Until 1970, Illinois imposed a property tax on shares of stock
held in incorporated banks, but in 1970 the Illinois Constitution
was amended to prohibit such taxes. The Illinois courts thereafter
held that the amendment violated the Federal Constitution, but,
pending disposition of the case in this Court, Illinois enacted a
statute providing for collection of the disputed taxes and
placement of the receipts in escrow. Petitioner Bank in No. 81-485
paid the taxes for its shareholders in 1972, taking the deduction
for the amount of the taxes pursuant to § 164(e) of the Internal
Revenue Code of 1954 (IRC), which grants a corporation a deduction
for taxes imposed on its shareholders but paid by the corporation
and denies the shareholders any deduction for the tax. The
authorities placed the receipts in escrow. After this Court upheld
the constitutional amendment, the amounts in escrow were refunded
to the shareholders. When petitioner, on its federal income tax
return for 1973, recognized no income from this sequence of events,
the Commissioner of Internal Revenue assessed a deficiency against
petitioner, requiring it to include as income the amount paid its
shareholders from the escrow. Petitioner then sought a
redetermination in the Tax Court, which held that the refund of the
taxes was includible in petitioner's income. The Court of Appeals
affirmed. In No. 81-930, respondent corporation, which operated a
dairy, in the taxable year ending June 30, 1973, deducted the full
cost of the cattle feed purchased for use in its operations as
permitted by § 162 of the IRC, but a substantial portion of the
feed was still on hand at the end of the taxable year. Two days
into the next taxable year, respondent adopted a plan of
liquidation and distributed its assets, including the cattle feed,
to its shareholders. Relying on § 336 of the IRC, which shields a
corporation from the recognition of gain on the distribution of
property to its shareholders on liquidation, respondent reported no
income on the transaction. The Commissioner challenged respondent's
treatment of
Page 460 U. S. 371
the transaction, asserting that it should have included as
income the value of the feed distributed to the shareholders, and
therefore increased respondent's income by $60,000. Respondent paid
the resulting assessment and sued for a refund in Federal District
Court, which rendered a judgment in respondent's favor. The Court
of Appeals affirmed.
Held:
1. Unless a nonrecognition provision of the IRC prevents it, the
tax benefit rule ordinarily applies to require the inclusion of
income when events occur that are fundamentally inconsistent with
an earlier deduction. Pp.
460 U. S.
377-391.
2. In No. 81-485, the tax benefit rule does not require
petitioner to recognize income with respect to the tax refund. The
purpose of § 164(e) was to provide relief for corporations making
payments for taxes imposed on their shareholders, the focus being
on the act of payment, rather than on the ultimate use of the funds
by the State. As long as the payment itself was not negated by a
refund to the corporation, the change in character of the funds in
the hands of the State does not require the corporation to
recognize income. Pp.
460 U. S.
391-395.
3. In No. 81-930, however, the tax benefit rule requires
respondent to recognize income with respect to the distribution of
the cattle feed to its shareholders on liquidation. The
distribution of expensed assets to shareholders is inconsistent
with the earlier deduction of the cost as a business expense.
Section 336, which clearly does not shield the taxpayer from
recognition of all income on distribution of assets, does not
prevent application of the tax benefit rule in this case. Section
336's legislative history, the application of other general rules
of tax law, and the construction of identical language in § 337,
which governs sales of assets followed by distribution of the
proceeds in liquidation and shields a corporation from the
recognition of gain on the sale of the assets, all indicate that §
336 does not permit a liquidating corporation to avoid the tax
benefit rule. Pp.
460 U. S.
395-402.
No. 81-485, 641 F.2d 529, reversed; No. 81-930, 645 F.2d 19,
reversed and remanded.
O'CONNOR, J., delivered the opinion of the Court, in which
BURGER, C.J., and WHITE, POWELL, and REHNQUIST, JJ., joined, and in
Parts I, II, and IV of which BRENNAN, J., joined. BRENNAN, J.,
filed an opinion concurring in part and dissenting in
part,
post, p.
460 U. S. 403.
STEVENS, J., filed an opinion concurring in the judgment in part
and dissenting in part, in which MARSHALL, J., joined,
post, p.
460 U. S. 403.
BLACKMUN, J., filed a dissenting opinion,
post, p.
460 U. S.
422.
Page 460 U. S. 372
JUSTICE O'CONNOR delivered the opinion of the Court.
These consolidated cases present the question of the
applicability of the tax benefit rule to two corporate tax
situations: the repayment to the shareholders of taxes for which
they were liable, but that were originally paid by the corporation,
and the distribution of expensed assets in a corporate liquidation.
We conclude that, unless a nonrecognition provision of the Internal
Revenue Code prevents it, the tax benefit rule ordinarily applies
to require the inclusion of income when events occur that are
fundamentally inconsistent with an earlier deduction. Our
examination of the provisions granting the deductions and governing
the liquidation in these cases leads us to hold that the rule
requires the recognition of income in the case of the liquidation,
but not in the case of the tax refund.
I
In No. 81-485,
Hillsboro National Bank v. Commissioner,
the petitioner, Hillsboro National Bank, is an incorporated bank
doing business in Illinois. Until 1970, Illinois imposed a property
tax on shares held in incorporated banks. Ill.Rev.Stat., ch. 120, §
557 (1971). Banks, required to retain earnings sufficient to cover
the taxes, § 558, customarily paid
Page 460 U. S. 373
the taxes for the shareholders. Under § 164(e) of the Internal
Revenue Code of 1954, 26 U.S.C. § 164(e), [
Footnote 1] the bank was allowed a deduction for the
amount of the tax, but the shareholders were not. In 1970, Illinois
amended its Constitution to prohibit
ad valorem taxation
of personal property owned by individuals, and the amendment was
challenged as a violation of the Equal Protection Clause of the
Federal Constitution. The Illinois courts held the amendment
unconstitutional in
Lake Shore Auto Parts Co. v.
Korzen, 49 Ill. 2d
137,
273 N.E.2d
592 (1971). We granted certiorari, 405 U.S. 1039 (1972), and,
pending disposition of the case here, Illinois enacted a statute
providing for the collection of the disputed taxes and the
placement of the receipts in escrow. Ill.Rev.Stat., ch. 120, �
676.01 (1979). Hillsboro paid the taxes for its shareholders in
1972, taking the deduction permitted by § 164(e), and the
authorities placed the receipts in escrow. This Court upheld the
state constitutional amendment in
Lehnhausen v. Lake Shore Auto
Parts Co., 410 U. S. 356
(1973). Accordingly, in 1973, the County Treasurer refunded the
amounts in escrow that were attributable to shares held by
individuals, along with accrued interest. The Illinois courts held
that the refunds belonged to the shareholders, rather than to the
banks.
See Bank & Trust Co. of Arlington Heights v.
Cullerton, 25 Ill.App.3d 721, 726, 324 N.E.
Page 460 U. S. 374
2d 29, 32 (1975) (alternative holding);
Lincoln National
Bank v. Cullerton, 18 Ill.App.3d 953, 310 N.E.2d 845 (1974).
Without consulting Hillsboro, the Treasurer refunded the amounts
directly to the individual shareholders. On its return for 1973,
Hillsboro recognized no income from this sequence of events.
[
Footnote 2] The Commissioner
assessed a deficiency against Hillsboro, requiring it to include as
income the amount paid its shareholders from the escrow. Hillsboro
sought a redetermination in the Tax Court, which held that the
refund of the taxes, but not the payment of accrued interest, was
includible in Hillsboro's income. On appeal, relying on its earlier
decision in
First Trust and Savings Bank of Taylorville v.
United States, 614 F.2d 1142 (1980), the Court of Appeals for
the Seventh Circuit affirmed. 641 F.2d 529, 531 (1981).
