Warren E. Burger: We'll hear arguments first this morning in Williams Company against the Commissioner of Internal Revenue, Number 1312. Mr. Schrager, you may proceed whenever you're ready.
Marvin L. Schrager: Mr. Chief Justice, may it please the Court. My name is Marvin L. Schrager and this is Durward J. Long, co-counsel for the Don E. Williams Company. The Don E. Williams Company is located in Moline, Illinois and engages in the sale of small tools. The corporation maintains its books in an accrual basis method of accounting and also has an employees' profit-sharing plan for the benefit of its company employees. The company has a fiscal year ending April 30th, and according to the accrual method of accounting, must file its tax return on or before July 15th of each year. For the years April 30, 1967, 1968 and 1969 the Board of Directors of the corporation before the end of the year, accrued a liability for the employees' profit-sharing plan. Subsequent to the end of the corporation fiscal year, but prior to the time for the filing of the tax return, the company transferred to the trustees of the profit-sharing plan a secured demand interest-bearing note of the corporation guaranteed by the president, vice-president, and treasurer of the company. It was -- has been stipulated that the value of the collateral and net worth of one of the guarantors exceeded the value of the note which was the amount of the claim deduction.
Harry A. Blackmun: Mr. Schrager, am correct in my impression that the note actually was paid within 10 or 11 months later?
Marvin L. Schrager: Yes, sir.
Harry A. Blackmun: Was there a -- perhaps you will cover it as you go along. Was there a business reason for the deferral of actual payment when it followed so closely upon the issuance of the note?
Marvin L. Schrager: I think the note was paid within approximately, as you say it, 10 or 11 months and at that time, there were several reasons. One of which was that the company was an expanding company and it's in capital intense and needs a lot of inventory. And also, they felt that the company was a good place to invest the money and pay as good a return as they would be getting and investing in the stocks or some other investment.
Harry A. Blackmun: I take it that on the Commissioner's computations anyway, the deduction was allowed for the year in which payment was made.
Marvin L. Schrager: That is correct.
Harry A. Blackmun: So that we come down really to which year that you end up getting your deduction.
Marvin L. Schrager: Right, and set forth in our factual situation, you will note that the first year is the largest denial of the deduction and it becomes correspondingly less because he allowed the deduction for the cash that was paid the following year.
Harry A. Blackmun: And did they in fact invest in what, treasury bills or something? Didn't -- didn't you indicate one reason was because of better return on other investments?
Marvin L. Schrager: Well, the corporation paid interests to the profit-sharing plan and they felt that in the years in question, this would be as good return as they would get by investing elsewhere. The Commissioner of Internal Revenue Service, upon examination, disallowed the claim deduction contending that the transfer of the note in satisfaction of the accrued liability did not constitute payment under Section 404 (a) of the Internal Revenue Code. After the denial, the petitioner filed a case in the Tax Court and after all of the facts were stipulated to arguments and briefs submitted, the Tax Court as it has consistently done, reaffirmed the Commissioner and denied the deduction. An appeal was then taken to the U.S. Court of Appeals for the Seventh Circuit and after arguments, the Court of Appeals held for the Commissioner, but by doing so, they declined to follow decisions of the Third, Ninth and Tenth Circuit which had previously held that the transfer of a note by an accrual basis taxpayer did constitute payment under Section 404 (a) of the Internal Revenue Code if the transfer was made and the delivery was made within two and a half months after the close of the taxpayer's fiscal year. This created a split in the circuits and we filed a petition for writ of certiorari which was granted by this Court and that's the basic issue. The issue before the Court is whether or not, as I've stated, the transfer or delivery of a note by an accrual basis taxpayer constitutes payment of an accrued liability to a profit-sharing plan if made within two and a half months after the close of the taxpayer's fiscal year.
Potter Stewart: Was this an interest-bearing note did you say?
Marvin L. Schrager: Yes, Your Honor. It was an interest-bearing note.
Potter Stewart: What -- what rate?
Marvin L. Schrager: Different rates that corresponded to the rates that were being charged by banks in our local community, and the rates would differ from the larger money senders. They don't -- they don't fluctuate quite as much. In dealing with the issue, I believe that we have to talk about three sections of the Internal Revenue Code. First, Section 162, which provides for the deduction of ordinary and necessary business expenses which are paid or incurred by the taxpayer. We also must deal with Section 267 which -- which refers to deductions which are allowed when paid and Section 267 deals with related taxpayers. We also are dealing with Section 404 which deals with contributions to an employee's pension or profit-sharing plan, and which also contains the language that the deduction is allowed when paid. The reason that we have to take into consideration these three sections is that were not for the express establishment of these sections, the deduction would have been allowable under Section 162 of the Internal Revenue Code. We maintain that contributions to an employee's pension or profit-sharing plan are considered as additional employee compensation, and should -- and would be covered under 162 were it not for Section 404. Now, prior to the Court of Appeals' decision below, 20 years of case law have treated Section 404 and Section 267 and their predecessors which 23 (p) is the predecessor -- predecessor to Section 404 and Section 24 (c) is the predecessor to Section 267. And case law has treated them synonymously, and we feel that this is important in following the evolution of the point where we are today. Petitioner maintains that first, Section 267 was established by Congress and then Section 404 was established by Congress to stop tax avoidance and to close a tax loophole that existed under the Internal Revenue Code for the following reason. Suppose that I am the president and -- and stockholder of a close corporation, the corporation is on a fiscal year and on an accrual basis method of accounting. I, as the president, would be on a cash basis. Under Section 162, the corporation could have accrued a liability to me, say, I got a salary and a bonus. They could have paid me the salary and accrued the bonus but never paid it. And therefore, they would be entitled to a deduction. I, as a cash basis taxpayer, not having received the money, would not have to report that on my income tax return until the year that it was paid. If I never took the money out of the corporation, I would never have to show it. They would just keep it as an accrued liability but would have taken the deduction.
Harry A. Blackmun: But isn't this -- the natural state of affairs in the overlapping of a cash basis in a -- an accrual basis taxpayer?
Marvin L. Schrager: It is --
Harry A. Blackmun: It -- it isn't peculiar to this pension plan kind of thing, is it?
