Court Opinion

ID: 4472345
Source: CourtListenerOpinion
Date Created: 2020-01-13 23:23:34.645166+00
Date Added: 2024-06-11T13:39:36.822387
License: Public Domain

Gerber, J., dissenting: I respectfully disagree with the majority’s holding that petitioner’s method of accounting for its settlement agreements does not clearly reflect income. The controversy in this case concerns the proper amount and timing of petitioner’s accrual and deduction of 1980 tort claim settlements. Petitioner, for tax reporting purposes, is on the accrual method of accounting and has met the regulatory and case law requirements for accrual under the all events test. Respondent does not argue that petitioner manipulated accrual accounting methodology, or that the transactions lack substance or were designed for tax-avoidance purposes. Instead, respondent argues that the period between the deduction and payment is too long and distorts income, and that petitioner is entitled to deduct only the present value of its obligations to claimants under the structured settlements. That position is rooted in time value of money concepts and ignores established legal principles concerning the accrual method of accounting (the all events test) and results in the retroactive application of 1984 legislation.1 Respondent’s determination is accordingly without an adequate basis in law, plainly arbitrary, and, therefore, an abuse of discretion under section 446(b). Until 1984, the courts looked to the all events test as the standard to determine, for tax purposes, whether an obligation could be accrued and deducted. All Events Test — The majority holds that, even assuming that the transactions pass the all events test, respondent may disallow a taxpayer’s deduction because it does not clearly reflect income when subjected to a time value analysis. The majority declares that petitioner has the burden of proving that respondent’s determination is an abuse of discretion. In order to meet that burden, petitioner would be required to show the lack of “any adequate basis in law for the Commissioner’s conclusion.” (Majority op. p. 92.) The majority’s analysis is flawed because the all events test contains the standard by which accruals are measured.2 Therefore, an analysis of the all events test is necessary to decide whether respondent had an adequate basis in law for her determination. Under such an analysis, the majority reached the wrong conclusion because petitioner has shown here that there is no adequate basis in law for respondent’s conclusion. The all events test was judicially devised to measure whether an item can be accrued and deducted. Meeting the all events test normally qualifies a taxpayer for a deduction under the accrual method of accounting for a 1980 taxable year.3 United States v. Hughes Properties, Inc., 476 U.S. 593, 600 (1986). The all events test was formulated in case law more than 50 years ago and has long been embodied in section 1.461-l(a)(2), Income Tax Regs., which contains the following two requirements: Under an accrual method of accounting, an expense is deductible for the taxable year in which [1] all the events have occurred which determine the fact of the liability and [2] the amount thereof can be determined with reasonable accuracy. * * * The Supreme Court in United States v. Hughes Properties, Inc., supra at 599, 604, made clear that “An accrual-method taxpayer is entitled to deduct an expense in the year in which it is ‘incurred,’ § 162(a), regardless of when it is actually paid” and that “the accrual method itself makes irrelevant the timing factor that controls when a taxpayer uses the cash receipts and disbursements method.” (Pn. ref. omitted.) The majority has incorrectly treated the holding in Hughes Properties as though it was purely factual in an effort to distinguish the facts of Hughes Properties without reconciling its foundational legal principles. Neither the legal principles 4 nor the factual context of Hughes Properties suggest or support the result reached by the majority. The majority is correct in its articulation that respondent is not preempted from questioning whether an accounting method or the particular treatment of a specific item under an accounting method clearly reflects income. But the fact that the deduction occurs prior to the payment (the timing factor) does not, by itself, cause the accrual to run afoul of the clear reflection requirement or the all events test. Id. The majority focuses upon the method by which petitioner funds its obligations and decides that petitioner is entitled to deduct only its true economic cost, which the majority holds is the cost of the annuities purchased to fund the obligations. In a pre-1984 setting, the majority’s consideration of the taxpayer’s method of funding in evaluating an accrual accounting method question results in treating taxpayers differently depending upon whether they funded their