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Tuesday, April 01, 2003


Be sure to consult your tax advisor before imposing obnoxiously unfair policies on your employees. Color Arts, Inc. allowed their employees to accrue vacation, but they were not allowed to take vacation accrued unless they were still employed with Color Arts on the first day of the year following year in which the vacation was accrued. But �accrued� has a slightly different meaning to the IRS, and when Color Arts claimed a deduction for vacation pay accrued in 1996, they found that it did not �accrue� for tax purposes until they were actually obligated to provide it, which was January 2, 1997. Of course, if the policy had said, �the last working day of the year in which the vacation was accrued,� they would have been fine, but that�s what happens when you screw your employees without checking with your tax consultant first.

So now Color Arts wants to claim the deduction for vacation, lets say �earned� in 1995, which they originally claimed on their 1995 taxes, but actually accrued in 1996. Fortunately for Color Arts, the statute of limitation for taxes years prior to 1996 has expired. Noting this would allow Color Arts to deduct for 1996 an amount they already deducted in 1995, IRS wants an adjustment required under section 481(a) when there is a change in accounting method. Color Arts says they never changed their accounting method.

Tax Court rightly finds for the IRS. The underlying facts about their vacation policy has not changed, only the year they take the deduction. Nor are they correcting an isolated error like claiming a previously overlooked deduction. They are correcting a previously incorrect method of accounting for their vacation expense. This case is a perfect example of the underlying reason that section 481(a) adjustments exist: To prevent exactly these types of double deductions.

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