Marvin L. Schrager: It was, Justice Blackmun, until such time that Section 267 was established at which time they stated that certain related taxpayers if you accrued it, it must be paid within two and a half months after the end of the year. And I must take it into income at that time, if you were an independent creditor of the company or a non-owner employee, they could have accrued the -- accrued the liability taken the deduction but you would not have to report it until received. But I as a related taxpayer, and that's what we're talking about, must show an income within two and a half months after the end of the year. It must be paid within that time. This was the reason that 267, we feel, was enacted by Congress to close that tax loophole between related taxpayers. Subsequently, we feel that Section 404 was also enacted to do the same thing with employee profit-sharing plans. We feel that Congress felt that because of the possible closeness and relationship between the owner and maybe the trustees of the plan that they felt that something must be paid within two and a half months that you must transfer something of value must be transferred and delivered to the trustees of the profit-sharing plan.
Potter Stewart: The profit-sharing plan is not a taxpayer though, is it?
Marvin L. Schrager: It is not a taxpayer because of the grace of Congress, however --
Potter Stewart: So, there's -- the reason that you explained was behind the enactment of 267 is was -- it does not exist here.
Marvin L. Schrager: We feel it is, Your Honor, because it's quite conceivable that I, as a owner of a corporation, could have accrued the liability to the employees' profit-sharing plan, but if I never paid it, but took the deduction when the employees went to retire, there maybe nothing in there but just an accrual on the books of the corporation. And prior to the enactment of ERISA, many corporations, small corporations, the shareholder was the sole trustee of the plan. And I think that there was this type of related taxpayer basis between the owner and the corporation that they were trying to stop potential misdealings and they wanted something actually delivered to the trustees of the plan, so that an employee in seeing the plan could know that something was there. And also, under the Internal Revenue Code, the corporate -- the trustees of the plan are obligated to file annual reports showing the assets of the plan. The -- in this area, there has been much litigation, and the Commissioner of Internal Revenue Service starting with Section 267 and following through with Section 404, has always maintained in the beginning that paid, meant paid in cash. You had to liquidate the obligation in cash.
Harry A. Blackmun: Well, it could be another tangible property too, doesn't it?
Marvin L. Schrager: Their wording was cash or cash value. In 1943, the case of Musselman Hub-Brake Company versus Commissioner dealt with an accrual basis corporation owing its controlling stockholder a debt for royalties and interests which were accrued on -- at the end of the year and notes were transferred within two and a half months after the end of each year. The corporation took a deduction and the Commissioner disallowed it stating that notes paid -- notes did not constitute payment under -- and that was Section 24 (c) which was the predecessor to Section 267 in that case. The Court of -- the Tax Court affirmed and the Court of Appeals for the Sixth Circuit overturned and ruled that paid included the transfer of a note, the delivery of a note, that a note constituted payment under Section 24 (c) for an accrual basis taxpayer. In that case, they talked about the things which I have talked about today, the tax avoidance and the history of why they wanted to establish this section. And they also, in addition stated that if were not for 24 (c), this would have been deductible under 24 (a). In holding for the taxpayer, Musselman Hub-Brake Company, the Court explicitly rejected the Commissioner of Internal Revenue Service position that accrual basis and cash basis taxpayers were on equal footing under Section 24 (c). And this is one of the main themes of our argument that there is a difference between a cash basis taxpayer and an accrual basis taxpayer. They are not on equal footing and they are not so treated by the Internal Revenue Code. And in the Musselman case, they rejected the argument and refused to follow the cases of Eckert v. Burnet and Helvering versus Price which is the basis for the Commissioner's argument in those cases and also in the case before you today. Following the Musselman Hub-Brake Company case, the Court in Anthony P. Miller versus Commissioner, which is a case following the example that I gave to you before, held that a corporation which transferred notes to its president within two and a half months after the close of the fiscal year of the corporation constituted payment under Section 24 (c) which is the predecessor to Section 267. They felt that the delivery of the note completed the transaction and relationships between the parties changed as of that time. They also felt in that case that a note was similar to a check and they again rejected the Eckert and the Price line of cases.
Potter Stewart: There's some dispute in the briefs, I gather, as to what the Uniform Commercial Code provides in this area.
Marvin L. Schrager: Yes. Well, I don't know if there is exactly a dispute there, Your Honor --
Potter Stewart: I guess the Illinois version of the Code provides that a note is equivalent to a check. That's your submission, isn't it?
Marvin L. Schrager: Yes, Your Honor.
Potter Stewart: But in other States and in the proposed Uniform Commercial Code, it is not, is that correct?
Marvin L. Schrager: Well, I think -- I think that we're dealing here -- first of all, we think that the Uniform Commercial Code argument is -- is very miniscule. I think we're dealing here with the matter of federal law and federal practice --
Potter Stewart: Well, I just wondered if you agreed as to what the state of the law was.
Marvin L. Schrager: We maintained that if -- if we're going to get into the Uniform Commercial Code, then the Illinois Code should be the one that's applicable and they defined both checks and negotiable notes as negotiable instruments, and that they both suspend the underlying debt pro tanto until the time of payment. Finally, after the Musselman and the Miller cases in Revenue Ruling 55-608, the Commissioner acquiesced to the decisions and the line of reasoning in those cases and they state where a solvent taxpayer on the accrual basis issued its notes or other evidence of indebtedness constituted a valid deduction. We feel that at that point in time, the Commissioner in that also acquiescing in the Section 404 line of cases created an inconsistent position and a conflict which we feel was wrong and untenable. We feel that if it constitutes paid under Section 267 to have consistency, it should be paid under Section 404 (a), and a taxpayer should know what he's dealing with in reading the language of the Code. We do not feel that and we also feel that when they acquiescence in that section in talking about an accrual basis taxpayer, that they can't argue that accrual basis means one thing under 267, but in Section 404, accrual and cash basis are identical. We don't feel that that's a valid argument. After decisions and the acquiescence, we then get into the area of cases, dealing specifically with Section 404. The first case to come before the Court of Appeals was really a consolidation of two cases, the Sachs case and the Slaymaker Lock Company case. In both of these cases, the corporation transferred to the trustees demand notes of the corporation in satisfaction of its accrued liability to its pension trust. The Tax Court, after hearing arguments by both parties, disallowed the deduction and affirmed the Commissioner's ruling. However, the Court of Appeals reversed the decisions and felt that transfer of the note did constitute payment within the meaning of Section 23 (p), the predecessor to Section 404. They felt --
Warren E. Burger: Do -- do you think, Mr. Schrager, on your comment on the use of the word paid, did only four lines parts. If contributions are paid by an employer and then four lines down, there is a reference or compensation is paid, do you think the word “paid” means the same thing in an operative sense in each of those lines?