obligations. Further, those taxpayers who were better at or more successful in their funding approach would be treated differently from those who were less successful. The question of funding or current cost of a transaction is unique to the cash accounting method, whereas the accrual accounting method is concerned with the obligation to pay or right to receive. Accordingly, the all events test must be the proper pre-1984 measure of the amount of an obligation and whether it is deductible. Here, petitioner passed that test and so there must be some abuse or other reasoning by which to measure or show how income was not clearly reflected. The majority has not found or explained that cause or abuse. In Hughes Properties, the Government argued that taxpayers would be able to meet the all events test but that a transaction might still not clearly reflect income. The Supreme Court indicated that “Nothing in * * * [that] record even intimates that * * * [the taxpayer] used its progressive machines for tax-avoidance purposes” and pointed out that the Commissioner had authority under section 446(b) to curb abuse which might occur in other cases. Id. at 605. The type of abuse that the Supreme Court suggested that respondent could curb is not present in this case. The majority relies upon Prabel v. Commissioner, 91 T.C. 1101 (1988), affd. 882 F.2d 820 (3d Cir. 1989), a tax shelter type case where the transactions were contrived to produce tax benefits. In Prabel the taxpayer used an accelerated method of computing interest (Rule of 78 method) that bunches interest deductions on the front end of a payment schedule. Distortion was found because the proposed obligation was for an extended period and a substantial portion of the deductions was taken early in the life of the stream of payments. It was the use of an accelerated computation method that caused the distortion in Prabel, and this Court found that the Rule of 78 method was not appropriate for long-term payment schedules. In the context of Prabel, the Commissioner and this Court had available established alternative methods of reporting the transaction that more clearly reflected income. Petitioner here does not use an accelerated method or any methodology different from other taxpayers using the accrual method of accounting for pre-1984 tax purposes. Nor has the majority found that the accrual method is only appropriate for shorter term transactions. It is only by the use of a time value of money analysis and consideration of the method by which petitioner funds its obligations that the difference between the amount of the deduction accrued and the time value cost to petitioner is even revealed. The majority, however, has not discussed the fact that all accrual basis taxpayers have a time value benefit due to the accrual. Additionally, there is no analysis showing at what point the passage of time makes a particular accrual abusive or distorts income. Finally, without the time value analysis, it would not be possible to show that petitioner’s transaction does or does not clearly reflect income. Respondent does not challenge the accrual principle that the deduction and payment may fall in different tax periods. Instead, it is the time lapse and time value concepts that respondent contends are the cause for the lack of clear reflection determination regarding petitioner’s claimed deductions. Respondent’s contention raises the inquiries of whether the passage of time and/or matching of income and deductions concepts singly or jointly do or should result in petitioner’s income not being clearly reflected. A single case was cited by respondent and referenced by the majority in support of the position that accrued obligations that have been incurred are not deductible solely because of remoteness or differences between the time of the accrual and the payment. The majority recognizes the paucity of authority and/or explanation in that case. Mooney Aircraft, Inc. v. United States, 420 F.2d 400 (5th Cir. 1969) (a 1969 opinion which was issued without the benefit of the Supreme Court’s 1986 opinion in United States v. Hughes Properties, Inc., supra). Furthermore, Mooney is distinguishable from this case. Mooney involved an aircraft manufacturer that issued $1,000 “bonds” in connection with the sale of aircraft. The bond was redeemable by the then owner of the aircraft at the time of the aircraft’s ultimate retirement. In the year of sale, the taxpayer deducted $1,000 for each aircraft sold. The Court of Appeals for the Fifth Circuit,5 after holding that the all events test had been met, held that the $1,000 deductions in the year of sale did not clearly reflect income for two integrated reasons: (1) “many or possibly most of the expenses which taxpayer wishes to presently deduct will not actually be paid for 15, 20 or even 30 years”; and (2) “The longer the time the less probable it becomes that the