## Facts

- Thor Power Tool Co. manufactured tools and component parts and maintained substantial inventories, including older items and spare parts.
- In 1964, management identified certain goods as “excess” inventory and, following GAAP, wrote them down from cost to estimated “net realizable value” (often scrap value).
- Thor continued to hold the written-down items and offer them for sale at original catalog prices rather than at reduced prices.
- Thor claimed the write-down as a deduction, generating a net operating loss carryback.
- The Commissioner disallowed the write-down, finding it inconsistent with Treasury inventory regulations and not a method that clearly reflected income under I.R.C. §§ 446 and 471.
- Thor did not establish that the goods were defective/subnormal or that they had been actually offered for sale at prices below replacement cost.
- In 1965, Thor claimed a large addition to its reserve for bad debts under I.R.C. § 166(c) using a charge-off rate higher than its recent experience.
- The Commissioner determined the claimed addition was excessive and recomputed a “reasonable” addition using a six-year moving average of Thor’s bad-debt history.
- The Tax Court upheld the Commissioner on both issues, and the Seventh Circuit affirmed.

## Issues

1. Whether the Commissioner abused his discretion in disallowing Thor’s GAAP-based inventory write-down to “net realizable value” as failing to clearly reflect income under I.R.C. §§ 446 and 471 and the governing Treasury regulations.
2. Whether the Commissioner abused his discretion under I.R.C. § 166(c) by reducing Thor’s claimed bad-debt reserve addition using a six-year moving-average method.

## Decision

- The Supreme Court affirmed the Seventh Circuit.
- The Commissioner did not abuse his discretion in disallowing the inventory write-down because it was inconsistent with the Treasury regulations governing valuation below cost or market.
- The Commissioner did not abuse his discretion in recalculating a lower, “reasonable” bad-debt reserve addition using the six-year moving-average method.

## Legal Principles

- Under I.R.C. § 446(b), the Commissioner may reject a taxpayer’s accounting method if it does not clearly reflect income and may require a method that, in the Commissioner’s judgment, does.
- Under I.R.C. § 471, inventory methods must conform as nearly as may be to best accounting practice while also most clearly reflecting income; the Commissioner has substantial authority to enforce regulatory limits on valuation.
- Compliance with GAAP does not create a presumption that an inventory practice is acceptable for tax purposes; financial accounting and tax accounting serve different objectives.
- Treasury inventory regulations generally require valuation at cost or lower of cost or market, with “market” tied to replacement cost; valuation below that level is permitted only in specified, objectively verifiable circumstances (such as actual offers below replacement cost or defective/subnormal goods).
- A taxpayer may not deduct inventory write-downs based on subjective managerial estimates of “excess” or future demand when the regulatory conditions for lower valuation are not met.
- Under I.R.C. § 166(c), the bad-debt reserve deduction is allowed only for a “reasonable” addition and is expressly committed to the Commissioner’s discretion; the taxpayer bears the burden to show the Commissioner’s determination is unreasonable.

## Conclusion

The Court held that the Commissioner acted within his statutory discretion in rejecting a GAAP-based inventory write-down that did not satisfy the Treasury regulations’ objective criteria and in limiting a claimed bad-debt reserve addition to an amount supported by the taxpayer’s historical experience.


Thor Power Tool Co. v. Commissioner, 439 U.S. 522 (1979)