Marvin L. Schrager: I -- I think you're dealing -- one is paying it in the plan, the other paying a bonus to --
Warren E. Burger: Paying compensation.
Marvin L. Schrager: Paying compensation. I think that -- yes, when they're talking about paying compensation to somebody, I think its clear that if I give an employee a note that they must report it as income and that's paid.
Potter Stewart: Well, if that's the case, what differences are made whether or not you're accrual or cash basis taxpayer?
Marvin L. Schrager: As the tax -- the tax -- the cash basis taxpayer, if you are the payor, you are not allowed a deduction under the Code until you pay in cash.
Potter Stewart: The check, a check is the same and -- and you told us that a -- a check and a note are the same.
Marvin L. Schrager: We have not dealt with -- and there have been no cases decided, Your Honor, wherein a cash basis taxpayer --
Potter Stewart: Has delivered the note --
Marvin L. Schrager: -- has delivered the note and taken a claim deduction in this area of cases.
Potter Stewart: But as I understand your argument, the same argument -- basic same argument could be made in the -- in the case of a cash basis taxpayer.
Marvin L. Schrager: Well, maybe it could. We're not -- we're not making that argument, Your Honor (Voice Overlap)
Potter Stewart: Because on the other hand you -- you do not claim that a mere accrual is sufficient, do you?
Marvin L. Schrager: A mere accrual of what?
Potter Stewart: On the books of -- of your client.
Marvin L. Schrager: A mere accrual of the profit-sharing contribution?
Potter Stewart: Yes.
Marvin L. Schrager: That is correct. We --
Potter Stewart: You don't claim that.
Marvin L. Schrager: No, we feel --
Potter Stewart: And normally, that would be sufficient for an accrual basis taxpayer.
Marvin L. Schrager: Under Section 162 deduction, yes, it would.
Potter Stewart: The normal rule?
Marvin L. Schrager: Right.
Potter Stewart: But you -- you concede that you must at least have transferred a note.
Marvin L. Schrager: We concede, yes.
Potter Stewart: And why should that be if you are an accrual basis taxpayer?
Marvin L. Schrager: Well, we can get into the -- we feel that the word “paid” means delivery of something.
Potter Stewart: So, let's go back to my original question. Couldn't be -- is the same argument applicable in full force to a cash basis taxpayer?
Marvin L. Schrager: The courts in Eckert v. Price have held, of course, that was the only -- the bad debt deduction --
Potter Stewart: Yes.
Marvin L. Schrager: -- but they have held in that case, no. And there has been some -- there have been some cash-basis cases I think mainly in the -- in the gift area where they have held that a cash basis taxpayer. No, I don't know. I think some of those are on appeal now, but to date, they have never held that it qualify a cash basis taxpayer to give a note but they have for accrual basis (Voice Overlap).
Potter Stewart: I did not say the argument would prevail but -- but your argument didn't prevail in the Court of Appeals either --
Marvin L. Schrager: In three Courts of Appeals --
Potter Stewart: -- in accrual basis.
Marvin L. Schrager: -- it did, Your Honor. In three Courts of Appeals, it has prevailed and also we feel that under their acquiescence in Section 267, the Commissioner has acknowledged the difference between cash and accrual basis taxpayers.
Potter Stewart: Well, certainly, there is a difference, but the basic difference has always been an accrual basis taxpayer can accrue a liability or accrue -- or on the other side of ledger income on his books and that's sufficient --
Marvin L. Schrager: Correct.
Potter Stewart: -- with or without payment.
Marvin L. Schrager: Correct.
Potter Stewart: But here, you can see that an accrual of the liability to the fund would not be sufficient to give you a deduction as I understand --
Marvin L. Schrager: That -- yes.
Potter Stewart: -- as I understand your argument that there must be a note. And the reason there must be a note as you can see there must be payment. You said a note is equivalent to payment and that would be equally true with tax basis taxpayer or cash basis taxpayer, I should think.
Marvin L. Schrager: Yeah, there is -- there has been some discussion about in the regulations talking about the word or was in the congressional report prior to the time that the final draft of the section came out talking about the word “actually paid”. And the Commissioner has maintained that actually means paid in cash. We contend that if the word “actually” has any significant meaning at all that it means that you actually delivered something of value.
Potter Stewart: But your basic argument is that actually paid as I understand it, anything to the word “paid”.
Marvin L. Schrager: Right.
Potter Stewart: It's like a sign where it says no smoking or positively no smoking, it means the same thing.
Marvin L. Schrager: That's correct. If you've paid it, you have paid it. And actually paid has really no significance to that.
Harry A. Blackmun: Mr. Schrager, can I ask you a factual question? In your brief at page 13, you say the parties have stipulated that the notes equaled the amount of the claim deduction. Now, did you mean to say that the equal -- that the term “market value” denotes equal (Inaudible)
Marvin L. Schrager: Your Honor, that was a misinterpretation. I thought I have corrected that, and it was brought to attention by counsel. The stipulation was that the value of the collateral and the net worth of one of the guarantors exceeded the value of the note.
Harry A. Blackmun: There is no -- nothing in the record to tell us whether or not the fair market value of the notes at the time of their delivery to the trust equaled the amount of the obligation, is it?
Marvin L. Schrager: No. That was an error, Your Honor, in our brief. We --
Harry A. Blackmun: I'm not concerned about the error in the brief. I'm concerned about the -- about the element of fact.
Marvin L. Schrager: Right.
Harry A. Blackmun: The record -- there really is no support in the record for what I'm assuming to be much should be your ultimate contention that you -- you paid by property having value at least equal to the obligation.