liability, though incurred, will ever in fact be paid.” Mooney Aircraft, Inc. v. United States, supra at 409, 410. The first reason advanced in Mooney addresses the same question that was addressed in United States v. Hughes Properties, Inc., supra; i.e., that payment will not occur in the year of accrual. In Hughes Properties the taxpayer was obligated under State law to pay a gaming machine jackpot, but at the close of the taxable year no winner had been identified. Further, it was possible that the jackpot would not be won for several accounting periods. The Supreme Court in Hughes Properties held that the amount of the jackpot payable in that case was fixed and determinable despite the timelag. In this regard, businesses may accrue and pay obligations based upon differing facts and circumstances. It is arbitrary to establish a rule that any particular length of time, ipso facto, would result in the denial of an otherwise accruable deduction. Petitioner here did not autonomously choose the number of years for payment in order to obtain a current deduction. The deductions are claimed in connection with settlements of the contested claims of adversarial third parties. Petitioner did not have unfettered control over the timing of the payments. Moreover, in Burnham Corp. v. Commissioner, 90 T.C. 953, 959-960 (1988), affd. 878 F.2d 86 (2d Cir. 1989), we found Mooney to be both inapposite to and distinguishable from situations such as this one involving payments under a settlement agreement which commenced contemporaneously with the accrual and claimed deduction. Finally, the discussion in the Mooney opinion seems to blur the distinction between the all events test and the measurement of the clear reflection of income. Although the discussion in Mooney straddles both concepts, it appears more aptly to be rooted in the principles of the all events test. In Mooney, it was stated that the taxpayer had passed both prongs of the all events test. Notwithstanding that holding, the reasons provided for disallowing the $1,000 deductions would just as easily have supported the holding that the all events test had not been met. The majority opinion in this case follows the same erroneous approach as was followed in Mooney. Application of 1984 Legislation — It is significant to note that the majority has, for the first time in a taxable year prior to the enabling 1984 tax legislation, permitted respondent to require an accrual basis taxpayer to use time value standards to measure accrual transactions. Although the accruals and deductions here may represent extreme examples of the deferral concept inherent in the accrual method, respondent was not justified in denying the deduction as decided by the majority. Congress, by enacting section 461(h)(2)(C)(ii) in the 1984 Tax Act, specifically required all taxpayers to, in essence, use the cash method to account for periodic payments made pursuant to tort settlements occurring after July 18, 1984. That statute provides that, for certain described items, “the all events test shall not be treated as met any earlier than when economic performance * * * occurs.” Deficit Reduction Act of 1984, Pub. L. 98-369, sec. 91(a), 98 Stat. 494, 598. Section 461(h) is prospective only and was described in the legislative history in the following manner: “the rules relating to the time for accrual of a deduction by a taxpayer using the accrual method of accounting should be changed to take into account the time value of money.” S. Prt. 98-169, at 266 (1984).6 Accordingly, to the extent that as a matter of tax policy the accrual method may be inappropriate to account for structured settlements, it has been prospectively remedied by the 1984 legislation.7  But for the addition of section 461(h) and the time value approaches in a limited number of other sections of the Internal Revenue Code,8 courts have not heretofore held that respondent is empowered to employ time value principles in a clear reflection analysis. See Follender v. Commissioner, 89 T.C. 943 (1987); Pritchett v. Commissioner, T.C. Memo. 1989-21, affd. without published opinion 944 F.2d 909 (9th Cir. 1991), affd. without published opinion sub nom. Buchbinder v. Commissioner, 994 F.2d 908 (9th Cir. 1991); Henkind v. Commissioner, T.C. Memo. 1992-555. The parade of “horribles” described in the majority’s examples are brought to light only through a time value or present value analysis. Matching of Income and Deductions — The majority holds that petitioner’s method of accounting for financial purposes results in a better matching of income and deductions than the method used for tax purposes. As rationale for this holding, the majority points out that for financial purposes, petitioner expenses only the cost of the annuity to fund its obligation or the present value of their obligation. “As * * * [the majority] [sees] it, the true economic costs of petitioner’s losses to the tort