In No. 81-930,
United States v. Bliss Dairy, Inc., the
respondent, Bliss Dairy, Inc., was a closely held corporation
engaged in the business of operating a dairy. As a cash basis
taxpayer, in the taxable year ending June 30, 1973, it deducted
upon purchase the full cost of the cattle feed purchased for use in
its operations, as permitted by § 162 of the Internal Revenue Code,
26 U.S.C. § 162. [
Footnote 3] A
substantial portion of the feed was still on hand at the end of the
taxable year. On July 2, 1973, two days into the next taxable year,
Bliss adopted a plan of liquidation, and, during the month of July,
it distributed its assets, including the remaining cattle feed, to
the shareholders. Relying on § 336, which shields the corporation
from the recognition of gain on the distribution
Page 460 U. S. 375
of property to its shareholders on liquidation, [
Footnote 4] Bliss reported no income on the
transaction. The shareholders continued to operate the dairy
business in noncorporate form. They filed an election under § 333
to limit the gain recognized by them on the liquidation, [
Footnote 5] and they therefore
calculated their basis in the assets received in the distribution
as provided
Page 460 U. S. 376
in § 334(c). [
Footnote 6]
Under that provision, their basis in the assets was their basis in
their stock in the liquidated corporation, decreased by the amount
of money received, and increased by the amount of gain recognized
on the transaction. They then allocated that total basis over the
assets, as provided in the regulations, Treas.Reg. § 1.334-2, 26
CFR § 1.334-2 (1982), presumably taking a basis greater than zero
in the feed, although the amount of the shareholders' basis is not
in the record. They in turn deducted their basis in the feed as an
expense of doing business under § 162. On audit, the Commissioner
challenged the corporation's treatment of the transaction,
asserting that Bliss should have taken into income the value of the
grain distributed to the shareholders. He therefore increased
Bliss' income by $60,000. Bliss paid the resulting assessment and
sued for a refund in the District Court for the District of
Arizona, where it was stipulated that the grain had a value of
$56,565,
see Pretrial Order, at 3. Relying on
Commissioner v. South Lake Farms, Inc., 324 F.2d 837 (CA9
1963), the District Court rendered a judgment in favor of Bliss.
While recognizing authority to the contrary,
Tennessee-Carolina
Transportation, Inc. v. Commissioner, 582 F.2d 378 (CA6 1978),
cert. denied, 440 U.S. 909 (1979), the Court of Appeals
saw
South Lake Farms as controlling, and affirmed. 645
F.2d 19 (CA9 1981) (per curiam).
Page 460 U. S. 377
II
The Government [
Footnote 7]
in each case relies solely on the tax benefit rule -- a judicially
developed principle [
Footnote
8] that allays some of the inflexibilities of the annual
accounting system. An annual accounting system is a practical
necessity if the federal income tax is to produce revenue
ascertainable and payable at regular intervals.
Burnet v.
Sanford & Brooks Co., 282 U. S. 359,
282 U. S. 365
(1931). Nevertheless, strict adherence to an annual accounting
system would create transactional inequities. Often an apparently
completed transaction will reopen unexpectedly in a subsequent tax
year, rendering the initial reporting improper. For instance, if a
taxpayer held a note that became apparently uncollectible early in
the taxable year, but the debtor made an unexpected financial
recovery before the close of the year and paid the debt, the
transaction would have no tax consequences for the taxpayer, for
the repayment of the principal would be recovery of capital. If,
however, the debtor's financial recovery and the resulting
repayment took place after the close of the taxable year, the
taxpayer would have a deduction for the apparently bad debt in the
first year under § 166(a) of the Code, 26 U.S.C. § 166(a). Without
the tax benefit rule, the repayment in the second year,
representing a return of capital, would not be taxable. The second
transaction, then, although economically identical to the first,
could, because of the differences in accounting, yield drastically
different tax consequences. The Government, by allowing a deduction
that it could not have known to be improper at the time, would be
foreclosed [
Footnote 9]
Page 460 U. S. 378
from recouping any of the tax saved because of the improper
deduction. [
Footnote 10]
Recognizing and seeking to avoid the possible distortions of
income, [
Footnote 11] the
courts have long required the
Page 460 U. S. 379
taxpayer to recognize the repayment in the second year as
income.
See, e.g., Estate of Block v. Commissioner, 39 B.
T. A. 338 (1939),
aff'd sub nom. Union Trust Co. v.
Commissioner, 111 F.2d 60 (CA7),
cert. denied, 311
U.S. 658 (1940);
South Dakota Concrete Products Co. v.
Commissioner,
Page 460 U. S. 380
26 B.T.A. 1429 (1932); Plumb, The Tax Benefit Rule Today, 57
Harv.L.Rev. 129, 176, 178, and n. 172 (1943) (hereinafter Plumb).
[
Footnote 12]
Page 460 U. S. 381
The taxpayers and the Government in these cases propose
different formulations of the tax benefit rule. The taxpayers
contend that the rule requires the inclusion of amounts recovered
in later years, and they do not view the events in these cases as
"recoveries." The Government, on the other hand, urges that the tax
benefit rule requires the inclusion of amounts previously deducted
if later events are inconsistent with the deductions; it insists
that no "recovery" is necessary to the application of the rule.
Further, it asserts that the events in these cases are inconsistent
with the deductions taken by the taxpayers. We are not in complete
agreement with either view.
An examination of the purpose and accepted applications of the
tax benefit rule reveals that a "recovery" will not always be
necessary to invoke the tax benefit rule. The purpose of the rule
is not simply to tax "recoveries." On the contrary, it is to
approximate the results produced by a tax system based on
transactional, rather than annual, accounting.
See
generally Bittker & Kanner 270; Byrne, The Tax Benefit
Rule as Applied to Corporate Liquidations and Contributions to
Capital: Recent Developments, 56 Notre Dame Law. 215, 221, 232,
(1980); Tye, The Tax Benefit Doctrine Reexamined, 3 Tax L.Rev. 329
(1948) (hereinafter Tye). It has long been accepted that a taxpayer
using accrual accounting who accrues and deducts an expense in a
tax year before it becomes payable and who for some reason
eventually does not have to
Page 460 U. S. 382
pay the liability must then take into income the amount of the
expense earlier deducted.
See, e.g., Mayfair Minerals, Inc. v.
Commissioner, 456 F.2d 622 (CA5 1972) (per curiam);
Bear
Manufacturing Co. v. United States, 430 F.2d 152 (CA7 1970),
cert. denied, 400 U.S. 1021 (1971);
Haynsworth v.
Commissioner, 68 T.C. 703 (1977),
affirmance order,
609 F.2d 1007 (CA5 1979);
G. M. Standifer Construction Corp. v.
Commissioner, 30 B.T.A. 184, 186-187 (1934),
petition for
review dism'd, 78 F.2d 285 (CA9 1935). The bookkeeping entry
canceling the liability, though it increases the balance sheet net
worth of the taxpayer, does not fit within any ordinary definition
of "recovery." [
Footnote 13]
Thus, the taxpayers' formulation of the rule neither serves the
purposes of the rule nor accurately reflects the cases that
establish the rule. Further, the taxpayers' proposal would
introduce an undesirable formalism into the application of the tax
benefit rule. Lower courts have been able to stretch the definition
of "recovery" to include a great variety of events. For instance,
in cases of corporate liquidations, courts have viewed the
corporation's receipt of its own stock as a "recovery," reasoning
that, even though, the instant that the corporation receives the
stock, it becomes worthless, the stock has value as it is turned
over to the corporation, and that ephemeral value represents a
recovery for the corporation.
Page 460 U. S. 383
See, e.g., Tennessee-Carolina Transportation, Inc. v.
Commissioner, 582 F.2d at 382 (alternative holding). Or
payment to another party may be imputed to the taxpayer, giving
rise to a recovery.
See First Trust and Saving Bank of
Tayorville v. United States, 614 F.2d at 1146 (alternative
holding). Imposition of a requirement that there be a recovery
would, in many cases, simply require the Government to cast its
argument in different and unnatural terminology, without adding
anything to the analysis. [
Footnote 14]
The basic purpose of the tax benefit rule is to achieve rough
transactional parity in tax,
see n 12,
supra, and to protect the Government
and the taxpayer from the adverse effects of reporting a
transaction on the basis of assumptions that an event in a
subsequent year proves to have been erroneous. Such an event,
unforeseen at the time of an earlier deduction, may in many cases
require the application of the tax benefit rule. We do not,
however, agree that this consequence invariably follows. Not every
unforeseen event will require the taxpayer to report income in the
amount of his earlier deduction. On the contrary, the tax benefit
rule will "cancel out" an earlier deduction only when a careful
examination shows that the later event is indeed fundamentally
inconsistent with the premise on which the deduction was initially
based. [
Footnote 15] That
is, if that event had occurred within the
Page 460 U. S. 384
same taxable year, it would have foreclosed the deduction.