Marvin L. Schrager: Equal to the obligation and it was in one of the -- and this has been decided in -- I believe, it was one of -- either the Sachs or the Slaymaker case and in the several cases that followed as they were remanded for a hearing on the value of the notes in those cases so and that is one of the points that has been covered. And one of the arguments that is made by counsel that it places a burden on the Commissioner to have to make valuations, we contend that the Internal Revenue Service is making valuations everyday on corporate stock and evaluations of gifts. In the Colorado National Bank case, they transferred real estate and they found a way to value that.
Harry A. Blackmun: No, but that I suppose to be opposed to the notion that you could avoid the whole problem by giving them the cash and then letting him come back and buy a note from you, which would have been payment and then a reinvestment of the -- of the paid funds.
Marvin L. Schrager: Yes.
Harry A. Blackmun: Would you say that's too much trouble?
Marvin L. Schrager: Well, yes, we feel that -- that they're making it tougher and tougher on the small companies to do this and I think after they -- they want to get into philosophy but after they enacted ERISA which was suppose to solve all the problems. Well, it solved many of them because a lot of the small corporations canceled their plans. So, instead of benefitting the people, they ended up hurting them again because they weren't going to -- they didn't want all of the --
Harry A. Blackmun: Well, is it -- is it in the stipulation that the value of the security is in excess to the value of the note?
Marvin L. Schrager: I believe that -- yes, that is and it's also contained --
Harry A. Blackmun: And -- and plus interest.
Marvin L. Schrager: Yes, it's all -- they paid --
Harry A. Blackmun: Well then, what is the value of the note when it's backed up by security like that?
Marvin L. Schrager: We believe that it's worth the base amount of the claim deduction, Your Honor.
Warren E. Burger: Mr. Schrager, what would you get for in your local community?
Marvin L. Schrager: Oh, 100% on the value of this company's --
Warren E. Burger: Right, that day or --
Marvin L. Schrager: Yes.
Warren E. Burger: -- several days later?
Harry A. Blackmun: Well, what -- what's the security behind it.
Marvin L. Schrager: Yes. Well, even.
Harry A. Blackmun: (Voice Overlap)
Marvin L. Schrager: -- even with the balance sheet -- you know that's not in -- I don't want to get off on the things that aren't in the record but even on the balance sheet of this company or (Voice Overlap).
John Paul Stevens: But counsel, the note wasn't payable on demand, was it?
Marvin L. Schrager: Yes, it was.
John Paul Stevens: Oh, I misunderstood. I thought it was payable in the -- at a future date.
Marvin L. Schrager: It was paid at a future date, Justice Stevens, but it was a demand note.
Potter Stewart: The demand interest-bearing note --
Marvin L. Schrager: Secure --
Potter Stewart: -- the flowing rate of interest.
Marvin L. Schrager: Yes.
Warren E. Burger: But the trustees -- the -- the holders of the note who could make the demand, make the decision to demand where --
Marvin L. Schrager: Three officers of the company plus a bank.There was an independent trustee.
Warren E. Burger: But only one?
Marvin L. Schrager: Only one, yes.
Warren E. Burger: If -- if it came down to that, the three trustees could have both the fourth trustee, could they not on the trust and the demand?
Marvin L. Schrager: Theoretically, yes, they could.
Warren E. Burger: Well, theoretically or --
Marvin L. Schrager: Right, it's factual, they could.
Warren E. Burger: Three holders cannot vote one.
Marvin L. Schrager: Yes. The other cases that supported the petitioner's position were the Wasatch Chemical Company case, another case involving a profit-sharing plan in which notes were transferred to the trustees and the Court of Appeals felt that paid or payment does not necessarily mean in cash. Payment was made when the note was delivered. There was a significant change in legal relationships between the parties and their real question and issue in that case was what was the value of the note transferred, was it equal to the amount of the claim deduction. They felt that that was the real issue. And for 20 years before this case was decided, that was the state of the law, and we felt that it was rightly so and even Justice Quigley in his dissenting opinion felt that taxpayers had a right to rely on 20 years of established law. My time is running out. I'd like to just briefly talk about the -- which I touched down is ERISA and since the enactment of ERISA and as we stated in our brief, the case doesn't have any perspective meaning because it is now a prohibited transaction. But it does have meaning to this taxpayer and it also has meaning to settle the conflict between the Circuits as it now stands. We feel --
Byron R. White: Mr. Schrager, before you sit down, could I follow up in one of my earlier questions. These notes were actually paid in about 10 or 11 months.
Marvin L. Schrager: Yes.
Byron R. White: And why would they pay them? Why they -- why wasn't payment deferred for 10 years if the pension from the fund was better off interest payments than by investment?
Marvin L. Schrager: The company had the cash and paid at -- in at that time, Your Honor, I --
Byron R. White: Who would have the cash at the time it delivered the notes, didn't it?
Marvin L. Schrager: Yes, I don't know exactly --
John Paul Stevens: (Inaudible)
Marvin L. Schrager: Pardon?
John Paul Stevens: Maybe the cost of the money went down.
Byron R. White: Right at that time.
Marvin L. Schrager: That was in 1967. I don't know the reason then, Your Honor.
Byron R. White: Your record doesn't show that anywhere.
John Paul Stevens: Anyway, the company had elected to pay.
Marvin L. Schrager: Yes.
John Paul Stevens: Mr. Schrager, let me just follow up on my misapprehension of the facts before. Am I correct in believing your argument would be the same if the note were not payable on demand but had a value at least equal to the amount of the application?
Marvin L. Schrager: Yes, there -- I believe one of the cases, I think it was the Wasatch case had time notes, Your Honor, and the same line of reasoning followed in the decision. They didn't care in that case exactly when it was paid as long as it had value. Thank you.
Warren E. Burger: Very well, Mr. Schrager. Mr. Jones.
