Second Circuit Rules that Taxpayer Could Not Use an Accounting Method Change to Deduct §179D Deductions Not Claimed on Prior Returns

The Cannon Corporation and Subsidiaries ("Cannon") appealed a Tax Court decision that upheld the Commissioner of Internal Revenue’s determination of a tax deficiency for the 2011 tax year. The central issue was whether Cannon, as a designer of energy-efficient buildings, could retroactively report Section 179D deductions for the 2007-2010 tax years on its 2011 tax return as an accounting method change, and whether its equitable estoppel, equitable recoupment, and duty of consistency claims were valid. The Court of Appeals affirmed the Tax Court’s judgment, finding that Cannon could not claim the deductions as an accounting method change and that its equitable claims lacked merit.

Facts of the Case

Cannon was involved in designing energy-efficient buildings for government clients between 2006 and 2011. These government clients allocated their Section 179D deductions to Cannon. Cannon did not initially report these deductions on its original tax returns for the tax years 2006 to 2010. After filing an amended 2006 tax return to claim Section 179D deductions, which the IRS allowed, Cannon sought to report its Section 179D deductions for the 2007–2010 tax years as a change in accounting method on its 2011 tax return. Cannon based this decision on Revenue Procedure 2011-14, which provided procedures for taxpayers to obtain automatic consent for changes in accounting methods. However, before Cannon filed its 2011 tax return, the IRS issued Revenue Procedure 2012-39, clarifying that designers could not use the automatic change in accounting method provisions for Section 179D deductions. Despite this, Cannon attempted to claim approximately $3.9 million in Section 179D deductions for the 2007–2010 tax years on its 2011 tax return, which the Commissioner denied.

Taxpayer’s Arguments for Relief

Cannon presented several arguments to support its claim for relief:

  1. Accounting Method Change Cannon argued that it should be allowed to report the Section 179D deductions for the 2007–2010 tax years on its 2011 tax return as a change in accounting method under Section 481(a) of the Internal Revenue Code. Cannon asserted that Revenue Procedure 2011-14 entitled it to report the deductions in this manner. Cannon contended that the deductions do not permanently change the combined lifetime income of the building owner and the designer because the building owner is required to reduce its basis in the property by the amount of the Section 179D deduction it allocated. Cannon asserted that the building owner and designer should be treated together as “a single taxpayer” because Section 179D’s requirement that the designer “shall be treated as the taxpayer for purposes of this section” should be interpreted to “combin[e] the designer and the owner” and “consider[] [them] together".
  2. Equitable Estoppel Cannon claimed that the Commissioner should be equitably estopped from denying the deductions because Revenue Procedure 2011-14 allegedly misrepresented that designers could claim Section 179D deductions as an accounting method change.
  3. Equitable Recoupment and Duty of Consistency Cannon argued that it was taxed under inconsistent theories because the Commissioner initially directed designers to report Section 179D deductions as an accounting method change but later forbade them from doing so. Cannon also maintained that the Commissioner breached its duty of consistency by subjecting Cannon to different reporting procedures.

Court’s Analysis of Law and Authorities

The court analyzed the relevant provisions of the Internal Revenue Code, Treasury Regulations, and Revenue Procedures to determine whether Cannon’s claims were valid.

  • Accounting Method Change The court referenced Section 481(a) of the Internal Revenue Code, which allows adjustments to prior tax returns due to changes in accounting methods to prevent duplication or omission of amounts. It also cited Treasury Regulations defining a change in accounting method as a change in the treatment of any material item used in an overall plan of accounting for gross income. The court emphasized that a material item involves timing only if it accelerates deduction or postpones income, not if it permanently distorts the taxpayer’s lifetime taxable income. The court found that a Section 179D deduction for a designer is a one-time allocated deduction that permanently reduces the designer’s taxable income, rather than an acceleration of depreciation.
  • The court cited Knight-Ridder Newspapers, Inc. v. United States, 743 F.2d 781, 798 (11th Cir. 1984), which stated, "The essential characteristic of a ’material item’ is that it determines the timing of income or deductions". The court also referenced Schuster’s Express, Inc. v. Comm’r, 66 T.C. 588 (1976), aff’d, 562 F.2d 39 (2d Cir. 1977) (per curiam), noting that Section 481 did not apply where a "taxpayer could avoid income for all time rather than simply deferring it".
  • The court rejected Cannon’s argument that the designer and building owner should be treated as a single taxpayer, citing Lee v. Bankers Tr. Co., 166 F.3d 540, 543 (2d Cir. 1999), which stated, "It is axiomatic that the plain meaning of a statute controls its interpretation, and that judicial review must end at the statute’s unambiguous terms". The court clarified that the phrase "treated as" implies an analogy, not a combination.
  • Regarding Revenue Procedure 2011-14, the court noted that Revenue Procedures are generally directory, not mandatory, and cannot override provisions of the Internal Revenue Code. The court cited Est. of Shapiro v. Comm’r, 111 F.3d 1010, 1017 (2d Cir. 1997), which described Revenue Procedures as "mere guidelines without the force of law". The court determined that Revenue Procedure 2011-14 did not entitle Cannon to report deductions as an accounting method change.
  • Equitable Claims The court stated that equitable estoppel applies only when the government makes a misrepresentation upon which the party reasonably and detrimentally relied and engages in affirmative misconduct. The court cited City of New York v. Shalala, 34 F.3d 1161, 1168 (2d Cir. 1994), and Schwebel v. Crandall, 967 F.3d 96, 103 (2d Cir. 2020), to support this principle. The court found that the Commissioner did not make any misrepresentations in Revenue Procedure 2011-14.
  • For equitable recoupment, the court referenced United States v. Dalm, 494 U.S. 596, 605 n.5 (1990), which stated that "a claim of equitable recoupment will lie only where the Government has taxed a single transaction, item, or taxable event under two inconsistent theories". The court also cited United States v. Forma, 42 F.3d 759, 767 (2d Cir. 1994). The court concluded that Revenue Procedure 2011-14 did not direct designers to report Section 179D deductions from prior years as an accounting method change and, therefore, there was no inconsistent treatment.

Court’s Findings

The court made the following findings in applying the law to the facts of the case:

  1. Accounting Method Change The court concluded that Cannon improperly reported its Section 179D deductions for the 2007–2010 tax years on its 2011 tax return as a Section 481(a) adjustment because claiming those deductions was not a change in accounting method.
  2. Equitable Claims The court found that Cannon’s equitable estoppel claim failed because the Commissioner did not make any misrepresentations. The court also determined that Cannon could not make out an equitable recoupment or duty of consistency claim because Revenue Procedure 2011-14 did not direct designers to report Section 179D deductions from prior years as an accounting method change.

Ultimately, the Court of Appeals affirmed the Tax Court’s judgment, denying Cannon’s appeal and upholding the Commissioner’s determination of a tax deficiency for the 2011 tax year.

Cannon Corp. v. Comm’r of Internal Revenue, CA2, Case No. 23-7693, February 18, 2025

Prepared with assistance from NotebookLM.