UNITED STATES TAX COURT



              SUZY’S ZOO®, Petitioner v.
     COMMISSIONER OF INTERNAL REVENUE, Respondent



Docket No. 9423-98.                    Filed January 6, 2000.


     P, a corporation the stock of which is owned 84
percent by S and 16 percent by two individuals
unrelated to S, sells greeting cards and other paper
products bearing an image of one or more of P’s
licensed cartoon characters. P’s employees develop and
draw the originals of all of the characters, and P
transfers the original drawings to independent printing
companies to reproduce images of the drawings onto P’s
paper products, which are made by the printers on P’s
behalf. The printers must reproduce the drawings and
make the products in accordance with P’s
specifications, and they may not sell to a third party
either P’s original drawings, or reproductions thereof,
or P’s paper products.
     Held: P produces, rather than resells, its paper
products; thus, P does not qualify for the “small
reseller” exception to the uniform capitalization
(UNICAP) rules of sec. 263A, I.R.C.
                                   - 2 -

          Held, further, P is not excepted from the UNICAP
     rules by virtue of the artist exemption of sec.
     263A(h), I.R.C.; none of P’s shareholders owns
     “substantially all” of P’s stock within the meaning of
     sec. 263A(h)(3)(D)(i)(I), I.R.C.
          Held, further, the “year of change” for purposes
     of sec. 481, I.R.C., is the subject year (i.e., the
     year in which P’s method of accounting is changed to
     conform to the UNICAP rules), rather than the first
     year to which the UNICAP rules apply.



     Richard A. Shaw and Bruce M. O’Brien (specially recognized),

for petitioner.

     Christine V. Olsen, for respondent.



                                  OPINION


     LARO, Judge:     This case is before the Court fully

stipulated.   See Rule 122.   Respondent determined a $131,077

deficiency in petitioner’s Federal income tax for its taxable

year ended June 30, 1994.     We decide primarily whether petitioner

is subject to the uniform capitalization (UNICAP) rules of

section 263A.    We hold it is.     We also decide whether the subject

year is the “year of change” for purposes of section 481.      We

hold it is.     Unless otherwise indicated, section references are

to the Internal Revenue Code applicable to the subject year, and

Rule references are to the Tax Court Rules of Practice and

Procedure.
                                - 3 -

                             Background

       All facts were stipulated.   The stipulation of facts and the

exhibits submitted therewith are incorporated herein by this

reference.    Petitioner is a corporation with a taxable year

ending on June 30.    Its business is “social expression” through

the original drawing of licensed cartoon characters and the

dissemination of images of those drawings on certain paper

products.    Its principal place of business was in California when

the petition was filed.

       Eighty-four percent of petitioner’s stock is owned by Suzy

Spafford; the balance is owned by two individuals unrelated to

her.    Ms. Spafford is an artist who graduated from San Diego

State University in 1967 with a bachelor’s degree in fine arts.

She obtained a teaching certificate in 1968 and taught high

school art from 1968 through 1969.      She began to develop cartoon

characters in the 1960's, and she gradually developed

petitioner’s business from those characters.     She incorporated

petitioner’s business in 1976, and she registered petitioner’s

name as a trademark with the Federal Government.

       Petitioner sells paper products (primarily Christmas and

greeting cards, but also secondary items such as stationery,

calendars, recipe books, and invitations), each bearing a copy of

one or more of its cartoon drawings.      Petitioner’s artistic work

is all done at its headquarters in San Diego by Ms. Stafford and
                                - 4 -

two nonshareholder employees.   Ms. Spafford is petitioner’s

principal artist; she has personally drawn and painted most of

petitioner’s original cartoon characters and most of the scenes

in which the characters appear.   The other two employees also

draw original cartoon characters and scenes; their drawings are

reviewed, modified (as necessary), and approved by Ms. Spafford.

Ms. Spafford and the two employees together draw between 300 and

400 cartoon character/scenes a year, and each character/scene is

numbered and licensed.

     Petitioner offers for sale at its headquarters all currently

available merchandise that bears an image of at least one of its

cartoon characters.   Petitioner does not sell items that do not

bear an image of at least one of its cartoon characters, and it

does not sell its original cartoon drawings.   Petitioner’s

primary customers are card and gift shops and licensing partners,

and most of its nonlicensing partner sales are by or through

independent sales representatives, each of whom has a specified

sales territory and each of whom earns a straight sales

commission.   Sales representatives order petitioner’s products

directly from it, and they place the products in card and gift

shops and the like.   Petitioner ships most of its inventory from

its headquarters, where petitioner’s employees generally package
                                 - 5 -

the paper products for sale to the retailers on the basis of the

sales representative’s orders.

