Court Opinion

ID: 9425775
Source: CourtListenerOpinion
Date Created: 2023-08-02 23:15:48.89773+00
Date Added: 2024-06-11T17:22:57.475007
License: Public Domain

Mr. Justice White,
with whom Mr. Justice Douglas, Mr. Justice Brennan, and Mr. Justice Powell join,
dissenting.
Ordinarily, gain from the sale of corporate property is taxed to the corporation. Under 26 U. S. C. § 337, however, gain from a sale or exchange occurring within 12 months after the adoption of a plan of liquidation is not recognized or taxed to the corporation. Concededly, the section applies to gain from involuntary conversions such as fire losses compensated by insurance, as long as the event qualifying as the sale or exchange takes place after, rather than before, the adoption of a plan of liquida*692tion. As the Court indicates, the sole issue in this case is when the sale or exchange occurred.
Here, the fire took place on September 10, 1965. The plan of liquidation was not adopted until May 14, 1966. But the destroyed property was insured, and the insurance claims were finally negotiated, settled, and paid after May 14, 1966. The Court holds that the sale or exchange took place at the time of the fire; for in its view, it was the fire that transformed “tangible property into a chose in action consisting of a claim for insurance proceeds . . . .” Ante, at 685.
I disagree. That the fire gave the company a claim under its insurance policies does not mean that the involuntary conversion qualifying as a sale or exchange took place at that moment. It is my view that such a claim does not ripen into a sale or exchange until it has attained a sufficiently definite quality and value to require the gain or loss to be accrued on the books of an accrual-basis taxpayer. It is plain enough for me that no gain was accruable by Central Tablet until after May 14, 1966, and that the sale or exchange therefore took place after rather than before the adoption of the liquidation plan.
The general rule is that “[t]here shall be allowed as a deduction any loss sustained during the taxable year and not compensated for by insurance or otherwise.” 26 U. S. C. § 165 (a). Without doubt, had there not been insurance in this case, Central Tablet would have suffered a deductible loss from the fire and that deduction would have been taken in the year the fire occurred. The ordinary rule also is, however, that deductible losses must be evidenced by closed and completed transactions and fixed by identifiable events. Boehm v. Commissioner, 326 H. S. 287, 291 (1945). In the context of an insured fire loss, where recovery of insurance is uncertain or unrealistic *693the loss is to be taken in the year it occurs. Coastal Terminals, Inc. v. Commissioner, 25 T. C. 1053 (1956); Cahn v. Commissioner, 92 F. 2d 674 (CA9 1937). But if there is a fair prospect of recovering insurance proceeds, the loss is to be postponed until the question of recovery is sufficiently settled. Commissioner v. Harwich, 184 F. 2d 835 (CA5 1950); Boston & M. R. Co. v. Commissioner, 206 F. 2d 617 (CA1 1953); Jeffrey v. Commissioner, 12 T. C. M. 534 (1953).1
*694Similar principles apply to determine when an accrual-basis taxpayer realizes income when an insured fire loss results in taxable gain. Under general principles of accrual accounting, two conditions must be met for income to be accrued in a given taxable year: the taxpayer must have a clear right to the income, and the quantum of the income must be ascertainable within reasonable limits. United States v. Anderson, 269 U. S. 422, 441 (1926); Continental Tie & Lamber Co. v. United States, 286 U. S. 290, 297 (1932); Dixie Pine Co. v. Commissioner, 320 U. S. 516, 519 (1944). “It has long been held that in order truly to reflect the income of a given year, all the events must occur in that year which fix the amount and the fact of the taxpayer’s liability. . . .” Ibid. These *695twin conditions have been formalized by Treas. Reg. § 1.451-1 (a), which provides in relevant part:
“Under an accrual method of accounting, income is includable in gross income when all the events have occurred which fix the right to receive such income and the amount thereof can be determined with reasonable accuracy. . .