claimants are the amounts it paid for the annuities.” Majority op. p. 104. The majority’s holding and analysis does not address the concept of matching.9 Instead, time value concepts — “true economic cost” and petitioner’s financial accounting method— are the focus of and rationale provided for the majority’s holding. In this regard, it is well established that financial and tax accounting may and do vary. Thor Power Tool Co. v. Commissioner, 439 U.S. 522 (1979). Although it may seem incongruous that a large numerical difference can exist between financial and tax accounting, such differences have long been recognized. Because petitioner was on the accrual method, it was entitled to accrue and deduct10 the amount permitted under the regulation and the all events test. More importantly, although financial accounting standards may have permitted the use of time value or present value analysis under the accrual method, such was not the case for the use of accrual method for tax purposes as it had developed and was in effect for the 1980 tax year. Again, the majority has not addressed the basic concepts underlying the accrual method. Those concepts do not focus upon actual payment or receipt, but rather upon the obligation to pay or the right to receive.11 Other than their reliance on the lapse of time, the majority does not attempt to explain why income is not clearly reflected or at what point in the infinite possibilities of taxpayers’ payment obligations the distortion may or could occur. The majority has not found any abuse or misapplication of the principles involved in petitioner’s practice or methodology and, accordingly, petitioner’s 1980 claim of $24,477,699 for structured settlements clearly reflects income for tax purposes.12  Abuse of Discretion — Here, randomly occurring human injury or death provoked controversy and the eventual settlement of claims. Settlements were reached between adversarial parties and were not contrived. Petitioner was not compelled or required to ignore the potential for a tax advantage because the claim being settled was founded in human pain and suffering. The time value analysis and related examples described in the majority opinion infer that iniquitous or sinister benefits inure to petitioner. There has been no finding here that petitioner, singly or in collusion with the claimants, caused or arranged these transactions merely or primarily to effectuate a tax benefit or that the transactions were without substance. Admittedly, petitioner here is aggressively pursuing an established tax accounting principle, but the transaction passes all of the traditional tests. This is a type of exploitation which Congress must address as it did in the 1984 Tax Act and is a policy matter beyond the fiat given to respondent in section 446 and beyond the authority of this Court to change. Although broad statutory discretion is vested in the Commissioner, a taxpayer cannot be required to change from an accounting method that clearly reflects income because the Commissioner considers an alternate method to more clearly reflect income. Molsen v. Commissioner, 85 T.C. 485, 498 (1985); Peninsula Steel Products & Equip. Co. v. Commissioner, 78 T.C. 1029, 1045 (1982); Fort Howard Paper Co. v. Commissioner, 49 T.C. 275 (1967).13 Similarly, if a taxpayer’s method of accounting is specifically authorized by the Internal Revenue Code or the underlying regulations and has been applied on a consistent basis, respondent has not been allowed to arbitrarily require a change or reject the taxpayer’s method. RLC Industries Co. v. Commissioner, 98 T.C. 457, 491-492 (1992); Prabel v. Commissioner, 91 T.C. 1101, 1112 (1988), affd. 882 F.2d 820 (3d Cir. 1989); Hallmark Cards, Inc. v. Commissioner, 90 T.C. 26, 31 (1988). In general, a method of accounting clearly reflects income when it results in accurately reported taxable income under a recognized method of accounting. Wilkinson-Beane, Inc. v. Commissioner, 420 F.2d 352, 354 (1st Cir. 1970), affg. T.C. Memo. 1969-79; Caldwell v. Commissioner, 202 F.2d 112, 115 (2d Cir. 1953), affg. a Memorandum Opinion of this Court; Herberger v. Commissioner, 195 F.2d 293 (9th Cir. 1952), affg. a Memorandum Opinion of this Court; Rotolo v. Commissioner, 88 T.C. 1500, 1513 (1987). Respondent has the authority under section 446(b) to curb abuse. However, as in United States v. Hughes Properties, Inc., supra, there is nothing in this record to indicate that petitioner set up the settlement agreements for tax avoidance purposes. Instead, petitioner minimized its tax liability while complying with the tax laws in force and effect during 1980. No authority existed for 1980 tax year to impose time value of money concepts in the reporting of transactions under the accrual method of accounting. Respondent’s use of such concepts for transactions prior to 1984 is arbitrary. Accordingly, I would hold that respondent’s disallowance of petitioner’s deduction was not adequately based in law and results in an abuse of discretion in this case. Shields and Chiechi, JJ., agree with this dissent.   