     Petitioner uses several independent printing companies to

print its products.    Generally, petitioner sends an original

cartoon drawing to a printer, and the printer photographs the

drawing, performs the necessary color separations, and creates

“proofs” of a particular paper product in accordance with

specifications dictated by petitioner (e.g., the size of the card

to be printed, the color of ink, and the grade of the card stock

to be used in printing the card).    The printer uses its own paper

and its own ink, and it holds title to and bears the risk of loss

of the supplies and printed goods until it ships the goods back

to petitioner for petitioner to accept or reject.    If petitioner

rejects the goods, it informs the printer of changes which must

be made to meet petitioner’s specifications.

     Printers do not print petitioner’s paper products absent an

order from it, and they are not allowed to sell petitioner’s

paper products or any of petitioner’s original cartoon characters

or reproductions thereof.    Petitioner sends a purchase order to a

printer indicating the number of a particular paper product that

it wants printed, and the printer prints the approximate number

of products ordered.    In the case of cards, the printer prepares

an invoice with artist’s adjustments noted and ships the printed
                                 - 6 -

items, per petitioner’s instructions, to San Diego Bindery.

Petitioner contracts with San Diego Bindery to cut the sheets of

cards into individual cards and to fold each individual card, and

San Diego Bindery bears the risk of loss if it damages any card

during that process.    San Diego Bindery ships the finished goods

(with an invoice) to petitioner’s headquarters, where petitioner

stores all of its inventory.

     In addition to selling products which bear at least one of

its cartoon characters, petitioner enters into licensing

agreements under which certain manufacturers are given the right

to use one or more of petitioner’s characters.   Under a licensing

agreement, petitioner generally charges the licensee a fee to use

an original cartoon drawing and a royalty equal to a percentage

of the licensed products sold.    The licensees sell and distribute

the products they create bearing images of petitioner’s cartoon

characters.   Petitioner does not sell its licensees’ products

through either its independent sales representatives or through

its catalogue; most of the licensees sell and distribute their

products themselves.    Petitioner does sell all of its licensees’

products at its retail store.

     Petitioner has never adjusted the value of its inventory to

reflect section 263A.   Petitioner’s reported ending inventory on
                               - 7 -

June 30, 1994, was $1,556,404, and its absorption ratio for the

year then ended would have been 42.87 percent.

     Petitioner’s gross receipts and other revenue for the

subject year totaled $5,874,039.   Of that amount, $5,241,830 was

from sales,1 $623,469 was from royalties from the licensing

agreements, and $8,740 was from interest, discounts, and service

charges.   The gross receipts from sales were attributable to the

following items:

                   ITEMS                          Receipts

     Greeting cards                              $2,034,561
     Boutique; e.g., party goods and balloons       849,656
     Stationery, box notes & memo pads              675,639
     Christmas products; e.g., cards                621,082
     Books, calendars, & recipe cards               315,034
     Wrap and tote                                  193,101
     Invitations                                    191,280
     Gift enclosures                                 86,425
     Other items                                    275,052
          Total                                   5,241,830

For the 3 taxable years preceding the subject year, petitioner’s

gross receipts were $6,711,723, $6,772,772, and $5,898,638,

respectively.

     Respondent determined that petitioner is subject to the

UNICAP rules.   Respondent determined that petitioner’s cost of

goods sold for the subject year was overstated by $667,267 by


     1
       The cost of goods attributable to those sales was
$2,108,921. The only item reportedly included in that cost was
“Purchases”.
                                 - 8 -

virtue of the fact that petitioner had failed to change its

method of accounting to account for the UNICAP rules.

                              Discussion

     We decide primarily whether petitioner is subject to the

UNICAP rules of section 263A.    The UNICAP rules, which generally

require capitalization of expenses related to tangible property,

were added to the Internal Revenue Code as part of section 803 of

the Tax Reform Act of 1986 (TRA), Pub. L. 99-514, 100 Stat. 2085,

2350.   As applicable herein, the UNICAP rules are effective with

respect to taxable years beginning after December 31, 1986.    See

TRA sec. 803(d)(2)(A).