[
Footnote 16] In some cases,
a subsequent recovery by the taxpayer will be the only event that
would be fundamentally inconsistent with the provision granting the
deduction. In such a case, only actual recovery by the taxpayer
would justify application of the tax benefit rule. For example, if
a calendar-year taxpayer made a rental payment on December 15 for a
30-day lease deductible in the current year under § 162(a)(3),
see Treas.Reg. § 1.461-1(a)(1), 26 CFR § 1.461-1(a)(1)
(1982);
e.g., Zaninovich v. Commissioner, 616 F.2d 429
(CA9 1980), [
Footnote 17]
the tax benefit rule would not require the recognition
Page 460 U. S. 385
of income if the leased premises were destroyed by fire on
January 10. The resulting inability of the taxpayer to occupy the
building would be an event not fundamentally inconsistent with his
prior deduction as an ordinary and necessary business expense under
§ 162(a). The loss is attributable to the business, [
Footnote 18] and therefore is consistent
with the deduction of the rental payment as an ordinary and
necessary business expense. On the other hand, had the premises not
burned and, in January, the taxpayer decided to use them to house
his family rather than to continue the operation of his business,
he would have converted the leasehold to personal use. This would
be an event fundamentally inconsistent with the business use on
which the deduction was based. [
Footnote 19] In the case of the fire, only if the lessor
-- by virtue of some provision in the lease -- had refunded the
rental payment would the taxpayer be required under the tax benefit
rule to recognize income on the subsequent destruction of the
building. In other words, the subsequent recovery of the previously
deducted rental payment would be the only event inconsistent with
the provision allowing the deduction. It therefore is evident that
the tax benefit rule must be applied on a case-by-case basis. A
court must consider the facts and circumstances of each case in the
light of the purpose and function of the provisions granting the
deductions.
When the later event takes place in the context of a
nonrecognition provision of the Code, there will be an inherent
tension between the tax benefit rule and the nonrecognition
provision.
See Putoma Corp. v. Commissioner, 601 F.2d 734,
742 (CA5 1979);
id. at 751 (Rubin, J., dissenting);
cf. Helvering v. American Dental Co., 318 U.
S. 322 (1943) (tension
Page 460 U. S. 386
between exclusion of gifts from income and treatment of
cancellation of indebtedness as income). We cannot resolve that
tension with a blanket rule that the tax benefit rule will always
prevail. Instead, we must focus on the particular provisions of the
Code at issue in any case. [
Footnote 20]
The formulation that we endorse today follows clearly from the
long development of the tax benefit rule. JUSTICE STEVENS'
assertion that there is no suggestion in the early cases or from
the early commentators that the rule could ever be applied in any
case that did not involve a physical recovery,
post at
460 U. S.
406-408, is incorrect. The early cases frequently framed
the rule in terms consistent with our view and irreconcilable with
that of the dissent.
See Barnett v. Commissioner,
Page 460 U. S. 387
39 B.T.A. 864, 867 (1939) ("Finally, the present case is
analogous to a number of others, where . . . [w]hen some event
occurs which is
inconsistent with a deduction taken in a
prior year, adjustment may have to be made by reporting a balancing
item in income for the year in which the change occurs") (emphasis
added);
Estate of Block v. Commissioner, 39 B.T.A. at 341
("When recovery
or some other event which is inconsistent
with what has been done in the past occurs, adjustment must be made
in reporting income for the year in which the change occurs")
(emphasis added);
South Dakota Concrete Products Co. v.
Commissioner, 26 B.T.A. at 1432 ("[W]hen an
adjustment occurs which is
inconsistent with what
has been done in the past in the determination of tax liability,
the adjustment should be reflected in reporting income for the year
in which it occurs") (emphasis added). [
Footnote 21] The reliance of the dissent on the early
commentators is equally misplaced, for the articles cited in the
dissent, like the early cases, often stated the rule in terms of
inconsistent events. [
Footnote
22]
Page 460 U. S. 388
Finally, JUSTICE STEVENS' dissent relies heavily on the
codification in § 111 of the exclusionary aspect of the tax benefit
rule, which requires the taxpayer to include in income only the
amount of the deduction that gave rise to a tax benefit,
see n 12,
supra. That provision does, as the dissent observes, speak
of a "recovery." By its terms, it only applies to bad debts, taxes,
and delinquency amounts. Yet this Court has held,
Dobson v.
Commissioner, 320 U. S. 489,
320 U. S.
505-506 (1943), and it has always been accepted since,
[
Footnote 23] that § 111
does not
limit the application of the exclusionary aspect
of the tax benefit rule. On the contrary, it lists a few
applications and represents a general endorsement of the
exclusionary aspect of the tax benefit rule to other situations
within the inclusionary part of the rule. The failure to mention
inconsistent events in § 111 no more suggests that they do not
trigger the application of the tax benefit rule than the failure to
mention the recovery of a capital loss suggests that it does not,
see Dobson, supra.
JUSTICE STEVENS also suggests that we err in recognizing
transactional equity as the reason for the tax benefit rule. It is
difficult to understand why even the clearest recovery should be
taxed if not for the concern with transactional equity,
see
supra at
460 U. S. 377.
Nor does the concern with transactional equity entail a change in
our approach to the annual accounting system. Although the tax
system relies basically
Page 460 U. S. 389
on annual accounting,
see Burnet v. Sanford & Brooks
Co., 282 U.S. at
282 U. S. 365,
the tax benefit rule eliminates some of the distortions that would
otherwise arise from such a system.
See, e.g., Bittker
& Kanner 268-270; Tye 350; Plumb 178, and n. 172. The limited
nature of the rule and its effect on the annual accounting
principle bears repetition:
only if the occurrence of the
event in the earlier year would have resulted in the disallowance
of the deduction can the Commissioner require a compensating
recognition of income when the event occurs in the later year.
[
Footnote 24]
Our approach today is consistent with our decision in
Nash
v. United States, 398 U. S. 1 (1970).
There, we rejected the Government's argument that the tax benefit
rule required a taxpayer who incorporated a partnership under § 351
to include in income the amount of the bad debt reserve of the
Page 460 U. S. 390
partnership. The Government's theory was that, although § 351
provides that there will be no gain or loss on the transfer of
assets to a controlled corporation in such a situation, the
partnership had taken bad debt deductions to create the reserve,
see § 166(c), and when the partnership terminated, it no
longer needed the bad debt reserve. We noted that the receivables
were transferred to the corporation along with the bad debt
reserve.
Id. at
398 U. S. 5, and
n. 5. Not only was there no "recovery,"
id. at
398 U. S. 4, but
there was no inconsistent event of any kind. That the fair market
value of the receivables was equal to the face amount less the bad
debt reserve,
ibid., reflected that the reserve, and the
deductions that constituted it, were still an accurate estimate of
the debts that would ultimately prove uncollectible, and the
deduction was therefore completely consistent with the later
transfer of the receivables to the incorporated business.
See
Citizens' Acceptance Corp. v. United States, 320 F.
Supp. 798 (Del.1971),
rev'd on other grounds, 462 F.2d
751 (CA3 1972); Rev.Rul. 78-279, 1978-2 Cum.Bull. 135; Rev.Rul.
78278, 1978-2 Cum.Bull. 134;
see generally O'Hare,
Statutory Nonrecognition of Income and the Overriding Principle of
the Tax Benefit Rule in the Taxation of Corporations and
Shareholders, 27 Tax L.Rev. 215, 219-221 (1972). [
Footnote 25]
In the cases currently before us, then, we must undertake an
examination of the particular provisions of the Code that govern
these transactions to determine whether the deductions
Page 460 U. S. 391
taken by the taxpayers were actually inconsistent with later
events and whether specific nonrecognition provisions prevail over
the principle of the tax benefit rule. [
Footnote 26]
III
In
Hillsboro, the key provision is § 164(e). [
Footnote 27] That section grants the
corporation a deduction for taxes imposed on its shareholders but
paid by the corporation. It also denies the shareholders any
deduction for the tax. In this case, the Commissioner has argued
that the refund of the taxes by the State to the shareholders is
the equivalent of the payment of a dividend from Hillsboro to its
shareholders. If Hillsboro does not recognize income in the amount
of the earlier deduction, it will have deducted a dividend. Since
the general structure of the corporate tax provisions does not
permit deduction of dividends, the Commissioner concludes that the
payment to the shareholders must be inconsistent with the original
deduction, and therefore requires the inclusion of the amount of
the taxes as income under the tax benefit rule.
Page 460 U. S. 392
In evaluating this argument, it is instructive to consider what
the tax consequences of the payment of a shareholder tax by the
corporation would be without § 164(e), and compare them to the
consequences under § 164(e). Without § 164(e), the corporation
would not be entitled to a deduction, for the tax is not imposed on
it.
See Treas.Reg. § 1.164-1(a), 26 CFR § 1.164-1(a)
(1982);
Wisconsin Gas & Electric Co. v. United States,
322 U. S. 526,
322 U. S.
527-530 (1944). If the corporation has earnings and
profits, the shareholder would have to recognize income in the
amount of the taxes, because a payment by a corporation for the
benefit of its shareholders is a constructive dividend.
See §§ 301(c), 316(a);
e.g., Ireland v. United
States, 621 F.2d 731, 735 (CA5 1980); B. Bittker & J.
Eustice, Federal Income Taxation of Corporations and Shareholders �
7.05 (4th ed.1979). The shareholder, however, would be entitled to
a deduction, since the constructive dividend is used to satisfy his
tax liability. § 164(a)(2). Thus, for the shareholder, the
transaction would be a wash: he would recognize the amount of the
tax as income, [
Footnote 28]
but he would have an offsetting deduction for the tax. For the
corporation, there would be no tax consequences, for the payment of
a dividend gives rise to neither income nor a deduction. 26 U.S.C.