Keith A. Jones: Mr. Chief justice, and may it please the Court. As Mr. Schrager has indicated, the issue in this case is whether an accrual basis taxpayer delivers its promissory note to an employees' profit-sharing trust is entitled to a deduction under Section 404 of the Internal Revenue Code. That statutory provision allows for a deduction for contributions to such trust a year end in which such contributions are paid. That's the narrow issue in this case, it's whether the delivery of the note constitutes payment. Consider -- excuse me, consideration of this issue is assisted by two limiting propositions on which there can be a little basis for disagreement. The first of this is the normal accrual basis rules do not apply in determining whether there has been a payment under Section 404. And the second is that under cash basis method of accounting, the delivery of a promissory note does not constitute payment. These two propositions taken together do not completely dispose of this case, but they do considerably narrow the range of permissible debate. I will therefore briefly explain why these propositions are sound and interned to the discussion of the area of disagreement that remains. The first proposition, as I have indicated, is that normal accrual basis rules do not apply in determining whether a contribution has been paid for purposes of Section 404. The statute provides and I quote, “A taxpayer on the accrual basis shall be deemed to have made a payment on the last day of the year of accrual. If the payment is not made -- excuse me, is made not later than the time prescribed by law for filing the return for such year.”
Potter Stewart: Where is the most convenient place to find the statute in these cases, in your brief?
Keith A. Jones: In the -- in the appendix to our brief, Mr. Justice Stewart.
Potter Stewart: Appendix to your brief, thank you.
Keith A. Jones: On page 33 of our brief. If accrual basis rules have applied, the deduction would always have been available for the year of accrual. No provision such as the one that I have just quoted would have been necessary. The Congress understood that such provision was necessary to permit an accrual basis taxpayer to take a deduction for the year of accrual if payment was not in fact made during that year. And the provision applies, it should be noted, only with respect to payments made shortly after the end of the year in the two and a half month grace period. Thus, it's plain that Congress understood and intended that the normal accrual basis rules do not apply. The second proposition is that the issuance and delivery of a promissory note by a cash basis taxpayer would not constitute payment. This Court so held in Eckert against Burnet and Helvering against Price, and the lower federal courts have uniformly followed these decisions. The rationale of Eckert and Price is straightforward. A cash basis method of accounting focuses upon movement, inflows and outflows of cash for its equivalent. And the giving of a promissory note or an IOU does not affect an outflow of property, an outflow of cash for its equivalent.
Potter Stewart: How do you square that with the well-settled and certainly well understood proposition that the drawing of a check for a deductible purpose is a deduction at the moment the check is delivered or mailed?
Keith A. Jones: Well, I think that --
Potter Stewart: One is a side draft and the others are note, each depends upon the --
Keith A. Jones: Yes, basically Eckert and Price --
Potter Stewart: There could be bad checks, just -- there could be bad notes.
Keith A. Jones: That's true, Mr. Justice Stewart. Basically, Eckert and Price rejected the argument that checks are to be treated or the notes are to be treated as equivalent to check. The -- the reasoning seems to me is that as a practical accommodation to the everyday business realities of -- or everyday realities of business life, the payment of a check is considered to be equivalent to the payment of cash.
Potter Stewart: Well --
Keith A. Jones: It has long been, I know it is.
Potter Stewart: Well, yeah, I know the purpose and that -- that is to beg the question.
Keith A. Jones: Well --
Potter Stewart: It's a side draft, that's what it is.
Keith A. Jones: That's my -- that's my first step, Mr. Justice Stewart. It's -- a check is an order to a payment. It's an order to a bank to make immediate payment --
Potter Stewart: To withdraw any to a bank, to pay to the order of the endorsement of the --
Keith A. Jones: That's right. It's an order directing a bank to make immediate payment. A note is not like that at all. When the maker issues a note, the maker himself or itself still has something left to do before the basic obligation is going to be satisfied. The maker himself must pay the note.
Thurgood Marshall: Mr. Jones, I thought the truth of the matter was the check is that the bank is ordered to pay the money if there's anything in that -- in that account.
Keith A. Jones: Well, that's true, Mr. Justice Marshall, and if there's no bank -- if there's no money in the bank account and the check bounces, then of course, the check does not constitute payment. It's a common law doctrine known as constructive payment in relation to bank or conditional payment in relation to bank under which the check was taken as payment. But -- but the note did not direct payment in that way. The note is just a mere promise that the maker himself, not the bank, is going to make payment in the future and I've always been treated by this Court and the lower courts as different implication as to tax payers.
Potter Stewart: They always have, I know. But sometimes it's not all that easy to make the distinction.
Keith A. Jones: Well, it's really --
Potter Stewart: Well, one can order to a (Inaudible) and -- and a notice much more personal and -- and direct.
Keith A. Jones: That's correct, Mr. Justice. It -- it's really a practical distinction that a note and a check is the conventional mode of affecting payment. A note is not and the courts have drawn the distinction, really on a practical rather than on a theoretical basis.
Warren E. Burger: Well, the notes are promised to pay in the future. The check is a direction to pay on the presentation.
Keith A. Jones: That's correct, Mr. Cheif Justice.
Potter Stewart: That you have a demand note if you promised to pay right now.
Keith A. Jones: A promise that the maker will pay not a direction to the bank to pay. The maker still has to pay it by check. In fact, in this case, the maker paid the note by check which indicates that there's a difference, a very real practical difference between the two transactions.
William H. Rehnquist: On which side of the line where 30-day draft on a bank fall?
Keith A. Jones: Well, I would think that -- I'm going to make sure I understand you. There's a 30-day -- it's a 30 day draft, a draft that's payable within 30 days or the expiration of 30 days.
William H. Rehnquist: No, the expiration of 30 days --
Potter Stewart: -- anytime after the expiration.
Keith A. Jones: I would think that that would only be payment at the time of the expiration of the 30-day period.
Warren E. Burger: So, if it came after the taxable year, it would be out and it'd be on the same category as this note in your view?
Keith A. Jones: Well, you're asking me about a hypothetical, but I really haven't very much thought to it, but I think that's the answer that I would give.
Harry A. Blackmun: If it were a payment to a pension fund.
Keith A. Jones: That's true or if it were payment by a cash basis taxpayer.
Harry A. Blackmun: Yes.