These are the governing principles when the issue is whether income from certain insurance policies covering business or personal loss had accrued to the taxpayer. Thus, where an insurance company does not admit liability in the year of the loss, or takes a position in negotiations which makes it quite uncertain whether the bulk of the claim will be recoverable, accrual is improper.2 *696Although it may generally be true that taxpayers seek to delay reporting income, this may not be so when there are large losses in the year of the conversion to absorb the insurance income. In that situation, the Commissioner may advocate that accrual in the year of the loss is improper. See E. T. Slider, Inc. v. Commissioner, 5 T. C. 263 (1945) (accrual improper in year of loss because col-lectibility of insurance proceeds doubtful). The principles of accrual accounting are designed to be neutral, so that the taxpayer may not time his gains and losses in inconsistent fashion to minimize his tax liability.
If normal accrual-accounting principles were to be applied in this case, it is clear that whatever the date on which income accrued to the corporation, it would not be the date of the fire, as the Court of Appeals held. At least some period of time, however short, must be allowed for the taxpayer to determine the extent of loss and to file a timely proof-of-loss form with the insurer. Cf. Thalhimer Bros. v. Commissioner, 27 T. C. 733 (1957). The question then becomes whether the amount should have accrued prior to or during the 12-month period beginning on May 14, 1966, the date on which the liquidation plan was adopted. This is largely a factual question, depending on whether liability was acknowledged, and whether the amount of liability was reasonably ascertainable before or after the adoption of the plan.
As to the issue of liability, there was some disagreement between the District Court and the Court of Appeals. The District Court found that “[a]t no time was an express admission of liability made by taxpayer’s insurance adjusters. Indeed, there is some evidence in the record that the insurance companies denied that notice of claim was properly given.” 339 F. Supp. 1134, 1139. The District Court further found that even if liability *697had been admitted at some point, there was insufficient evidence in the record to determine at what point that admission occurred, even though that subject had been explored at trial. The Court of Appeals, on the other hand, believed that “the insurance carrier questioned neither the validity of the insurance contracts nor the fulfillment of the conditions for payment thereunder ...” 481 F. 2d 954, 956.
However, even accepting the view of the Court of Appeals that liability was not at issue, both courts found that the amount of liability was subject to dispute and negotiation. A number of issues divided the parties throughout the negotiations on the extent of coverage. Negotiations of Central Tablet’s claim for business-interruption loss began on approximately October 8, 1965. Disputes subsequently arose over the estimated period of loss to be covered and the probable duration of the strike had there not been a fire, for the purpose of determining the “actual loss sustained.” No settlement on this claim was negotiated until August 25, 1967, and, on or about September 22, 1967, petitioner received payment of $67,000, as compared with the maximum of $200,000 available under the two policies, which represented petitioner’s initial request in the negotiations.
Negotiation of the building, machinery, and personal property loss claims began on approximately November 1, 1965. On the building insurance policies, dispute focused on a co-insurance clause.3 The District Court *698found that the questions over the applicability of the clause would reduce petitioner's coverage by 43% if the insurance companies prevailed. The parties also disagreed as to the extent of building loss and the value of the building at the time of the loss. Central Tablet accepted a settlement of its claim on approximately May 20, 1966, and, on June 15, 1966, received $174,595.05 in payment, as compared with the $225,000 stated maximum.
Finally, as to the personal property policy, dispute focused on the value of machinery and equipment and the cost of repair of repairable machinery and equipment. On approximately August 25, 1966, Central Tablet accepted a $104,609.27 settlement on this claim, as compared with the $450,000 stated maximum.
The District Court stated that these negotiations were "exceedingly complex and difficult,” and “[i]n each case, substantial discrepancies existed between the initial offers made by the insurance companies, the maximum permissible coverage, and the amounts ultimately negotiated.” 339 F. Supp., at 1139. Due to the factual record before it, the District Court concluded that the insurance proceeds did not accrue until after the plan had been adopted. The court stated that “it would be an utter fiction for us to conclude that the taxpayer realized fixed and estimable income before it adopted a plan of liquidation. ...” Ibid. The Court of Appeals also recognized that there was a dispute over the amount to be paid under each policy. The factual findings of the District Court were consistent with the well-settled rule that accrual is only required when the quantum of income is ascertainable within reasonable limits. On the two insurance policies at issue here, the amounts received, $174,000 on the building policy and $104,000 on the personal property policy, compared with stated máximums of $225,000 and $450,000, respectively. These discrepancies bolster *699the District Court’s conclusion that there were substantial disagreements between the parties.