§ 311(a) (1976 ed., Supp. V).
Under § 164(e), the economics of the transaction of course
remain unchanged: the corporation is still satisfying a liability
of the shareholder, and is therefore paying a constructive
dividend. The tax consequences are, however, significantly
different, at least for the corporation. The transaction is still a
wash for the shareholder; although § 164(e) denies him the
deduction
Page 460 U. S. 393
to which he would otherwise be entitled, he need not recognize
income on the constructive dividend, Treas.Reg. § 1.164-7, 26 CFR §
1.164-7 (1982). But the corporation is entitled to a deduction that
would not otherwise be available. In other words, the only effect
of § 164(e) is to permit the corporation to deduct a dividend.
Thus, we cannot agree with the Commissioner that, simply because
the events here give rise to a deductible dividend, they cannot be
consistent with the deduction. In at least some circumstances, a
deductible dividend is within the contemplation of the Code. The
question we must answer is whether § 164(e) permits a deductible
dividend in these circumstances -- when the money, though initially
paid into the state treasury, ultimately reaches the shareholder --
or whether the deductible dividend is available, as the
Commissioner urges, only when the money remains in the state
treasury, as properly assessed and collected tax revenue.
Rephrased, our question now is whether Congress, in granting
this special favor to corporations that paid dividends by
satisfying the liability of their shareholders, was concerned with
the
reason the money was paid out by the corporation or
with the
use to which it was ultimately put. Since §
164(e) represents a break with the usual rules governing corporate
distributions, the structure of the Code does not provide any
guidance on the reach of the provision. This Court has described
the provision as
"prompted by the plight of various banking corporations which
paid and voluntarily absorbed the burden of certain local taxes
imposed upon their shareholders, but were not permitted to deduct
those payments from gross income."
Wisconsin Gas & Electric Co. v. United States,
supra, at
322 U. S. 531
(footnote omitted). The section, in substantially similar form, has
been part of the Code since the Revenue Act of 1921, 42 Stat. 227.
The provision was added by the Senate, but its Committee Report
merely mentions the deduction without discussing it,
see
S.Rep. No. 275, 67th Cong., 1st Sess., 19 (1921). The only
discussion of
Page 460 U. S. 394
the provision appears to be that between Dr. T. S. Adams and
Senator Smoot at the Senate hearings. Dr. Adams' statement explains
why the States imposed the property tax on the shareholders and
collected it from the banks, but it does not cast much light on the
reason for the deduction. Hearings on H.R. 8245 before the
Committee on Finance, 67th Cong., 1st Sess., 250-251 (1921)
(statement of Dr. T. S. Adams, tax advisor, Treasury Department).
Senator Smoot's response, however, is more revealing:
"I have been a director in a bank . . . for over 20 years. They
have paid that tax ever since I have owned a share of stock in the
bank. . . . I know nothing about it. I do not take 1 cent of credit
for deductions, and the banks are entitled to it.
They pay it
out."
Id. at 251 (emphasis added).
The
payment by the corporations of a liability that
Congress knew was not a tax imposed on them [
Footnote 29] gave rise to the entitlement to a
deduction; Congress was unconcerned that the corporations took a
deduction for amounts that did not satisfy their tax liability. It
apparently perceived the shareholders and the corporations as
independent of one another, each "know[ing] nothing about" the
payments by the other. In those circumstances, it is difficult to
conclude that Congress intended that the corporation have no
deduction if the State turned the tax revenues over to these
independent parties. We conclude that the purpose of § 164(e) was
to provide relief for corporations making these payments, and the
focus of Congress was on the act of payment, rather than on the
ultimate use of the funds by the State. As long as the payment
itself was not negated by a refund to the corporation, the change
in character of the funds in the hands of the
Page 460 U. S. 395
State does not require the corporation to recognize income, and
we reverse the judgment below. [
Footnote 30]
IV
The problem in
Bliss is more complicated. Bliss took a
deduction under § 162(a), so we must begin by examining that
provision. Section 162(a) permits a deduction for the "ordinary and
necessary expenses" of carrying on a trade or business. The
deduction is predicated on the consumption of the asset in the
trade or business.
See Treas.Reg. § 1.162-3, 26 CFR §
1.162-3 (1982) ("Taxpayers . . . should include in expenses the
charges for materials and supplies only in the amount that they are
actually consumed and used in operation in the taxable
year . . .") (emphasis added). If the taxpayer later sells the
asset, rather than consuming it in furtherance of his trade or
business, it is quite clear that he would lose his deduction, for
the basis of the asset would be zero,
see, e.g., Spitalny v.
United States, 430 F.2d 195 (CA9 1970), so he would recognize
the full amount of the proceeds on sale as gain.
See §§
1001(a), (c). In general, if the taxpayer converts the expensed
asset to some other, nonbusiness use, that action is inconsistent
with his earlier deduction, and the tax benefit rule would require
inclusion in income of the amount of the unwarranted deduction.
That nonbusiness use is inconsistent with a deduction for an
ordinary and necessary business expense is clear from an
examination of the Code. While § 162(a) permits a deduction for
ordinary and necessary business expenses, § 262 explicitly
Page 460 U. S. 396
denies a deduction for personal expenses. In the 1916 Act, the
two provisions were a single section.
See § 5(a)(First),
39 Stat. 756. The provision has been uniformly interpreted as
providing a deduction only for those expenses attributable to the
business of the taxpayer.
See, e.g., Kornhauser v. United
States, 276 U. S. 145
(1928); Hearings on Proposed Revision of Revenue Laws before the
Subcommittee of the House Committee on Ways and Means, 75th Cong.,
3d Sess., 54 (1938) ("a taxpayer should be granted a reasonable
deduction for the direct expenses he has incurred
in connection
with his income") (emphasis added);
see generally 1
Bittker,
supra, n 9, �
20.2. Thus, if a corporation turns expensed assets to the analog of
personal consumption, as Bliss did here -- distribution to
shareholders [
Footnote 31]
-- it would seem that it should take into income the amount of the
earlier deduction. [
Footnote
32]
Page 460 U. S. 397
That conclusion, however, does not resolve this case, for the
distribution by Bliss to its shareholders is governed by a
provision of the Code that specifically shields the taxpayer from
recognition of gain -- § 336. We must therefore proceed to inquire
whether this is the sort of gain that goes unrecognized under §
336. Our examination of the background of § 336 and its place
within the framework of tax law convinces us that it does not
prevent the application of the tax benefit rule. [
Footnote 33]
Section 336 was enacted as part of the 1954 Code. It codified
the doctrine of
General Utilities Co. v. Helvering,
296 U. S. 200,
296 U. S. 206
(1935), that a corporation does not recognize gain on the
distribution of appreciated property to its shareholders. Before
the enactment of the statutory provision,
Page 460 U. S. 398
the rule was expressed in the regulations, which provided that
the corporation would not recognize gain or loss, "however [the
assets] may have
appreciated or depreciated in value since
their acquisition." Treas. Regs. 118, § 39.22(a) 20 (1953)
(emphasis added). The Senate Report recognized this regulation as
the source of the new § 336, S.Rep. No. 1622, 83d Cong., 2d Sess.,
258 (1954). The House Report explained its version of the
provision:
"Thus, the fact that the property distributed has
appreciated or depreciated in value over its adjusted
basis to the distributing corporation will in no way alter the
application of subsection (a) [providing nonrecognition]."
H.R.Rep. No. 1337, 83d Cong., 2d Sess., A90 (1954) (emphasis
added). This background indicates that the real concern of the
provision is to prevent recognition of market appreciation that has
not been realized by an arm's-length transfer to an unrelated
party, rather than to shield all types of income that might arise
from the disposition of an asset.
Despite the breadth of the nonrecognition language in § 336, the
rule of nonrecognition clearly is not without exception. For
instance, § 336 does not bar the recapture under § 1245 and § 1250
of excessive depreciation taken on distributed assets. §§ 1245(a),
1250(a); Treas.Reg. §§ 1.1245-6(b), 1.1250-1(c)(2), 26 CFR §§
1.1245-6(b), 1.1250-1(c)(2) (1982). Even in the absence of
countervailing statutory provisions, courts have never read the
command of nonrecognition in § 336 as absolute. The "assignment of
income" doctrine has always applied to distributions in
liquidation.