Keith A. Jones: And really, I was -- at this point advancing the proposition that the delivery of a note is not payment by a cash basis taxpayer under any circumstances, whether it's the pension, trust or --
Potter Stewart: Right.
Keith A. Jones: -- to any other creditor.
Potter Stewart: And that's the Eckert case?
Keith A. Jones: Eckert and Price, Helvering against Price. Petitioner has argued this similarity between checks and notes. And also in its brief, it's argued that the delivery of a note should be treated as equivalent to the payment of cash followed by receipt of the cash back and exchange for the note. And it seems to us that Eckert and Price foreclosed this argument as well. In those cases, this Court treated the delivery of a note as the delivery of a note and not as the end result of some series of hypothetical transactions that never took place.
Byron R. White: Of course, the statute doesn't say that this -- that -- payors will be treated as cash basis taxpayers.
Keith A. Jones: That's correct, Mr. Justice White.
Byron R. White: Well, I gather -- I gather --
Keith A. Jones: What I said at the outset.
Byron R. White: -- that's anticipating the rest of your argument.
Keith A. Jones: That's right. I said it at the outset that I'm really advancing two limiting propositions.
Byron R. White: Right.
Keith A. Jones: Well, as Mr. Justice Blackmun recently observed on behalf of the Court in the National Alfalfa case and I quote, “While a taxpayer is free to organize his affairs as he chooses. Nevertheless, once having done so, he must accept the tax consequences of his choice whether contemplated or not, and may not enjoy the benefit of some other route he might have chosen to follow but did not.” Because of the multiplicity and the imperfection of possible analogies between different transactions, the courts have long followed the doctrines stated by Mr. Justice Blackmun, that a taxpayer must accept the adverse tax consequences of the form in which he cash his transaction and that the courts will not re-cash that transaction to mitigate the tax liability that he has incurred. The transaction here was the mere giving of a note, not the payment of cash followed by a loan, and should be treated as what it was and not as what it was not.
Thurgood Marshall: But one of the questions, guarantors on the note they make any debt?
Keith A. Jones: I think that the fact that the net worth of the guarantors exceeded the face value of the note that provided adequate security. Under Section 503 of the Code, if the note had not been adequately secured, it might have been a prohibited transaction that would have resulted in the lost of taxes, so I think that's the only effect from our point of view.
Lewis F. Powell, Jr.: What -- what is the security for this note?
Keith A. Jones: There were three forms of security. One was --
Harry A. Blackmun: The guarantor.
Keith A. Jones: -- stock in the bank or stock in the company.
Lewis F. Powell, Jr.: Right.
Keith A. Jones: One was the interest of the certain of the officers and their share in the pension trust. But the third security, which we think is the most relevant, was the personal liability of the wife of Mr. Williams, personal life of Mrs. Williams and her net worth apparently was about four times that of the value of the note.
Lewis F. Powell, Jr.: Let's assume that the stock of this company was listed, so that you had the market value read it as attainable and that instead of getting a promissory note, the taxpayer had discharged its indebtedness as if you need to by delivering the appropriate number of shares of its own stock from it's treasury, (Inaudible) Would that have been the payment?
Keith A. Jones: Well, I think it would be payment, Mr. Justice Powell. The reason I briefly hesitate --
Lewis F. Powell, Jr.: You say you think it would or would not?
Keith A. Jones: I think it would constitute payment if it were shares of a publicly traded corporation. The reason I hesitate --
Byron R. White: The statute of the regulation specifically refer property, don't they somewhere?
Keith A. Jones: Well, actual payment of property, I think that's right. Sorry, the reason I hesitate is that if the corporation had given a note that was secured by stock in a corporation, I think the Commissioner would take the position that that is not constitute adequate security because if the corporation goes bankrupt the stock is not security.
Byron R. White: Well, let's -- let's --
Keith A. Jones: But if -- if it actually --
Byron R. White: Let's say the stock -- let's say the stock was in AT&T.
Keith A. Jones: Well, as long as -- as long as the pension trustee has to look to the assets of the company, if the company goes bankrupt, the stock is not going to be very helpful because it is subordinate even to the unsecured liability of a creditor. However, if the taxpayer corporation actually transfers the stock to the pension trust, then it seems to me that that is property.
Byron R. White: Well, Mr. Jones I didn't -- you mean your argument in -- in the Court here really does depend on what the value of the note is? I thought your argument is only independent of whether -- that even -- you make the -- even if the note was concededly was more than the -- than the amount of the contribution, was it right or not?
Keith A. Jones: Yes, that's right. From our point of view, the market value of the note is irrelevant to the -- the question here.
Byron R. White: So, it wouldn't make much difference what the security was.
Keith A. Jones: But the difference is that the actual issue into the stock does decrease the holdings of the --
Byron R. White: Oh, no, I wasn't talking about the issue into the stock.
Keith A. Jones: I'm sorry. Perhaps I misunderstood.
Byron R. White: But even if either of the stock was secured by -- two to one by government bonds, you would (Voice Overlap).
Keith A. Jones: Even if the notes -- even if the note was --
Byron R. White: I mean the note, yeah.
Keith A. Jones: That's correct. Security is -- is irrelevant to the determination whether there's a deductible contribution.
Byron R. White: And even though you stipulated it, you can go to the bank and get 100% on the note.
Keith A. Jones: That's correct, especially in circumstances such as we have here.
Byron R. White: Because the affiliate has paid, the company still has the use of the money --
Keith A. Jones: That's correct.
Byron R. White: -- so as the asset in it.
Keith A. Jones: It hasn't given up anything, (Inaudible) other than a promise to give up something in the future.
William J. Brennan, Jr.: But instead of -- instead transferring AT&T stock, an asset of the corporation, and security for the note to the pension plan, the stock itself were paid over in the amount of the obligation of the pension plan. And what do you think?
Keith A. Jones: I think that would be paid Mr. Justice Brennan.
William J. Brennan, Jr.: So, this whole thing turns on the fact that it say, “No, that is the primary --
Keith A. Jones: That's correct. Well, so far as I know, there has never been an issue in stock that's been litigated, but --
Potter Stewart: But doesn't the -- I can't find it, but doesn't the statute or the regulation specifically refer to money or property? I thought remember that from reading in this the brief, but I can't find it now.