     Section 263A provides in relevant part:

     SEC. 263A.    CAPITALIZATION AND INCLUSION IN INVENTORY
                   COSTS OF CERTAIN EXPENSES.

          (a) Nondeductibility of Certain Direct and
     Indirect Costs.--

                (1) In general.--In the case of any
           property to which this section applies, any
           costs described in paragraph (2)--

                       (A) in the case of property
                  which is inventory in the hands of
                  the taxpayer, shall be included in
                  inventory costs, and

                       (B) in the case of any other
                  property, shall be capitalized.

                (2) Allocable costs.--The costs
           described in this paragraph with respect to
           any property are –
                         - 9 -

               (A) the direct costs of such
          property, and

               (B) such property's proper
          share of those indirect costs
          (including taxes) part or all of
          which are allocable to such
          property.

Any cost which (but for this subsection) could not be
taken into account in computing taxable income for any
taxable year shall not be treated as a cost described
in this paragraph.

     (b) Property to Which Section Applies.-–Except as
otherwise provided in this section, this section shall
apply to–-

          (1) Property produced by the taxpayer.-
     –Real or tangible personal property produced
     by the taxpayer.

          (2) Property acquired for resale.--

               (A) In general.–-Real or
          personal property described in
          section 1221(1) which is acquired
          by the taxpayer for resale.

               (B) Exception for taxpayer
          with gross receipts of $10,000,000
          or less.-–Subparagraph (A) shall
          not apply to any personal property
          acquired during any taxable year by
          the taxpayer for resale if the
          average annual gross receipts of
          the taxpayer * * * for the 3-
          taxable year period ending with the
          taxable year preceding such taxable
          year do not exceed $10,000,000.

          *    *    *    *       *   *   *

     (g) Production.-–For purposes of this section–-
                          - 10 -

          (1) In general.-–The term “produce”
     includes construct, build, install,
     manufacture, develop, or improve.

          (2)   Treatment of property produced under
     contract   for the taxpayer.–-The taxpayer
     shall be   treated as producing any property
     produced   for the taxpayer under a contract
     with the   taxpayer * * *.

     (h) Exemption for Free Lance Authors,
Photographers, and Artists.--

          (1) In general.–-Nothing in this section
     shall require the capitalization of any
     qualified creative expense.

          (2) Qualified creative expense.--For
     purposes of this subsection, the term
     “qualified creative expense” means any
     expense--

               (A) which is paid or incurred
          by an individual in the trade or
          business of such individual (other
          than as an employee) of being a
          writer, photographer, or artist,
          and

               (B) which, without regard to
          this section, would be allowable as
          a deduction for the taxable year.

          *      *    *    *     *   *    *

          (3) Definitions.--For purposes of this
     subsection--

          *      *    *    *     *   *    *

                 (C) Artist.--

                    (i) In general.--The term
          “artist” means any individual if
          the personal efforts of such
          individual create (or may
              - 11 -

reasonably be expected to create) a
picture, painting, sculpture,
statue, etching, drawing, cartoon,
graphic design, or original print
edition.

          (ii) Criteria.--In
determining whether any expense is
paid or incurred in the trade or
business of being an artist, the
following criteria shall be taken
into account:

               (I) The originality
and uniqueness of the item created
(or to be created).

               (II) The
predominance of aesthetic value
over utilitarian value of the item
created (or to be created).

     (D) Treatment of certain
corporations.--

          (i) In general.--If--

               (I) substantially
all of the stock of a corporation
is owned by a qualified employee-
owner and members of his family (as
defined in section 267(c)(4)), and

                (II) the principal
activity of such corporation is
performance of personal services
directly related to the activities
of the qualified employee-owner and
such services are substantially
performed by the qualified
employee-owner,

this subsection shall apply to any
expense of such corporation which
directly relates to the activities
of such employee-owner in the same
manner as if such expense were
incurred by such employee-owner.
                                - 12 -

                            (ii) Qualified employee-
                  owner.--For purposes of this
                  subparagraph, the term “qualified
                  employee-owner” means any
                  individual who is an employee-owner
                  of the corporation (as defined in
                  section 269A(b)(2)) and who is a
                  writer, photographer, or artist.