See, e.g., Siegel v. United States, 464 F.2d
891 (CA9 1972),
cert. dism'd, 410 U.S. 918 (1973);
Williamson v. United States, 155 Ct.Cl. 279, 292 F.2d 524
(1961);
see also Idaho First National Bank v. United
States, 265 F.2d 6 (CA9 1959) (decided before
General
Utilities codified in § 336). That judicial doctrine prevents
taxpayers from avoiding taxation by shifting income from the person
or entity that earns it to
Page 460 U. S. 399
someone who pays taxes at a lower rate. [
Footnote 34] Since income recognized by the
corporation is subject to the corporate tax, and is again taxed at
the individual level upon distribution to the shareholder, shifting
of income from a corporation to a shareholder can be particularly
attractive: it eliminates one level of taxation. Responding to that
incentive, corporations have attempted to distribute to
shareholders fully performed contracts or accounts receivable, and
then to invoke § 336 to avoid taxation on the income. In spite of
the language of nonrecognition, the courts have applied the
assignment-of-income doctrine and required the corporation to
recognize the income. [
Footnote
35] Section 336, then, clearly does not shield the taxpayer
from recognition of
all income on the distribution.
Next, we look to a companion provision -- § 337, which governs
sales of assets followed by distribution of the proceeds in
liquidation. [
Footnote 36]
It uses essentially the same broad language to
Page 460 U. S. 400
shield the corporation from the recognition of gain on the sale
of the assets. The similarity in language alone would make the
construction of § 337 relevant in interpreting § 336. In addition,
the function of the two provisions reveals that they should be
construed in tandem. Section 337 was enacted in response to the
distinction created by
United States v. Cumberland Public
Service Co., 338 U. S. 451
(1950), and
Commissioner v. Court Holding Co.,
324 U. S. 331
(1945). Under those cases, a corporation that liquidated by
distributing appreciated assets to its shareholders recognized no
income, as now provided in § 336, even though its shareholders
might sell the assets shortly after the distribution.
See
Cumberland. If the corporation sold the assets, though, it
would recognize income on the sale, and a sale by the shareholders
after distribution in kind might be attributed to the corporation.
See Court Holding. To eliminate the necessarily
formalistic distinctions and the uncertainties created by
Court
Holding and
Cumberland, Congress enacted § 337,
permitting the corporation to adopt a plan of liquidation, sell
Page 460 U. S. 401
its assets without recognizing gain or loss at the corporate
level, and distribute the proceeds to the shareholders. The very
purpose of § 337 was to create the same consequences as § 336.
See Midland-Ross Corp. v. United States, 485 F.2d 110 (CA6
1973); S.Rep. No. 1622,
supra, at 258.
There are some specific differences between the two provisions,
largely aimed at governing the period during which the liquidating
corporation sells its assets, a problem that does not arise when
the corporation distributes its assets to its shareholders. For
instance, § 337 does not shield the income produced by the sale of
inventory in the ordinary course of business; that income will be
taxed at the corporate level before distribution of the proceeds to
the shareholders.
See § 337(b). These differences indicate
that Congress did not intend to allow corporations to escape
taxation on business income earned while carrying on business in
the corporate form; what it did intend to shield was market
appreciation.
The question whether § 337 protects the corporation from
recognizing income because of unwarranted deductions has arisen
frequently, and the rule is now well established that the tax
benefit rule overrides the nonrecognition provision.
Connery v.
United States, 460 F.2d 1130 (CA3 1972);
Commissioner v.
Anders, 414 F.2d 1283 (CA10),
cert. denied, 396 U.S.
958 (1969);
Krajeck v. United States, 75-1 USTC 9492 (ND
1975);
S.E. Evans, Inc. v. United States, 317 F.
Supp. 423 (Ark.1970);
Anders v. United States, 199
Ct.Cl. 1, 462 F.2d 1147,
cert. denied, 409 U.S. 1064
(1972);
Estate of Munter v. Commissioner, 63 T.C. 663
(1975); Rev.Rul. 61-214, 1961-2 Cum.Bull. 60; Byrne, The Tax
Benefit Rule as Applied to Corporate Liquidations: Recent
Developments, 56 Notre Dame Law. 215, 221 (1980); Note, Tax
Treatment of Previously Expensed Assets in Corporate Liquidations,
80 Mich.L.Rev. 1636, 1638-39 (1982);
cf. Spitalny v. United
States, 430 F.2d 195 (CA9 1970) (when deduction and
liquidation occur within a single year, though tax benefit rule
does not apply, principle does). Congress has recently under
Page 460 U. S. 402
taken major revisions of the Code,
see Economic
Recovery Tax Act of 1981, Pub.L. 97-34, 95 Stat. 172, and has made
changes in the liquidation provisions,
e.g., Pub.L.
95-600, 92 Stat. 2904 (amending § 337); Pub.L. 95-628, 92 Stat.
3628 (same), but it did not act to change this longstanding,
universally accepted rule. If the construction of the language in §
337 as permitting recognition in these circumstances has the
acquiescence of Congress,
Lorillard v. Pons, 434 U.
S. 575,
434 U. S. 580
(1978), we must conclude that Congress intended the same
construction of the same language in the parallel provision in §
336.
Thus, the legislative history of § 336, the application of other
general rules of tax law, and the construction of the identical
language in § 337 all indicate that § 336 does not permit a
liquidating corporation to avoid the tax benefit rule.
Consequently, we reverse the judgment of the Court of Appeals and
hold that, on liquidation, Bliss must include in income the amount
of the unwarranted deduction. [
Footnote 37]
Page 460 U. S. 403
V
Bliss paid the assessment on an increase of $60,000 in its
taxable income. In the District Court, the parties stipulated that
the value of the grain was $56,565, but the record does not show
what the original cost of the grain was or what portion of it
remained at the time of liquidation. The proper increase in taxable
income is the portion of the cost of the grain attributable to the
amount on hand at the time of liquidation. In
Bliss, then,
we remand for a determination of that amount. In
Hillsboro, the taxpayer sought a redetermination in the
Tax Court, rather than paying the tax, so no further proceedings
are necessary, and the judgment of the Court of Appeals is
reversed.
It is so ordered.
* Together with No. 81-930,
United States v. Bliss Dairy,
Inc., on certiorari to the United States Court of Appeals for
the Ninth Circuit.
[
Footnote 1]
Section 164(e) provides:
"Where a corporation pays a tax imposed on a shareholder on his
interest as a shareholder, and where the shareholder does not
reimburse the corporation, then -- "
"(1) the deduction allowed by subsection (a) shall be allowed to
the corporation; and"
"(2) no deduction shall be allowed the shareholder for such
tax."
Subsection (a) provides, in part:
"Except as otherwise provided in this section, the following
taxes shall be allowed as a deduction for the taxable year within
which paid or accrued:"
* * * *
"(2) State and local personal property taxes."
[
Footnote 2]
Although the returns of the shareholders of the bank are not
before us, the Commissioner explained that they were required to
recognize the refund as income.
See 641 F.2d 529, 533, and
n. 4 (CA7 1981) (Pell, J., dissenting).
[
Footnote 3]
Section 162(a) provides in relevant part:
"There shall be allowed as a deduction all the ordinary and
necessary expenses paid or incurred during the taxable year in
carrying on any trade or business. . . ."
[
Footnote 4]
Section 336 provides:
"Except as provided in subsection (b) of this section and in
section 453B (relating to disposition of installment obligations),
no gain or loss shall be recognized to a corporation on the
distribution of property in partial or complete liquidation."
26 U.S.C. § 336 (1976 ed., Supp. V).
[
Footnote 5]
Section 333 provides, in relevant part:
"(a) In the case of property distributed in complete liquidation
of a domestic corporation . . . if -- "
"(1) the liquidation is made in pursuance of a plan of
liquidation adopted, and"
"(2) the distribution is in complete cancellation or redemption
of all the stock, and the transfer of all the property under the
liquidation occurs within some one calendar month,"
"then in the case of each qualified electing shareholder . . .
gain on the shares owned by him at the time of the adoption of the
plan of liquidation shall be recognized only to the extent provided
in subsections (e) and (f)."
* * * *
"(e) In the case of a qualified electing shareholder other than
a corporation -- "
"(1) there shall be recognized, and treated as a dividend, so
much of the gain as is not in excess of his ratable share of the
earnings and profits of the corporation accumulated after February
28, 1913, such earnings and profits to be determined as of the
close of the month in which the transfer in liquidation occurred
under subsection (a)(2), but without diminution by reason of
distributions made during such month; but by including in the
computation thereof all amounts accrued up to the date on which the
transfer of all the property under the liquidation is completed;
and"
"(2) there shall be recognized, and treated as short-term or
long-term capital gain, as the case may be, so much of the
remainder of the gain as is not in excess of the amount by which
the value of that portion of the assets received by him which
consists of money, or of stock or securities acquired by the
corporation after December 31, 1953, exceeds his ratable share of
such earnings and profits."
