Court Opinion

ID: 4483828
Source: CourtListenerOpinion
Date Created: 2020-01-16 21:16:19.549135+00
Date Added: 2024-06-11T14:53:44.704547
License: Public Domain

Chabot, J., dissenting: The majority state: “In short, a substantial legitimate business purpose satisfies the distortion of income test.” (p. 1106 supra). In the context of Rev. Rul. 75-152 (as analyzed by the majority), that statement effectively renders section 446(b) meaningless. Accordingly, I respectfully dissent. The majority cite Sandor v. Commissioner, 62 T.C. 469 (1974), affd. per curiam 536 F.2d 874 (9th Cir. 1976), as having “recognized * * * implicitly” that such a business purpose satisfies the “clear reflection of income” standard provided by section 446(b). Although in Sandor it was found that tax reduction was the predominant motive for the prepayment there in issue (62 T.C. at 481), it does not follow that subordination of that motive to business considerations is sufficient to override section 446(b). This was made clear in Baird v. Commissioner, 68 T.C. 115, 133 (1977), as follows: While we are not altogether convinced that the tax deduction was not a substantial motive in petitioner’s decision to enter into the transaction,16 we are constrained to uphold respondent’s determination whether or not petitioner purposely sought tax relief in the form of a prepaid interest deduction. The existence of a tax motive is but a factor to be considered in determining whether the payment was actually interest, and whether there was an impermissible distortion of income. See Rubnitz v. Commissioner, supra. The issue is whether allowance of the deduction would clearly reflect income; “the test of clear reflection of income is intended to be an objective one,” Cole v. Commissioner, supra at 1105. * * * See, e.g., Resnik v. Commissioner, 66 T.C. 74, 81-82 (1976), affd. per curiam 555 F.2d 634 (7th Cir. 1977); Cole v. Commissioner, 64 T.C. 1091, 1103-1104 (1975), affd. 586 F.2d 747 (9th Cir. 1978); Burck v. Commissioner, 63 T.C. 556, 562 (1975), affd. 533 F.2d 768, 773-774 (2d Cir. 1976). Further, if the majority intend to eliminate the material distortion of income standard from section 446(b) only as it applies to farming, the majority fail to tell us of the reason for the distinction. The Commissioner possesses broad powers in determining whether accounting methods used by a taxpayer clearly reflect income. Commissioner v. Hansen, 360 U.S. 446, 467 (1959). Even if an accounting method may be in accord with generally accepted accounting principles, the requirement that the accounting method clearly reflect income is paramount. Thor Power Tool Co. v. Commissioner, 439 U.S. (1979). The majority note that the cash method of accounting will usually result in some distortions of income, and that over a period of years the distortions will tend to cancel out each other, quoting from Spitalny v. United States, 430 F.2d 195, 197 (9th Cir. 1970). Firstly, in Spitalny, the Court of Appeals held that the taxpayer therein could not both (1) deduct the cost of feed and (2) exclude gain on sale of the feed upon liquidation (under sec. 337). The court there concluded (430 F.2d at 198) that it did not matter whether the correction of the situation was regarded as a disallowance of a deduction under section 446(b) (the same result for which respondent contends in the instant case) or an application of tax benefit principles. Secondly, there is a big difference between showing that deductions even out over a period of years and showing that tax consequences even out over a period of years. This difference can result from, among other things, the time value of money (e.g., accelerated depreciated deduction provisions designed to encourage investment in depreciable property by reducing the current “value” of the investors’ overall tax liabilities), changes in marginal tax brackets (a deduction in a high marginal tax bracket year is worth more than a deduction in a low marginal tax bracket year), and different methods of tax treatment (as illustrated in Spitalny by the playoff of ordinary deductions against nonrecognized gains). We may assume that, if the tax distortions truly canceled out over a number of years in the case before us, the case before us would not be before us. Thirdly, although some distortion clearly is contemplated and acceptable (note the reference in Spitalny to “roughly the same result”), respondent is authorized and expected to prevent a material distortion. In the instant case there clearly has been a material distortion of income. Sandor v. Commissioner, 536 F.2d at 875;1 Baird v. Commissioner, 68 T.C. at 132; Cole v. Commissioner, 64 T.C. at 1104. To paraphrase the language of our opinion in Resnik (66 T.C. at 81), in the instant case, the partnership claimed a loss of $360,400. This was the result because the partnership during its 5-day initial taxable year earned no income and neither paid nor incurred any other deductible expenses. This is more than a distortion of income; it is “a distortion of non-income.” Petitioners have utterly failed to show that the Commissioner abused the discretion granted to him in section 446(b) of the Code in disallowing the prepaid feed deduction to more clearly reflect income. The majority also conclude that by disallowing the feed deduction, the Commissioner is attempting to put the partnership on the inventory method of accounting. This is not necessarily the case. Under section 446, the accounting treatment of an item is unacceptable if, in the Commissioner’s opinion, it does not clearly reflect income. In the instant case, the Commissioner has used the authority granted him under section 446(b) to determine that the partnership’s method of accounting for the $360,400 in prepaid feed expense materially distorts the partnership’s income for 1972, the one year before the Court. The Commissioner may use his powers to correct the treatment of an individual item of income or expense. Sec. 1.446-l(a)(l), Income Tax Regs.; e.g., Resnik v. Commissioner, supra at 78. Thus the Commissioner may disallow the current deduction and prescribe that under these circumstances the deduction should be taken in a different period in order to clearly reflect income as with items under sec. 1.461-l(a), Income Tax Regs. This power to prescribe the treatment of this item of feed expense because petitioners’ treatment does not clearly reflect income does not necessarily determine the appropriate treatment of all feed expense items in future years. Even Rev. Rul. 75-152, 1975-1 C.B. 144, concerning farmers’ deductions for advance payments for livestock feed, provides that generally a taxpayer using the cash receipts and disbursements method of accounting can deduct feed expenses in the year paid. The ruling merely provides that a farmer cannot take a current deduction for prepaid feed expense items that fail to satisfy three tests, one of which is that the deduction not result in a material distortion of income. Also see Resnik v. Commissioner, supra, and Sandor v. Commissioner, supra, where we upheld the Commissioner’s discretion to determine that that taxpayer should be on the accrual method with respect to prepaid interest items which distort income but where it does not follow that that taxpayer is thereby forced on the accrual method for all interest payments in the future. Simpson, J., agrees with this dissenting opinion.   Petitioners’ adjusted gross income for 1970 ($123,449) was considerably higher than he had reported in prior years. (For 1966 it was $36,492; for 1967 it was $67,747; for 1968 it was $53,729; and for 1969 it was $83,957.) For 1970 petitioner reported capital gains in the amount of $20,024 and one item of miscellaneous income of $50,000.   As the majority note, an appeal in the instant ease will lie in the same Court of Appeals that affirmed our decision in Sandor.