     Petitioner makes two arguments as to why it is not subject

to the UNICAP rules.    First, petitioner argues, it is excepted

from those rules because it is a small reseller under section

263A(b)(2)(B).2    Petitioner asserts that it engages in no

manufacturing or production activity with respect to its paper

products and that it resells those products after buying them

from the producers thereof; namely, petitioner asserts, the

printers.    Second, petitioner argues, it is an artistic business

that is exempt from the UNICAP rules by virtue of section

263A(h).    Petitioner asserts that Ms. Spafford is a qualified

employee-owner and that she owns substantially all of

petitioner’s stock.    Petitioner asserts that Ms. Spafford’s

cartoon characters are original and unique and that her artwork

is reproduced and disseminated through the paper products

primarily for the character’s aesthetic value.

     Respondent argues that petitioner does not meet the reseller

exception because it produces rather than resells its paper


     2
       For purposes of sec. 263A, “resellers” are “retailers,
wholesalers and other taxpayers that acquire property described
in section 1221(1) for resale”. Sec. 1.263A-1(a)(3)(iii), Income
Tax Regs.
                                - 13 -

products.3   Respondent argues that petitioner does not qualify

under section 263A(h).   Respondent asserts that Ms. Spafford does

not own substantially all of petitioner’s stock within the

meaning of section 263A(h)(3)(D)(i)(I) and that petitioner’s

paper products are utilitarian rather than unique.

     We agree with respondent that petitioner is subject to the

UNICAP rules of section 263A.    As to petitioner’s primary

argument, namely, that it is a reseller and not the producer of

its paper products, we disagree.    The facts of this case lead us

to conclude that petitioner is and has been the only “owner” of

its paper products up until the time that they are sold to its

customers, and, thus, that petitioner is the only producer of

those products for purposes of section 263A.      See sec. 1.263A-

2(a)(1)(ii), Income Tax Regs. (“a taxpayer is not considered to

be producing property unless the taxpayer is considered an owner

of the property produced under federal income tax principles”).

Petitioner’s ownership interest in the paper products attaches at

the first stage of their production; i.e., when the cartoon

characters are developed and drawn.      Petitioner performs this

step solely by itself, and this step, which requires the most

skill, expertise, and creativity of any step in the production



     3
       For purposes of sec. 263A, the term “produce” “includes *
* * construct, build, install, manufacture, develop, improve,
create, raise, or grow.” Sec. 1.263A-2(a)(1)(i), Income Tax
Regs.
                               - 14 -

process, is critical and indispensable to the paper products’

production.    But for these characters, petitioner would not be

able to sell its paper products in the form that it does.

Petitioner also does not let anyone (e.g., a printer) sell, copy,

or use any of its cartoon characters without its permission, and

anyone who does so is in breach of the license that petitioner

holds as to its characters.

     Petitioner focuses on the fact that the producers actually

develop the paper products and argues therefrom that the printers

are the producers of its products.      We disagree with this

argument.   The printer’s reproduction of petitioner’s characters

onto ordinary paper is merely one small step in petitioner’s

process of exploiting its characters as sellable images, and the

reproduction process is mechanical in nature in that it involves

little independence on the printers’ part and is subject to

petitioner’s control, close scrutiny, and approval.      Petitioner

personally selects the printers merely to reproduce the

character’s images in a specified manner onto standard sheets of

plain paper.   The printers cannot print the paper products

without the cartoon images, and the finished products must

conform to petitioner’s specifications.      Given the added fact

that a printer does not acquire a proprietary interest in a

cartoon drawing so that it may sell the drawing (or copy thereof)

either separately or as part of a paper product, we conclude that
                                - 15 -

the printers are not producers because they never meet the

necessary requirement of owning the paper products for Federal

income tax purposes.     See Charles Peckat Manufacturing Co. v.

Jarecki, 

(7th Cir. 1952).4

     Nor do we believe that a product such as petitioner’s paper

products may be considered within the meaning of section 263A

(g)(2) when the product, in its finished form, requires such an

extensive involvement on the part of the taxpayer vis-a-vis the

purported producer, and the taxpayer has the exclusive right to

sell the finished product.    See id.; see also Polaroid Corp. v.