Keith A. Jones: I think the regulation does.
William J. Brennan, Jr.: You may have given cash, are you?
Keith A. Jones: Now, cash or it's equivalent property. That's correct. There's no question about it and it was so held in Colorado case that is cited in our brief.
Harry A. Blackmun: Well, it couldn't have been paid in the note of someone else?
Keith A. Jones: Yes, that's true, if it were someone else's note that would constitute payment. We're just focusing here on the question of the taxpayers now, which we say, it does not give up anything, any property of the taxpayer, so yes.
Harry A. Blackmun: But here, we have, with that note, collateral that could have been seized via the notes, presumably on an attempt of the note.
Keith A. Jones: That's correct, although that --
Harry A. Blackmun: That exceeded -- that exceed the face value of the note.
Keith A. Jones: That -- that collateral would have not come out of the taxpayer. There's no reason to give a taxpayer deduction for the payment of collateral of some third party sense.
Harry A. Blackmun: And the taxpayer would owe the people --
Keith A. Jones: Well, we're hypothesizing a situation which the taxpayer is bankrupt, I suppose, so otherwise the -- the requirement for collateral probably -- I mean the collateral would probably never have to be reached.
John Paul Stevens: Mr. Jones, do you rely it all on these -- on the facts that the principle beneficiaries and the trustees of the trust were the same -- basically the same people as the obligor the note?
Keith A. Jones: Yes, we do think that's important Mr. Justice Stevens, and I think if I can develop our affirmative arguments under Section 404, the relevance to that will become clearer. But to summarize my argument up to this point, we think petitioner finds itself between (Inaudible) that is the accrual basis method of accounting is not available under Section 404. But under the cash basis method of accounting, petitioner is not entitled to deductions and claims. Now, petitioner, per force, must argue as it has that Congress intended to permit accrual basis taxpayers to utilize a hybrid or intermediate method of accounting for purposes of Section 404, and our position to the contrary is that Congress intended to place all taxpayers on the same footing for purposes of this provision that cash basis rules govern. We rely from the legislative history, language of the statute, statutes over right purpose and considerations of administrability.
Potter Stewart: And what -- considerations of what?
Keith A. Jones: Administrability. A legislative history in the statutory language admittedly are not conclusive but they are, we submit, highly suggestive. A witness before the Senate Finance Committee testified apparently without contradiction that, “The law has been drafted in such a way that all corporations are put on a cash basis on the payment to trust.” The Senate and House Committee reports refer to a requirement of actual payment which is a cash basis concept, but the statute itself refers to the requirement of a payment. Now, the construction of this term “payment,” which at least allude to cash basis rules, must be informed by an inquiry into the underlying legislative objective. In enacting Section 404, and I think this point is crucial, Congress was not principally concerned with providing a precise measure of the taxpayer's economic net income. Section 404 predominately reflects non-tax concerns related to the general social welfare. Congress understood that millions of workers depend on their employer's pension plans for a large portion of their retirement income, and we submit that Congress sought to ensure the financial viability of those plans by encouraging employers to make their contributions in cash for it's equivalent, and if it did so --
Potter Stewart: There's a -- there's a 1974 law that takes care of those concerns in there.
Keith A. Jones: That's true as to the future, Mr. Justice Stewart. We have about 116 cases pending for the past and we're talking about what interpretation should properly be given to the statute --
Potter Stewart: In other words, Congress --
Keith A. Jones: -- prior cases.
Potter Stewart: -- wanted to deal with and meet those concerns and directly did so --
Keith A. Jones: Well, it is --
Potter Stewart: -- as it did so --
Keith A. Jones: -- it is now done so --
Potter Stewart: -- in the -- in the Internal Revenue Code.
Keith A. Jones: It is now dow so more fully. But ERISA does constitute an amendment to the Internal Revenue Code.
Potter Stewart: Oh, I see.
Harry A. Blackmun: Mr. Jones, is there any of the Court of Appeals opinion in the pipeline now that favors the Government on this issue?
Keith A. Jones: To my knowledge, this case has not been decided in a Court of Appeals since the Williams' case, but there are a lot of cases pending, either in the Tax Court or an administrative stage. But so far as I know, there's been no subsequent Court of Appeals action.
Harry A. Blackmun: So, the tax court is kind of hopeless for taxpayers issue.
Keith A. Jones: Yes, but nevertheless this taxpayer and many others have continued to go there. There is an advantage as you know. In other words, we believe that Congress' purpose in requiring a payment was to ensure that the employees' trust would secure the full advantage of any contribution for which a tax benefit in a form of a deduction was made available to the employer. A petitioner argues, and I tell you this is part of the essence to this argument, that that purpose is sufficiently served by the delivery to the trust of a note having value. That argument and this is response to Mr. Justice Stevens to your question, that argument seems to us overlooks the fact, the trust and the employer are ordinarily not dealing at arms length in situations such as this. Often, as it's true here, A majority of the trustees are also officers of the corporation and there can be no assurance that such trustees will treat the note in its hands, a salable property, as far more likely we submit that they will, as the trustees here did, hold the note until the corporation itself is willing and able to make payment. But this course of action jeopardizes the interest of the affected employees that Congress sought to protect.
Potter Stewart: But surely your argument today doesn't -- isn't limited to cases in which it may depend upon the identity of the trustees, does it?
Keith A. Jones: No, that's -- that's correct Mr. Justice Stewart, but as a practical matter, it's frequently true that the trust which after all is established by the corporation will have trustees that are also officers in the corporation. Indeed, it would be surprising if that was not case.
Harry A. Blackmun: Your position would be precisely the same that these were complete strangers.
Potter Stewart: Yes.
Keith A. Jones: As to Section 404, that's true, Mr. Justice Blackmun, and we think that the term “payment” would have to have the same meaning in all the situations in which it was applied under Section 404.
Potter Stewart: What if the company had deliberated instead of a note one of its corporate bonds?
Keith A. Jones: That's a difficult question, Mr. Justice Stewart.
Potter Stewart: I know it is.