The general rule is that “[tjaxable income shall be computed under the method of accounting on the basis of which the taxpayer regularly computes his income in keeping his books.” 26 U. S. C. § 446. Central Tablet was an accrual-basis taxpayer, and it is clear that the amount of the insurance proceeds was not ascertainable with reasonable certainty until after May 14, 1966. No gain was accruable prior to that date, and the District Court was clearly right in holding that there had been no involuntary conversion and no sale or exchange prior to the adoption of the plan of liquidation. Absent the insurance policy, there could have been only a casualty loss, no “involuntary conversion” and no “sale or exchange.” And with the various insurance policies owned by the taxpayer, the conversion into cash in an amount reasonably ascertainable did not become sufficiently predictable until after May 14, 1966.
To me, the Government’s position in this case is anomalous. Although in arguing that the “sale or exchange” must be deemed to have occurred on the date of the fire, it was suggested by the Government in the Court of Appeals that if the issue were decided in favor of the Government, then a remand would be in order to determine in which year the gain was taxable. The Court of Appeals, whose judgment is now affirmed, followed this suggestion and remanded the case to the District Court. It is thus possible that the District Court, having already once concluded that the gain was not realized until the period of liquidation had begun in 1966, will reach the same conclusion on remand; but the gain under the Court’s holding will nonetheless be taxable to the corporation. This seems a very odd result, for if insufficient events occurred in 1965 to warrant the accrual of gain by *700an accrual-basis taxpayer, it is incongruous to hold that an involuntary conversion based on the collectibility of insurance proceeds nevertheless occurred at the time of the fire. In the context of the compensated fire loss, the time of realizing gain is the more realistic criterion of when the sale or exchange takes place within the meaning of §337.
The statute does not tell us when an involuntary conversion qualifying as a sale or exchange must be deemed to have taken place. It provides sufficient flexibility so that in ordinary liquidations, sales or exchanges may be negotiated and all but completed by the corporation before the plan is adopted. It is contemplated that the corporate taxpayer may plan the liquidation and the timing of gains and losses from liquidating sales and exchanges. I perceive no reason why Congress would treat those whom accident forces to convert their property into cash any less favorably than those who have total control of whether a sale is to be made at all. If a compensated fire loss qualifies as a sale or exchange, as the Government concedes it does, it appears perfectly consistent with the terms as well as the purpose of § 337 to hold that the qualifying event occurs when the gain is realized and must be accrued. This would place those who are forced to liquidate on a par with those who chose to liquidate and to realize gains without paying the corporate tax.
The Commissioner argues, however, that there is an analogy between the treatment of condemnation “conversions” and losses by accidents. He would apply to compensated fire losses the uniform rule of the courts of appeals that a corporation is not entitled to the benefits of § 337 when property is condemned prior to the adoption of a liquidation plan. Wendell v. Commissioner, 326 F. 2d 600 (CA2 1964); Dwight v. United States, 328 F. 2d 973 (CA2 1964); Covered Wagon, Inc. v. Commissioner, 369 F. 2d 629 (CA8 1966); Likins-Foster Honolulu Corp. *701v. Commissioner, 417 F. 2d 285 (CA10 1969). The rule in condemnation cases, however, is not directly at odds with accrual-accounting principles. Recognition of income is required at the time of a taking which transfers title to the property and creates an immediate obligation upon the condemning authority to pay just compensation. Rev. Rui. 59-108, 1959-1 Cum. Bull. 72. At the time the Government takes title to the property, it offers to pay a certain amount, thereby fixing its liability in a reasonably ascertainable amount. Under federal law, when the United States condemns property, it files its Declaration of Taking and deposits the amount of estimated compensation for the property in court. Covered Wagon, Inc., supra, at 634. The taking vests title in the Government, the condemnee is deprived of his property, and he is certain to recover at least the fair market value estimated by the Government.4
*702This is not the case here. The fire is an irrevocable event and except for the insurance, it would represent a loss immediately accruable. But with insurance coverage, there may be a gain, the amount of which may or may not be reasonably ascertainable, either then or within a short time; and until it is ascertainable, normal rules of accrual accounting would not require any gain to be recognized; and until that occurs the transaction has not sufficiently congealed to qualify as a sale or exchange.