Prior to the Deficit Reduction Act of 1984, Pub. L. 98-369, sec. 91(a), 98 Stat. 494, 598 (1984 Tax Act), time value of money standards did not play a role in the use of the accrual method of accounting for Federal tax purposes.    The majority, by assuming that the all events test was met, has ignored the standards encompassed in that test for determining whether an item is deductible under the accrual method of accounting for income tax purposes. Assuming arguendo that the majority could determine that the reporting of a particular transaction clearly reflects income without reference to the all events test, the majority has not used the proper measure to reach its conclusion. If a taxpayer’s transaction meets the statutory and regulatory standard and measure for accrual, then, under case law, the Commissioner has authority to inquire about any abuse which may cause income not to be clearly reflected. The Commissioner, however, cannot invent or create a method for which there is no adequate basis in law. An abuse could occur in the manner that a taxpayer applies or manipulates a tax accounting method. But here petitioner applied the method in accord with case law and the regulations, and no tax avoidance purpose or manipulation has been found by the majority.    Ordinarily, when a taxpayer has satisfied both prongs of the all events test, our inquiry would be complete. This is so because the two prongs address the questions of whether the obligation was fixed and, if fixed, its amount.    Neither United States v. Hughes Properties, Inc., 476 U.S. 593 (1986), nor any other case provides an established legal principle or standard that would require accrual method taxpayers to report structured settlements on a present value basis or using concepts of time value.    Appeal of the decision in this case would ordinarily be taken to the Court of Appeals for the Sixth Circuit.    The majority points out that the legislative history concerning sec. 461(h) does not indicate that respondent did not have the authority to use time value analysis in an accrual tax accounting situation. But that is not to say that any basis in law or fact existed prior to the enactment of sec. 461(h) upon which respondent could have based the determination that petitioner’s claimed accrual for tax purposes does not clearly reflect income.    It should be noted that the regulations applicable to similar transactions occurring after the prospective effect of the 1984 Tax Act were issued in T.D. 8408, 1992-1 C.B. 155. Sec. 1.461— 4 and, more specifically, sec. 1.461-4(g)(2), Income Tax Regs., explain and address the concept of economic performance (a time value concept) concerning structured settlements, but are not applicable to the transactions in this case because they occurred prior to the effective date. See sec. 1.461-4(g)(8), Example (1), Income Tax Regs.    See secs. 163(e), 483, 1232, 1272-1275, 7872.    “Matching” is a term used to describe the accounting principle involving attempts to associate related deductions and income in the same accounting period. Matching, however, is a desired goal of financial accounting, but it has not been cast as an overriding rule of tax accounting. See United States v. Hughes Properties, Inc., 476 U.S. at 603-604; Eastman Kodak Co. v. United States, 209 Ct. Cl. 365, 534 F.2d 252, 255-256 (1976); RLC Industries Co. v. Commissioner, 98 T.C. 457, 497 (1992).    If petitioner reported its income and deductions under the cash method of accounting, it would be limited to the actual payments it made, either cost of the annuities or the amount of the payments to the claimants if no annuity were purchased.    It should be recognized that the accrual method works in a correlative manner with respect to deductions and income. Accordingly, some taxpayers are required to include in income amounts which they might not receive for an extended period of time in the same manner as petitioner may be entitled to deduct amounts which are not paid for an extended period. There is no forced or artificial manipulation here — instead, the limits of the accrual methodology are being tested. One could surmise that in enacting sec. 461(h), Congress recognized there is no inherent limit and no practical way to devise a bright line beyond which taxpayers would generally not be entitled to accrue an item for tax purposes.    We are not in a position to decide which approach represents the best or most appropriate tax policy. Our opinion should be based upon the statutes, regulations, and case precedent. It should be noted that the majority’s approach is statutorily mandated for settlements occurring after July 18, 1984.    See also Applied Communications, Inc. v. Commissioner, T.C. Memo. 1989-469.