Keith A. Jones: And I'm not sure that I can speak for the Commissioner. So far as I know, there's no ruling directly on point. I -- I think that we would take the position that the bond is -- is more properly analogous to a note than it is to the corporate stock and it would not be treated as payment for the purposes of Section 404.
Potter Stewart: Well, there's -- there's a bond that's publicly traded.
Keith A. Jones: Well, to avoid problems of administrability, Mr. Justice Stewart, I think that a Commissioner would probably seek to avoid a case by case determination of whether a particular bond was more like a note or more like a share of stock. But -- as I say --
Potter Stewart: Well, we know it's more like a note in indebtedness, it's not equity.
Keith A. Jones: Well, I mean more like a note for purposes of this provision. But it seems to me that analytically, it would be appropriate to treat the bond as a note. But as I say, I -- I cannot speak for the Commissioner because I'm unaware of any ruling to that effect and I'm not sure what decision he would do.
Warren E. Burger: On that same analysis, in light of some of your prior responses, the bond of a third-party could constitute to the transfer of property.
Keith A. Jones: Oh, there's no question about that, Mr. Chief Justice, when a taxpayer holds the bond of a third party, that's property in his hands --
Warren E. Burger: That's the time --
Keith A. Jones: -- when he gives it over to the trust, he's actually giving a property. We think that Congress' purpose in this provision can be fully served only by requiring an actual out layer transfer of cash or property from the employer to the trust, but when the employer holds the property in the form of a note of the third-person and transfers it over, that would be sufficient in our view.
Thurgood Marshall: Well, you keep arguing about the investment, the fund holding the money, what about the equivalent of the check for a year without cash. Would that will be all right?
Keith A. Jones: Well --
Thurgood Marshall: Would that will be all right?
Keith A. Jones: Again, Mr. Justice Marshall, the only reason a check is treated as equivalent as cash are practical reasons, theoretically. I mean if you -- if you only adhere to theories, you would treat it a check, not as cash but like a note. But as a practical matter to accommodate what actually goes on in the marketplace, the Commissioner does what the taxpayers do which is to treat a check as cash until it's approved otherwise. Well, finally --
Potter Stewart: What the -- does the new law, the 1974 law, make it illegal and not makes it illegal for two, purport to make payment by the note of the employer? How about the -- does it make it illegal to make payment in anything other than cash or what does it do?
Keith A. Jones: To my knowledge, it does not. I -- I think that they only prohibit transactions with which we're concerned here is the loan of money or its equivalent from the trust back to the employer, then the new law treats the payment of the note or the delivery of a note in the first place is equivalent to loan.
Potter Stewart: It's the borrowing of money --
Keith A. Jones: That's right.
Potter Stewart: -- by the -- by the employer.
Keith A. Jones: As far as I know, nothing prohibit the transfer his real estate.
Potter Stewart: So that would cover the corporate bond, wouldn't it or would it?
Keith A. Jones: Oh, I think it would.
Potter Stewart: It would be the purchaser of --
Keith A. Jones: Well, it has a purpose -- the purpose is to --
Potter Stewart: -- of a bond would be the lender -- a lender to the company, I guess.
Keith A. Jones: The purpose of the statute is to protect the financial viability of the trust and that purpose is best served by making its investments independent of the employer. Self-employer suffers financial that whether the trust --
Potter Stewart: (Inaudible)
Keith A. Jones: -- will nevertheless, that's right. All these considerations, we submit, point toward the uniform application of cash basis rules under Section 404. The cash basis method of accounting affords a fair, objective, easily administrable set of rules to further the underlined statutory purposes. It was therefore reasonable for the Commissioner to construe the statute is requiring actual payment, cash or its equivalent. And we submit that this longstanding interpretation by the agency charged with the administration of the statute should be sustained. Now, petitioner's argument for a different treatment for special treatment for accrual basis taxpayers, rest almost exclusively upon an analogy to Section 267, a section which we believe is not relevant here. Broadly speaking, that provision deals with transactions between related taxpayers, and those familiar example may be the wage expense incurred by an accrual basis corporation tying one of its cash basis shareholders. Section 267 provides that the corporation is entitled to a deduction on account of the wages only if they are paid. Now, early in the history of the predecessor of this provision, the lower federal courts in these circumstances held that the delivery of a note to the shareholder constituted payment because the note was income to the cash basis shareholder. And in 1953, Congress amended the statute to ensure that deduction -- that the deduction would be available only if the income was in fact realized by the cash basis recipient. And after that amendment, the Commissioner acquiesced in the earlier decisions, but in doing so, explicitly distinguished between Section 267 and Section 404. Well, this history does not support the petitioner's construction for Section 404. The meaning of the term “paid” in Section 267 turns on the specific purpose of creating symmetry in the treatment of related taxpayers and that is the result that has been achieved.
Harry A. Blackmun: Do you think the symmetry isn't there because the plan is exempt?
Keith A. Jones: That's true, Mr. Justice Blackmun. Now, the petitioner, in his reply to the belief, says, “Well, Section 267 and 404 really are similar because (b)(9) of 267 applies the certain charitable organizations. But the history or the purpose of Section 267(b)(9) as its legislative history plainly shows is to prevent the deduction of losses on the sale of property to a charitable organization controlled by the seller. And the rationale of that provision is that since the seller attains effective control of the property, he should not be entitled to the benefit of a loss deduction. But that consideration lends nothing, sheds no light on the meaning of the term “paid” and either Section 267 or 404. My final point is that the proper analogy here is not the Section 267 but to Section 170, which allows in language virtually identical to that of Section 404, a deduction for contributions paid to charitable organizations. The term “paid” is used in Section 170 as it is in Section 404 to ensure that the tax exempt recipient of the contribution will obtain a substantial present benefit, not just the promise of a future benefit as a the result of the transaction giving rise to the tax deduction. For that reason, Section 170 has always been interpreted as requiring more than the giving of a promissory note. The same result for the same reason is appropriate here. Congress intended that the taxpayer should part for something more than its bear promise to part with something in the future for obtaining the benefit of a deduction. Now, petitioner gave only its promise, not as property, the judgment of the Court of Appeals denying the deduction should therefore be affirmed.
Warren E. Burger: Thank you gentlemen, the case is submitted.