I add a final note. The controlling Treasury Regulations under § 337 provide considerable flexibility to the parties in liquidation situations. Indeed, Treas. Reg. § 1.337-1 provides that “sales may be made before the adoption of the plan of liquidation if made on the same day such plan is adopted.” (Emphasis added.) Thus, even under the Court’s view that the sale or exchange occurs at the time of the fire, § 337 would be available to the property owner if it were sufficiently aware and took sufficient pains to plan in advance to comply with the Regulation or was a closely held corporation that could adopt its liquidation plan before the day of the fire was over. Other taxpayers not so inclined or so circumstanced to provide for contingencies would be foreclosed. Section 337 would remain a trap for the unwary, the precise situation Congress sought to avoid.

 Treas. Reg. §§ 1.165-1 (d) (1) and (2) provide:
“(d) Year of deduction. (1) A loss shall be allowed as a deduction under section 165 (a) only for the taxable year in which the loss is sustained. For this purpose, a loss shall be treated as sustained during the taxable year in which the loss occurs as evidenced by closed and completed transactions and as fixed by identifiable events occurring in such taxable year. For. provisions relating to situations where a loss attributable to a disaster will be treated as sustained in the taxable year immediately preceding the taxable year in which the disaster actually occurred, see section 165 (h) and § 1.165-11.
“(2) (i) If a casualty or other event occurs which may resultan a loss and, in the year of such casualty or event, there exists a claim for reimbursement with respect to which there is a reasonable prospect of recovery, no portion of the loss with respect to which reimbursement may be received is sustained, for purposes of section 165, until it can be ascertained with reasonable certainty whether or not such reimbursement will be received. Whether a reasonable prospect of recovery exists with respect to a claim for reimbursement of a loss is a question of fact to be determined upon an examination of all facts and circumstances. Whether or not such reimbursement will be received may be ascertained with reasonable certainty, for example, by a settlement of the claim, by an adjudication of the claim, or by an abandonment of the claim. When a taxpayer claims that the taxable year in which a loss is sustained is fixed by his abandonment of the claim for reimbursement, he must be able to produce objective evidence of his having abandoned the claim, such as the execution of a release.
“(ii) If in the year of the casualty or other event a portion of the loss is not covered by a claim for reimbursement with respect to *694which there is a reasonable prospect of recovery, then such portion of the loss is sustained during the taxable year in which the casualty or other event occurs. For example, if property having an adjusted basis of $10,000 is completely destroyed by fire in 1961, and if the taxpayer’s only claim for reimbursement consists of an insurance claim for $8,000 which is settled in 1962, the taxpayer sustains a loss of $2,000 in 1961. However, if the taxpayer’s automobile is completely destroyed in 1961 as a result of 'the negligence of another person and there exists a reasonable prospect of recovery on a claim for the full value of the automobile against such person, the taxpayer does not sustain any loss until the taxable year in which the claim is adjudicated or otherwise settled. If the automobile had an adjusted basis of $5,000 and the taxpayer secures a judgment of $4,000 in 1962, $1,000 is deductible for the taxable year 1962. If in 1963 it becomes reasonably certain that only $3,500 can ever be collected on such judgment, $500 is deductible for the taxable year 1963.