[
Footnote 6]
Section 334(e) provides:
"If -- "
"(1) property was acquired by a shareholder in the liquidation
of a corporation in cancellation or redemption of stock, and"
"(2) with respect to such acquisition -- "
"(A) gain was realized, but"
"(B) as the result of an election made by the shareholder under
section 333, the extent to which gain was recognized was determined
under section 333,"
"then the basis shall be the same as the basis of such stock
cancelled or redeemed in the liquidation, decreased in the amount
of any money received by the shareholder, and increased in the
amount of gain recognized to him."
[
Footnote 7]
In No. 81-485, the Solicitor General represents the Commissioner
of Internal Revenue, while in No. 81-930, he represents the United
States. We refer to the Commissioner and the United States
collectively as "the Government."
[
Footnote 8]
Although the rule originated in the courts, it has the implicit
approval of Congress, which enacted 26 U.S.C. § 111 as a limitation
on the rule.
See n
12
infra.
[
Footnote 9]
A rule analogous to the tax benefit rule protects the taxpayer
who is required to report income received in one year under claim
of right that he later ends up repaying. Under that rule, he is
allowed a deduction in the subsequent year.
See generally
26 U.S.C. § 1341; 1 B. Bittker, Federal Taxation of Income, Estates
and Gifts � 6.3 (1981).
[
Footnote 10]
When the event proving the deduction improper occurs after the
close of the taxable year, even if the statute of limitations has
not run, the Commissioner's proper remedy is to invoke the tax
benefit rule and require inclusion in the later year, rather than
to reopen the earlier year.
See Lexmolt Corp. v.
Commissioner, 20 T.C. 185 (1953);
South Dakota Concrete
Products Co. v. Commissioner, 26 B.T.A. 1429, 1432 (1932); 1
J. Mertens, Law of Federal Income Taxation § 7.34 (J. Doheny rev.
ed.1981); Bittker & Kanner, The Tax Benefit Rule, 26 UCLA
L.Rev. 265, 266 (1978) (hereinafter Bittker & Kanner).
Much of JUSTICE BLACKMUN's dissent takes issue with this
well-settled rule. The inclusion of the income in the year of the
deductions by amending the returns for that year is not before us
in these cases, for none of the parties has suggested such a
result, no doubt because the rule is so settled. It is not at all
clear what would happen on the remand that JUSTICE BLACKMUN
desires. Neither taxpayer has ever sought to file an amended
return. The statute of limitations has now run on the years to
which the dissent would attribute the income, § 6501(a), and we
have no indication in the record that the Government has held those
years open for any other reason.
Even if the question were before us, we could not accept the
view of JUSTICE BLACKMUN's dissent. It is, of course, true that the
tax benefit rule is not a precise way of dealing with the
transactional inequities that occur as a result of the annual
accounting system,
post at
460 U. S. 423,
460 U. S. 426.
See n 12,
infra. JUSTICE BLACKMUN's approach, however, does not
eliminate the problem; it only multiplies the number of rules. If
the statute of limitations has run on the earlier year, the dissent
recognizes that the rule that we now apply must apply.
Post at
460 U. S. 425.
Thus, under the proposed scheme, the only difference is that, if
the inconsistent event fortuitously occurs between the end of the
year of the deduction and the running of the statute of
limitations, the Commissioner must reopen the earlier year or
permit an amended return even though it is settled that the
acceptance of such a return after the date for filing a return is
not covered by statute, but within the discretion of the
Commissioner.
See, e.g., Koch v. Alexander, 561 F.2d 1115
(CA4 1977) (per curiam);
Miskovsky v. United States, 414
F.2d 954 (CA3 1969). In any other situation, the income must be
recognized in the later year. Surely a single rule covering all
situations would be preferable to several rules that do not
alleviate any of the disadvantages of the single rule.
A second flaw in JUSTICE BLACKMUN's approach lies in his
assertion that the practice he proposes is like any correction made
after audit. Changes on audit reflect the proper tax treatment of
items under the facts as they were known at the end of the taxable
year. The tax benefit rule is addressed to a different problem --
that of events that occur
after the close of the taxable
year.
In any event, whatever the merits of amending the return of the
year of the improper deduction might originally have been, we think
it too late in the day to change the rule. Neither the judicial
origins of the rule nor the subsequent codification permits the
approach suggested by JUSTICE BLACKMUN.
The dissent suggests that the reason that the early cases
expounding the tax benefit rule required inclusion in the later
year was that the statute of limitations barred adjustment in the
earlier year.
Post at
460 U. S.
423-424, n. That suggestion simply does not reflect the
cases cited. In
Burnet v. Sanford & Brooks Co.,
282 U. S. 359
(1931), the judgment of the Court of Appeals reflected JUSTICE
BLACKMUN's approach, holding that the amount recovered in the later
year was not income in that year, but that the taxpayer had to
amend its returns for the years of the deductions.
Id. at
282 U. S. 362.
This Court reversed, stating: "That the recovery made by respondent
in 1920 was gross income
for that year . . . cannot, we
think, be doubted."
Id. at
282 U. S. 363.
(Emphasis added.) Neither does
Healy v. Commissioner,
345 U. S. 278
(1953), a case dealing with income received under claim of right,
provide any support for this novel theory. On the contrary, the
Court's discussion of the statute of limitations, cited by the
dissent, in context, is as follows:
"A rule which required that the adjustment be made in the
earlier year of receipt, instead of the later year of repayment,
would generally be unfavorable to taxpayers, for the statute of
limitations would frequently bar any adjustment of the tax
liability for the earlier year. Congress has enacted an annual
accounting system under which income is counted up at the end of
each year. It would be disruptive of an orderly collection of the
revenue to rule that the accounting must be done over again to
reflect events occurring after the year for which the accounting is
made, and would violate the spirit of the annual accounting
system."
Id. at
345 U. S.
284-285 (footnote omitted). Even the earliest cases,
then, reflect the currently accepted view of the tax benefit
rule.
Further, § 111, the partial codification of the tax benefit
rule,
see n 8,
supra, contradicts JUSTICE BLACKMUN's view. It provides
that gross income for a year does not include a specified portion
of a recovery of amounts earlier deducted, implying that the
remainder of the recovery is to be included in gross income for
that year.
See, e.g., S.Rep. No. 830, 88th Cong., 2d
Sess., 100 (1964); S.Rep. No. 1631, 77th Cong., 2d Sess., 79
(1942). Even if the judicial origins of the rule supported JUSTICE
BLACK, we would still be obliged to bow to the will of
Congress.
[
Footnote 11]
As the rule developed, a number of theories supported taxation
in the later year. One explained that the taxpayer who had taken
the deduction "consented" to "return" it if events proved him not
entitled to it,
e.g., Philadelphia National Bank v.
Rothensies, 43 F. Supp.
923, 925 (ED Pa.1942), while another explained that the
deduction offset income in the earlier year, which became "latent"
income that might be recaptured,
e.g., National Bank of
Commerce v. Commissioner, 115 F.2d 875, 876-877 (CA9 1940);
Lassen, The Tax Benefit Rule and Related Problems, 20 Taxes 473,
476 (1942). Still a third view maintained that the later
recognition of income was a balancing entry.
E.g., South Dakota
Concrete Products Co. v. Commissioner, 26 B.T.A. 1429, 1431
(1932). All these views reflected that the initial accounting for
the item must be corrected to present a true picture of income.
While annual accounting precludes reopening the earlier year, it
does not prevent a less precise correction -- far superior to none
-- in the current year, analogous to the practice of financial
accountants.
See W. Meigs, A. Mosich, C. Johnson, & T.
Keller, Intermediate Accounting 109 (3d ed.1974). This concern with
more accurate measurement of income underlies the tax benefit rule,
and always has.
[
Footnote 12]
Even this rule did not create complete transactional
equivalence. In the second version of the transaction discussed in
the text, the taxpayer might have realized no benefit from the
deduction, if, for instance, he had no taxable income for that
year. Application of the tax benefit rule as originally developed
would require the taxpayer to recognize income on the repayment, so
that the net result of the collection of the principal amount of
the debt would be recognition of income. Similarly, the tax rates
might change between the two years, so that a deduction and an
inclusion, though equal in amount, would not produce exactly
offsetting tax consequences. Congress enacted § 111 to deal with
part of this problem. Although a change in the rates may still lead
to differences in taxes due,
see Alice Phelan Sullivan Corp. v.
United States, 180 Ct.Cl. 659, 381 F.2d 399 (1967), § 111
provides that the taxpayer can exclude from income the amount that
did not give rise to some tax benefit.
See Dobson v.
Commissioner, 320 U. S. 489,
320 U. S.
505-506 (1943). This exclusionary rule and the
inclusionary rule described in the text are generally known
together as the tax benefit rule. It is the inclusionary aspect of
the rule with which we are currently concerned.
