 1, 1996, deducted workers’
compensation claims when they were filed, under its accounting
method. The taxpayer then changed its accounting method in 1999,
requiring a positive section 481 adjustment to include in income
the previous deductions for filed claims that were still unpaid.
The example states that the section 481 adjustment is recognized
built-in gain insofar as it relates to items (the deductions for
workers’ compensation claims filed, but unpaid) attributable to
periods before the recognition period.
Petitioners’ section 481 adjustment reverses petitioners’
1997 deduction and includes the amount of the 1997 deduction
ratably in petitioners’ income over 4 years. The 1997 deduction
is the item to which the section 481 adjustment relates, and it
arose before the beginning of the recognition period (i.e. the
period beginning with the year petitioners elected S corporation
status). See sec. 1.1374-4(d)(1), Income Tax Regs. The section
481 adjustment thus relates to an item attributable to a period
before the beginning of the recognition period. Id. We
accordingly hold that petitioners’ section 481 adjustment is
recognized built-in gain.
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Last modified: March 27, 2008