United States, 

(1st Cir. 1956).     Petitioner’s

transfer of the cartoon characters to the printers gave the

printers only the bare right to possess the characters or

reproductions thereof.    It did not give the printers any right to

sell the characters (or reproductions thereof) either alone or as



     4
       The case of Charles Peckat Manufacturing Co. v. Jarecki,

(7th Cir. 1952), is instructive to our analysis.
There, the taxpayer owned a patent on a certain bracket for
automobile visors and contracted with an independent machine shop
to fabricate the bracket for it. The machine shop’s entire output
had to be sold to the taxpayer at a per-piece price, and the
machine shop never had a proprietary interest in the bracket.
The court held that the taxpayer manufactured the bracket for
purposes of the Federal excise tax. The court focused on the
control maintained by the taxpayer over the manufacturing process
and observed that the fabricator "never had a proprietary
interest in the completed product" because the bracket was
subject to the patent that the taxpayer controlled. 

The court stated: “it is not unusual in taxing statutes for the
term 'manufacturer' to include one who has contracted with others
to actually fabricate the product". 

                              - 16 -

part of a product such as petitioner’s paper products.    The ink

and characterless paperstock which the printers sell to

petitioner is sufficiently different from the character-filled

paper products which petitioner sells to its customers so as to

characterize the latter products as sold initially by petitioner,

rather than as sold first by the printers to petitioner and then

resold by petitioner to its customers.   We also note that the

approximately 60-percent gross profit percentage reported by

petitioner for the subject year on the sale of its paper products

leads directly to the conclusion that the printers charge

petitioner solely for the paper, ink, and labor devoted to the

paper products, rather than for the value of the paper products

as items that are sold to petitioner for purposes of resale.

     Petitioner focuses on the fact that the printers bear the

risk of loss during the printing process.   We do not find this

fact dispositive as to who owns (and thus produces) the paper

products.   The identification of the owner of property for

purposes of the UNICAP rules does not necessarily rest on who

bears the risk of loss when the product is fabricated or

assembled, or, for that matter, on who actually turns the screws

or hammers the nails into the product.   The owner of property

must be identified from the facts and circumstances of the case,
                              - 17 -

see sec. 1.263A-2(a)(1)(ii), Income Tax Regs.,5 and who bears the

risk of loss is merely one factor to consider.   That a good

damaged during the printing process may cause a printer to suffer

a loss for the ink and paper used on that good (and possibly the

labor spent or value of the machinery used in applying the ink to

the paper) does not necessarily mean that the printer was the

damaged good’s owner.   As a matter of fact, a reasonable printer

would most likely have factored into its price of the print job

the projected expense for damaged or nonconforming goods.6

     As to petitioner’s second argument that it qualifies for

section 263A(h)’s exemption for artists and other stated

professionals, we also disagree.   This exemption was not included

in section 263A as originally enacted, but was added to that



     5
       Sec. 1.263A-2(a)(1)(ii), Income Tax Regs., also provides
that a taxpayer may be considered the owner of property produced
even though it does not have legal title thereto.
     6
       Petitioner also discusses at length sec. 1.263A-3(a)(3),
Income Tax Regs. That section is inapplicable to the facts at
hand. Sec. 1.263A-3(a)(3), Income Tax Regs., provides:
          (3) Resellers with property produced under
     contract. Generally, property produced for a taxpayer
     under a contract * * * is treated as property produced
     by the taxpayer. * * * However, a small reseller is
     not required to capitalize additional section 263A
     costs to personal property produced for it under
     contract with an unrelated person if the contract is
     entered into incident to the resale activities of the
     small reseller and the property is sold to its
     customers. * * *

That section is inapplicable because petitioner has no resale
activities in that it is not a reseller of its paper products.
                               - 18 -

section by way of an amendment that was retroactive to the

effective date of the TRA.   See sec. 6026(a) of the Technical and

Miscellaneous Revenue Act of 1988 (TAMRA), Pub. L. 100-647, 102

Stat. 3342, 3691.   As amended by TAMRA, section 263A(h)(3)(D)(i)

and (ii) allowed a “personal service corporation” (as defined in

section 269A(b)) to qualify for section 263A(h)’s exemption if,

among other requirements, “substantially all of * * * [its] stock

* * * is owned by * * * [a qualified employee-owner] and members

of his family”.    The House Ways and Means Committee stated in its

report that “For this purpose, the term “substantially all” means

95 percent or more of the value of the corporation’s stock”.     H.

Rept. 100-795, at 531, 532 (1988).      In the following year,

Congress amended section 263A(h) a second time, again retroactive

to the effective date of section 263A, to provide that any

corporation (and not simply a personal service corporation) could

qualify for section 263A(h)’s exemption if, among other

requirements, “substantially all of * * * [its] stock * * * is

owned by a qualified employee-owner and members of his family”.