[
Footnote 13]
See, e.g., Bittker & Kanner 267;
cf.
Zysman, Income Derived from the Recovery of Deductions, 19 Taxes
29, 30 (1941) (We are "not concerned with a theoretical or pure
economic concept of income, but with gross income within the
meaning of the statute").
Although JUSTICE STEVENS insists that this situation falls
within the standard meaning of "recovery," it does so only in the
sense that an increase in balance sheet net worth is to be
considered a recovery.
Post at
460 U. S.
416-417, n. 26. But in
Bliss, JUSTICE STEVENS
asserts that there is no recovery. There, the corporation's balance
sheet shows zero as the historic cost of the grain on hand, because
the corporation expensed the asset upon acquisition. At the date of
liquidation, the historic cost of the grain on hand was, in fact,
greater than zero, and an accurate balance sheet would have
reflected an asset account balance greater than zero. The necessary
adjustment thus reflects an increase in balance sheet net
worth.
[
Footnote 14]
Despite JUSTICE STEVENS' assertion that
Tennessee-Carolina was wrong,
post at
460 U. S. 417,
n. 26, the case fits what seems to be his definition of a recovery
-- an enhancement of the taxpayer's wealth -- for the corporation
in
Tennessee-Carolina received stock worth more than the
balance sheet book value of its assets.
See n 13,
supra. Thus, we disagree
with the assertion that the recovery rule is a bright-line rule
easily applied.
[
Footnote 15]
JUSTICE STEVENS accuses us of creating confusion at this point
in the analysis by requiring the courts to distinguish
"inconsistent events" from "fundamentally inconsistent events."
Post at
460 U. S. 418.
That line is not the line we draw; rather, we draw the line between
merely unexpected events and inconsistent events.
This approach differs from that proposed by the Government in
that the Government has not attempted to explain why two events are
inconsistent. Apparently, in the Government's view, any unexpected
event is inconsistent with an earlier deduction. That view we
cannot accept.
[
Footnote 16]
JUSTICE STEVENS apparently disagrees with this rule, for,
although he concurs in the result in
Hillsboro, he asserts
that the events there would have resulted in denial of the
deduction had they all occurred in one year.
Post at
460 U. S. 418.
We find it difficult to believe that Congress placed such a premium
on having a transaction straddle two tax years.
[
Footnote 17]
JUSTICE STEVENS questions whether this amount was properly
deductible under § 162(a)(3), and seems to suggest that, if it was,
Congress meant the deduction to be irrevocable.
Post at
460 U. S.
415-416, n. 25. It is clear that § 162(a)(3) permits the
deduction of prepaid expenses that will benefit the taxpayer for a
short time into the next taxable year, as in our example, rather
than benefiting the taxpayer substantially beyond the taxable year.
See generally 1 B. Bittker,
supra, n 9, � 20.4.1.
The dissent's view that the preferable approach is to scrutinize
the deduction more carefully in the year it is taken ignores two
basic problems. First, reasons unrelated to the certainty that the
taxpayer will eventually consume the asset as expected often enter
into the decision when to allow the deduction. For instance, the
desire to save taxpayers the burden of careful allocation of
relatively small expenditures favors the allowance of the entire
deduction in a single year of some business expenditures
attributable to operations after the close of the taxable year.
See generally ibid. Second, we simply cannot predict the
future, no matter how carefully we scrutinize the deduction in the
earlier year. For instance, in the case of the bad debt that is
eventually repaid, we already require that the debt be apparently
worthless in the year of deduction,
see § 166(a)(1), but
we often find that the future does not conform to earlier
perceptions, and the taxpayer collects the debt. Then,
"the deductions are practical necessities due to our inability
to read the future, and the inclusion of the recovery in income is
necessary to offset the deduction."
South Dakota Concrete Products Co. v. Commissioner, 26
B.T.A. at 1432.
[
Footnote 18]
The loss is properly attributable to the business because the
acceptance of the risk of loss is a reasonable business judgment
that the courts ordinarily will not question.
See Welch v.
Helvering, 290 U. S. 111,
290 U. S. 113
(1933); 1 B. Bittker,
supra, n 9, � 20.3.2.
[
Footnote 19]
See 1 B. Bittker,
supra, n 9, � 20.2.2 ("[F]ood and shelter are
quintessential nondeductible personal expenses").
See also
infra at
460 U. S.
395-396.
[
Footnote 20]
An unreserved endorsement of the Government's formulation might
dictate the results in a broad range of cases not before us.
See, e.g., Brief for United States in No. 81-930 and for
Respondent in No. 81-485, p. 20; Reply Brief for Petitioner in No.
81-485, p. 12; Tr. of Oral Arg. 33. For instance, the Government's
position implies that an individual proprietor who makes a gift of
an expensed asset must recognize the amount of the expense as
income,
but cf. Campbell v. Prothro, 209 F.2d 331, 335
(CA5 1954).
See generally 2A J. Rabkin & M. Johnson,
Federal Income, Gift and Estate Taxation § 6.01(3) (1982)
(discussing Commissioner's treatment of gifts of expensed assets).
Similarly, the Government's view suggests the conclusion that one
who dies and leaves an expensed asset to his heirs would, in his
last return, recognize income in the amount of the earlier
deduction. Our decision in the cases before us now, however, will
not determine the outcome in these other situations; it will only
demonstrate the proper analysis. Those cases will require
consideration of the treatment of gifts and legacies, as well as §§
1245(b)(1), (2), and 1250(d)(1), (2), which are a partial
codification of the tax benefit rule,
see O'Hare,
Statutory Nonrecognition of Income and the Overriding Principle of
the Tax Benefit Rule in the Taxation of Corporations and
Shareholders, 27 Tax L.Rev. 215, 216 (1972), and which exempt
dispositions by gift and transfers at death from the operation of
the general depreciation recapture rules. Although there may be an
inconsistent event in the personal use of an expensed asset, that
event occurs in the context of a nonrecognition rule,
see,
e.g., Campbell v. Prothro, supra, at 336; 1 B. Bittker,
supra, n 9, � 5.21,
and resolution of these cases would require a determination whether
the nonrecognition rule or the tax benefit rule prevails.
[
Footnote 21]
JUSTICE STEVENS' attempt to discount the explicit statement in
Estate of Block that inconsistent events would trigger the
recognition of income,
post at
460 U. S. 408,
n. 9, is singularly unpersuasive. The Board of Tax Appeals used the
word "recovery" later in the opinion because it was faced with a
recovery in that case, not because it meant to repudiate hastily
its discussion in the same opinion of the general rule. Similarly,
the mere assertion that the broad formulation in
Barnett
followed a discussion of a Treasury Regulation,
post, at
460 U. S. 408,
n. 10, does not support the view of the dissent that the concept of
inconsistent events represents a break with the early cases.
[
Footnote 22]
"The rule requiring taxation of income from the recovery or
cancellation of items previously deducted is a remedial
expedient, designed to prevent the unjust enrichment of a taxpayer
and to offset the benefit derived from a deduction to which,
in
the light of subsequent events, the taxpayer was not
entitled."
Plumb 176 (emphasis added).
See also id. at 131,
178.
"In a few words, the basic idea of the Tax Benefit Rule is this:
if a taxpayer has derived a benefit from a deduction by reducing
his taxable income in the year of deduction, he must declare as
taxable income any recovery
or other change of his status
which --
ex nunc -- makes the original deduction seem
unjustified."
Lassen, The Tax Benefit Rule and Related Problems, 20 Taxes 473
(1942) (emphasis added).
One author saw his subject -- the recovery of deductions -- as
an example of the broader rule:
"Sometimes a
subsequent event reveals the income or
deductions as reported by the taxpayer to be erroneous. Thus the
unexpected recovery of a portion of an amount lost and already
deducted reduces the loss as originally determined. There are even
cases in which items apparently finally and accurately determined
have to be adjusted
on account of a subsequent event."
Zysman, Income Derived from the Recovery of Deductions, 19 Taxes
29 (1941) (emphasis added).
[
Footnote 23]
See, e.g., Bittker & Kanner 266; Tye 330; Plumb
144-145.
