Thor Hammers Home Tax Lessons for a Recession

A 30-year-old Supreme Court case involving inventory write-downs pits financial accounting against tax accounting — and continues to serve as a warning to companies in a slumping economy.

GAAP is not controlling

Thor then contended that an inventory practice that conforms to GAAP (it was undisputed that Thor’s practice so conformed) is presumptively valid for tax purposes. But the Supreme Court did not agree. It concluded that no such presumption is present.

The code and the regulations, the court observed, give the Commissioner “broad discretion” to set aside a taxpayer’s method of accounting if, in his opinion, it does not clearly reflect income. This language , is “clearly at odds with the notion of a presumption in the taxpayer’s favor,” noted the court. The presumption that Thor postulated is insupportable in light of the very different objectives that financial accounting and tax accounting have.

To be sure, the high court said that financial accounting has as its “foundation” the principle of conservatism. By contrast, the goal of the income tax system is the equitable collection of revenue. Quite clearly, understatement of income, the natural outgrowth of conservatism, is not the “guiding light” of the income tax system.

In short, an accountant’s conservatism cannot bind the tax commissioner in his efforts to collect taxes. Accordingly, the fact that an inventory method may be acceptable for financial accounting purposes has absolutely no bearing on its efficacy for tax purposes. In the instant case, the method employed did not — in the commissioner’s judgment — clearly reflect the taxpayer’s income. And in virtually every case, such a determination, will be more than adequate to render the taxpayer’s accounting method unacceptable for tax purposes.

Contributor Robert Willens, founder and principal of Robert Willens LLC, writes a weekly tax column for


1 Under current practice, the term “market’ means the aggregate of the current bid prices that is prevailing at the date of the inventory. The prices take into consideration the basic elements of cost reflected in inventories of goods purchased and on hand, goods in process of manufacture, and finished manufactured goods on hand. The basic elements of cost include direct materials, direct labor, and indirect costs required to be included in inventories under Section 263A of the tax code, and its underlying regulations. (See Regulation Section 1.471-4(a).)


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