Recent guidance raises long-standing issue of what is a separate trade or business.

• Author: Fitzpatrick, Ellen

Taxpayers engaged in more than one trade or business can use different methods of accounting for each trade or business in computing taxable income, as long as the chosen method for each trade or business provides a clear reflection of income. The regulations under Sec. 446 provide that for different accounting methods to be used, the trades or businesses must be separate and distinct. So what constitutes a separate and distinct trade or business? Chief Counsel Advice (CCA) 201430013 takes a fresh look at whether divisions of a business are separate and distinct.

"Separate and distinct" is not defined in the regulations, although Regs. Sec. 1.446-1(d) provides that, to be considered separate and distinct, each trade or business must have a complete and separable set of books and records. However, even a taxpayer that maintains separate books and records is not considered to have separate and distinct trades or businesses if there is a creation or shifting of profits or losses between the trades or businesses by reason of their different methods of accounting. Given the lack of clarity in the regulations, taxpayers must look to case law for guidance in appropriately analyzing whether trades or businesses are separate and distinct.

The courts have looked to the following additional factors when considering whether a taxpayer is engaged in separate trades or businesses: (1) the existence of common management; (2) whether the taxpayer holds out each fine as a separate business; (3) the use of separate bank accounts; (4) whether the businesses share employees; and (5) the nature of each business. However, case law has generally treated the last factor as the most important. One example in the regulations notes that a taxpayer may account for the operations of a personal service business by the cash method and of a manufacturing business by the accrual method (Regs. Sec. 1.446-1(d)(1)).

In Stem, 14 B.T.A. 838 (1928), the Board of Tax Appeals noted that the two businesses examined were "wholly different in character"--one was a mercantile business, and the other bought and sold coal lands--in holding that the two businesses were separate and distinct. Two trades or businesses in different lines of business that have separate books and records likely will be considered separate and distinct. But what about businesses that are similar in activity or are vertically integrated?

Where activities are vertically integrated, such that one division...