See secs. 7816(d)(1) and 7817 of the Omnibus Budget

Reconciliation Act of 1989, Pub. L. 101-239, 103 Stat. 2106,

2420.

     We must apply the term “substantially all” to determine

whether petitioner qualifies for the exemption set forth in

section 263A(h).    We generally apply statutory text in accordance
                              - 19 -

with its ordinary, everyday usage.     When the meaning of statutory

text is “unescapably ambiguous”, however, we may resort to the

relevant legislative history to resolve that ambiguity.     Garcia

v. United States, 

, 76 n.3 (1984) (quoting Schweumann

Bros. v. Calvert Distillers Corp., 

, 395 (1951)

(Jackson, J., concurring)); see Venture Funding, Ltd. v.

Commissioner, 

, 241-242 (1998), affd.        F.3d

(6th Cir. 1999); see also Albertson's, Inc. v. Commissioner, 

, 545 (9th Cir. 1994), affg. 

(1990).    Here,

we believe that the term “substantially all” is “unescapably

ambiguous”, and, accordingly, we consult the term’s legislative

history for guidance as to its meaning.    As mentioned above, we

find in the report of the House Ways and Means Committee that it

clearly intended for that term to require that a qualified

employee-owner and members of his family own “95 percent or more

of the value of the corporation’s stock”.7    H. Rept. 100-795,

supra at 531, 532 (1988).   We also find in the House conference

report that the conference agreement followed the House bill as




     7
       The legislative history to the TRA reveals that Congress
also equated a 95-percent test with the term “substantially all”
for purposes of sec. 448(d)(2), a provision included in the TRA
as sec. 801(a). See H. Conf. Rept. 99-841 (Vol. II) at II-287
(1986), 1986-3 C.B. (Vol. 4) 1, 287. The legislative history to
TAMRA reveals that the joint conferees to that Act knew that the
term “substantially all” had been equated with a 95-percent
requirement. See H. Conf. Rept. 100-1104 (Vol. 2) at II-152
(1988), 1988-3 C.B. 473, 642.
                              - 20 -

amended by the Senate.8   See H. Conf. Rept. 100-1104 (Vol. II),

at 145, 146 (1988), 1988-3 C.B. 473, 635-636.    Given the fact

that none of petitioner’s shareholders owns the requisite

percentage of stock as set forth in the report of the House Ways

and Means Committee, we hold that petitioner does not qualify for

the exemption set forth in section 263A(h).9    We need not and do

not address whether petitioner was otherwise disqualified for

that exemption because, as asserted by respondent, its paper

products are utilitarian in nature.

     Having concluded that petitioner is subject to the UNICAP

rules, we now turn to the remaining issue; i.e., the year in

which section 481 requires that petitioner account for its change

to the UNICAP rules.   Petitioner argues that TRA section

803(d)(2) requires that it account for this change in its taxable

year ended June 30, 1988.   In relevant part, that section

provides:


     8
       None of the Senate’s amendments are relevant for purposes
of our discussion.
     9
       Petitioner argues that the Court should apply a “facts and
circumstances test” to determine whether Ms. Spafford owns
“substantially all” of petitioner’s stock for purposes of sec.
263A(h). Petitioner notes that neither the text of sec. 263A nor
the regulations thereunder have ever mentioned the 95 percent
test referenced in the committee report and states that the
“House Committee Report to Public Law 100-246 * * * suggested
that a 95% interest would clearly satisfy the substantially all
test.” Suffice it to say that the 95-percent test referenced in
the committee report is more than a mere suggestion and that
petitioner fails the 95-percent test because none of its
shareholders owns the requisite percentage of stock.
                              - 21 -

          (d) Effective date.--

               (1) In General.--Except as provided in
          this subsection, the amendments made by this
          section shall apply to costs incurred after
          December 31, 1986, in taxable years ending
          after such date.

               (2) Special Rule For Inventory
          Property.--In the case of any property which
          is inventory in the hands of the taxpayer–-

                    (A) IN GENERAL--The amendments
               made by this section shall apply to
               taxable years beginning after
               December 31, 1986.

               *    *     *      *      *    *    *

     Petitioner focuses on the fact that section 803(d)(2)(A) of

the TRA provides explicitly that the amendments contained therein

“shall” apply to taxable years beginning in or after 1987 and

asserts that this language means that the “year of change” for

purposes of section 481 is the year for which it was required to

change its method of accounting to conform to the UNICAP rules

rather than the first year for which it actually made the change.