“(iii) If the taxpayer deducted a loss in accordance with the provisions of this paragraph and in a subsequent taxable year receives reimbursement for such loss, he does not recompute the tax for the taxable year in which the deduction was taken but includes the amount of such reimbursement in his gross' income for the taxable year in which■ received, subject to the provisions of section 111, relating to recovery of amounts previously deducted.”

 Maryland Shipbuilding & Drydock Co. v. United States, 187 Ct. Cl. 523, 409 F. 2d 1363 (1969) (accrual not required because extent of liability contested by insurance company in negotiations not completed in taxable year); Cappel House Furnishing Co. v. United States, 244 F. 2d 525 (CA6 1957) (liability and approximate amount determined in year of fire because of unreasonable delay of taxpayer in presenting claim, and liability was both clear and could be approximated) ; Georgia Carolina Chemical Co. v. Commissioner, 3 T. C. M. 1213 (1944) (extent of liability not fixed in year of loss because of uncertainty as to whether co-insurance clause, which would reduce coverage, would be invoked by insurance company); Luckenbach S. S. Co. v. Commissioner, 9 T. C. 662 (1947) (amount of recovery on war risk insurance uncertain in years of loss because of controversy between War Shipping Administration and Comptroller General) ; Rite-Way Products v. Commissioner, 12 T. C. 475 (1949) (extent and amount of liability of insurance company known in year of loss); Thalhimer Bros v. Commissioner, 27 T. C. 733 (1957) (where fire occurred six days prior to completion of tax year, insurance proceeds did not accrue because extent of damage still uncertain) ; Curtis Electro Lighting v. Commissioner, 60 T. C. 633 (1973) (accrual not required because insurance company had never admitted to liability in any amount in taxable year); Kurtz v. Commissioner, 8 B. T. A. 679 (1927) (accrual required where insurance company *696had admitted liability and conceded bulk of loss claimed by taxpayer in year of loss).

 This is formally termed a replacement-cost-endorsement coinsurance clause. The insurance adjuster explained at trial that a replacement-cost endorsement is bought by the insured to cover, in the event of compensable loss, the replacement cost of lost property. The co-insurance clause requires that the insured carry coverage up to a sufficient limit so that the premiums will justify the coverage. He additionally explained that, if the premiums are determined not to justify the actual replacement cost, coverage is reduced.

 The Commissioner also seeks to analogize this case to those dealing with computing of the holding period of lost or destroyed property in connection with measuring whether the gain from the sale of a capital asset is taxable as short-term or long-term capital gain or ordinary income. See Rose v. United States, 229 F. Supp. 298, 300 (SD Cal. 1964); Steele v. United States, 52-2 U. S. Tax Cas. ¶ 9451 (SD Fla. 1952). In Bose, which dealt with involuntary conversion in 1960, the holding period of the asset was found to terminate when the ship involved was lost at sea, rather than when insurance proceeds were received. The test for the dating of the end of the holding period is when the benefits or burdens of ownership are transferred or when title passes, whichever occurs first. See Comment, Extending Section 337 to Liquidations Triggered by the Involuntary Conversion of Corporate Assets, 62 Geo. L. J. 1203, 1213 n. 55 (1974). In Bose, when the ship was lost the owners totally abandoned it and gave all rights to salvage income to the insurer. Thus, all rights of ownership were relinquished at the time of the loss. The case does not relate to the timing of the receipt of income, as does the instant case, but only to the period of time a capital asset is held. The parties in Bose did not dispute that the gain, whether it *702was short-term or long-term, as determined by the holding period, was to be recognized in 1960. This was largely because it appears that all relevant events occurred in that year; the loss, admission of liability, and settlement.
In Steele, there was also no dispute as to the timing of recognition. The taxpayer, reporting on a cash basis, received insurance in 1944 for the loss which occurred in 1943. The Commissioner asserted a deficiency for 1944- Even though the court held that there was not a 6-month holding period, so that the gain was ordinary income, it was still incurred in 1944, the date of the receipt of insurance proceeds, and not in 1943, the date of the loss of the vessel.