Respondent argues that the “year of change” for purposes of

section 481 is the year in which the change actually occurred;

i.e., the subject year.

     We agree with respondent.       Section 481(a)(1) provides that

where in computing a taxpayer's taxable income the computation is

under a method of accounting different from the method under

which the taxpayer's income for the preceding taxable year was

computed, there shall be taken into account those adjustments
                               - 22 -

which are determined to be necessary solely by reason of the

change in order to prevent an amount from being duplicated or

omitted.   Section 481 was designed by Congress to prevent the

duplication or omission of income or expense that may otherwise

occur solely through a change in a method of accounting that is

used by a taxpayer to compute his or her taxable income.   See

Graff Chevrolet Co. v. Campbell, 

, 572 (5th Cir.

1965); Pursell v. Commissioner, 

, 271 (1962), affd.

(3d Cir. 1963).   Congress designed section 481

broadly to allow the Commissioner to adjust income for a "year of

the change" by increasing that year's income by any income that

was earned in a "closed year" but went unreported due to the

mechanics of the taxpayer's old accounting method.   See Graff

Chevrolet Co. v. Campbell, supra at 572.   The year of change is

the first taxable year in which taxable income is computed under

a method of accounting that is different from the method of

accounting that was used in the prior year.   See sec. 1.481-

1(a)(1), Income Tax Regs.

     In accordance with this firmly established law, the year of

change in this case is the subject year; i.e., the first year in

which petitioner’s method of accounting was changed to reflect

the UNICAP rules.   Petitioner attempts to distinguish this law by

arguing that, as of its first taxable year beginning in 1987, TRA

section 803(d)(2) changed its method of accounting to conform to
                              - 23 -

the UNICAP rules as an operation of law.10   We find that argument

unpersuasive.   The fact of the matter is that, up until and

including the subject year, petitioner used a method of

accounting that did not reflect the UNICAP rules, and our

holdings herein mean that petitioner must recompute its income

for the subject year under a method of accounting that does take

into account those rules.   See also sec. 1.263A-1T(e)(11),

Temporary Income Tax Regs., 52 Fed. Reg. 10052, 10083-10084 (Mar.

30, 1987) (“Taxpayers who are required to change their method of

accounting under this section and who fail to comply with the

requirements of this paragraph (e)(11) [regarding an automatic


     10

 Petitioner also notes that the Commissioner had previously
examined some of its earlier taxable years that postdated the
effective date of the UNICAP rules and that the Commissioner had
never changed its method of accounting for those years to conform
to those rules. Petitioner suggests that the Commissioner now is
estopped from making the sec. 481 adjustment for the subject
year. We find this suggestion unavailing. The fact that the
Commissioner had the opportunity to, but did not, change an
improper method of accounting in an earlier year does not mean
that he is estopped from making the change in the later year.
See Knight-Ridder Newspapers Inc. v. United States, 

(11th Cir. 1984). The doctrine of equitable estoppel does not
bar the Commissioner from correcting a mistake of law, see
Automobile Club v. Commissioner, 

, 183 (1957); see
also Norfolk S. Corp. v. Commissioner, 

, 61 (1995),
and the cases cited therein, affd. 

(4th Cir. 1998),
"even where a taxpayer may have relied to his detriment on the
Commissioner's mistake", Dixon v. United States, 

,
72-73 (1965). The Commissioner may correct mistakes of law
because "'Whoever deals with the government does so with notice
that no agent can, by neglect or acquiescence, commit it to an
erroneous interpretation of the law."' Graff v. Commissioner, 

, 762 (1980) (quoting Schafer v. Helvering, 

,
320 (D.C. Cir. 1936)), affd. 

(5th Cir. 1982).
                              - 24 -

change in method of accounting to comply with the UNICAP rules]

shall be considered as using an improper method of accounting

under the Code”).   Because the subject year is the first taxable

year in which taxable income is computed under a method of

accounting that is different from the method of accounting used

in the prior year, we agree with respondent that the subject year

is the “year of change” for purposes of section 481.    See also

sec. 1.481-1(a)(1), Income Tax Regs.

     All arguments not discussed herein are either irrelevant or

without merit.   To reflect concessions,

                                           Decision will be entered

                                    under Rule 155.