[
Footnote 24]
JUSTICE STEVENS seems to fear that our approach to the annual
accounting system is inconsistent with
Sanford &
Brooks in a way that will vest new power in the tax collector
to ignore the annual accounting system. The fear is unfounded. In
Sanford & Brooks, a taxpayer who had incurred a net
loss on a long-term contract managed to recoup the loss in a
lawsuit in a later year. The earlier net losses on the contract
contributed to net losses for the business in most of the tax years
during the performance of the contract. The Court rejected the
taxpayer's contention that it should be able to exclude the award
on the theory that the award offset the earlier net losses. This
adherence to the annual accounting system is perfectly consistent
with the approach we follow in the cases now before us. In
situations implicating the tax benefit rule or the analogous
doctrine permitting the taxpayer to take a deduction when income
recognized earlier under a claim of right must be repaid,
see n 9,
supra, the problem is that the taxpayer has
mischaracterized some event. Either he has recognized income that
eventually turns out not to be income, or he has taken a deduction
that eventually turns out not to be a deduction. Neither of these
problems arose in
Sanford & Brook. Instead, the
problem there was that the taxpayer had properly deducted
expenditures and was properly recognizing income, but thought that
the two should have been matched in the same year. The tax benefit
rule does not permit the Commissioner or the taxpayer to rematch
properly recognized income with properly deducted expenses; it
merely permits a balancing entry when an apparently proper expense
turns out to be improper.
[
Footnote 25]
JUSTICE STEVENS attempts to read our prior cases as somehow
inconsistent with our approach here.
Nash is the only case
in which we have dealt with the inclusionary aspect of the tax
benefit rule, and, as we have established, there was neither a
recovery nor an inconsistent event in that case. In
Dobson v.
Commissioner, 320 U. S. 489
(1943), we considered the exclusionary aspect of the rule. That
case involved a recovery that was clearly inconsistent with the
deduction, and the only question was whether the deduction had
created a benefit. The references to "recovery" in the opinion
describe the case before the Court. They do not in any way impose
general requirements for inclusion, as the dissent seems to
suggest.
[
Footnote 26]
It is worth noting that a holding requiring no recognition of
income is not, as JUSTICE BLACKMUN's dissent suggests, a conclusion
that the tax benefit rule "has no application to the situation
presented."
Post at
460 U. S. 422.
As a general principle of tax law, the rule of course applies; it
simply does not require the recognition of income.
[
Footnote 27]
The Commissioner asserts also that Hillsboro deducted the taxes
as a contested liability under § 461(f), and that the legislative
history of § 461(f) shows that Congress intended that the tax
benefit rule apply if a taxpayer successfully contested a liability
deducted under § 461(f). We do not view this argument as in any way
separate from the Commissioner's argument under § 164(e). Section
461(f) does not grant deductions of its own force; the expenditure
must qualify as deductible in character under some other section.
See Treas.Reg. § 1.461-2(a)(1)(iv), 26 CFR §
1.461-2(a)(1)(iv) (1982). If the expenditure does qualify
independently as deductible, but, because it is contested, it lacks
the certainty otherwise required for deduction, § 461(f) grants the
deduction, on the condition that the tax benefit rule will apply.
But for the tax benefit rule to apply, there must be some event
that is inconsistent with the provision granting the deduction. The
question here then remains whether the deduction is appropriate
under § 164(e) or whether later events are inconsistent with that
deduction.
[
Footnote 28]
There would be an exception for a shareholder who had not yet
earned $200 in interest and dividend income from his stock holdings
in this and other corporations during the taxable year. He would be
able to exclude up to $200 received in dividend and interest income
for the year.
See 26 U.S.C. §§ 116(a)(1), (b) (1976 ed.,
Supp. V). At the time of the Hillsboro transaction, the exclusion
was $100.
See 26 U.S.C. § 116(a).
[
Footnote 29]
Dr. Adams testified repeatedly that the banks paid the tax
"voluntarily." Hearings on H.R. 8245 before the Committee on
Finance, 67th Cong., 1st Sess., 250 (1921).
[
Footnote 30]
Our examination of the legislative history thus leads us to
reject JUSTICE BLACKMUN's unsupported suggestion that Congress
focused on the payment of a tax.
Post at
460 U. S. 422.
The theory he suggests leads to the conclusion that, even if the
State had not refunded the taxes, the bank would not have been
entitled to the deduction, because it had not paid a "tax." It is
difficult to believe that the Congress that acted to alleviate "the
plight of various banking corporations which paid and voluntarily
absorbed the burden,"
Wisconsin Gas & Electric Co. v.
United States, 322 U. S. 526,
322 U. S. 531
(1944), intended the result suggested by the dissent.
[
Footnote 31]
"Paying the dividend was the enjoyment of [the corporate]
income. A body corporate can be said to enjoy its income in no
other way."
Williamson v. United States, 155 Ct.Cl. 279,
289, 292 F.2d 524, 530 (1961).
[
Footnote 32]
JUSTICE STEVENS' dissent takes issue with this conclusion,
characterizing the situation as identical to that in
Nash v.
United States, 398 U. S. 1 (1970),
which he explains as a case in which we held that, although "a
business asset matching a prior deduction . . . would not be used
up . . . until it had passed to a different taxpayer," the transfer
did not require the recognition of income.
Post at
460 U. S. 415.
What is misleading in this description is its failure to recognize
that, in Nash, the prior deduction was reflected in the asset
transferred because of the contra-asset account: uncollectible
accounts. That contra-asset diminished the asset,
see
generally W. Meigs, A. Mosich, C. Johnson, & T. Keller,
Intermediate Accounting 140-141 (3d ed.1974), and was inseparable
from it. Therefore, the transfer of the notes did not establish
that they were worth their face value, and there was no
inconsistent event.
In
Bliss, the taxpayers took a deduction for an expense
and credited the asset account. Unlike the debit to the expense
account in
Nash, the debit to the expense account did not
reflect any economic decrease in the value of the asset. When the
taxpayers transferred the asset, it became clear that the economic
decrease would not take place in the hands of Bliss -- and possibly
never would occur.
To see the difference more clearly, consider the views of a
third party contemplating purchasing the asset on hand in
Nash and one contemplating purchasing the asset on hand in
Bliss. In
Nash, the purchaser would be willing to
pay only the face amount of the receivables
less the amount in
the contra-asset account -- the amount earlier deducted by the
taxpayer -- because that is all the purchaser could expect to
realize on them. In other words, the deduction reflected a real
decrease in the value of the asset. In
Bliss, on the other
hand, the purchaser would be happy to pay the value of the grain,
undiminished by the expense deducted by the taxpayer. The
deduction and the asset remain separable, and the taxpayer can
transfer one without netting out the other.
[
Footnote 33]
We are aware that Congress considered, but failed to enact, a
bill amending §§ 1245 and 1250 to cover any deduction of the
purchase price of property. H.R. 10936, 94th Cong., 1st Sess.
(1975). That bill would have settled the question here, since it is
clear that § 1245 overrides § 336. § 1245(a)(1); Treas.Reg. §
1.1245-6(b), 26 CFR § 1.1245-6(b) (1982). The failure to enact the
bill does not suggest that Congress intended that deductions under
§ 162 not be subject to recapture. Both the House and Senate
Committees reported favorably on the bill, S.Rep. No. 94-1346
(1976); H.R.Rep. No. 94-1350 (1976), the House passed it, and
Congress adjourned without any action by the Senate.
See
Calendars of the United States House of Representatives and History
of Legislation 174 (Final ed.1977). The Reports suggest that
Congress focused on disposition by sale and thought the income
subject to recapture in any event, but possibly at capital gains,
rather than ordinary income, rates. S.Rep. No. 94-1346,
supra, at 2; H.R.Rep. No. 94-1350,
supra, at 2.
Given this background, we cannot draw any inference from the
failure to enact the amendment.
[
Footnote 34]
For instance, a taxpayer cannot avoid recognizing the interest
income on bonds that he owns by clipping the coupons and giving
them to another party.
See, e.g., Helvering v. Horst,
311 U. S. 112
(1940);
Lucas v. Earl, 281 U. S. 111
(1930).
[
Footnote 35]
Indeed, the legislative history of § 335 compels such a result.
Section 336 arose out of the same provision in the House bill as
did § 311, which provides for nonrecognition of gain on
nonliquidating distributions of appreciated property, and the
Senate comment on § 311 explicitly provides for the application of
the assignment-of-income doctrine. S.Rep. No. 1622, 83d Cong., 2d
Sess., 247 (1954).
[
Footnote 36]
In relevant part, § 337 provides:
"(a) If within the 12-month period beginning on the date on
which a corporation adopts a plan of complete liquidation, all of
the assets of the corporation are distributed in complete
liquidation, less assets retained to meet claims, then no gain or
loss shall be recognized to such corporation from the sale or
exchange by it of property within such 12-month period."
"(b)(1) For purposes of subsection (a), the term 'property' does
not include --"
"(A) stock in trade of the corporation, or other property of a
kind which would properly be included in the inventory of the
corporation if on hand at the close of the taxable year, and
property held by the corporation primarily for sale to customers in
the ordinary course of its trade or business,"
"(B) installment obligations acquired in respect of the sale or
exchange (without regard to whether such sale or exchange occurred
before, on, or after the date of the adoption of the plan referred
to in subsection (a)) of stock in trade or other property described
in subparagraph (A) of this paragraph, and"
"(C) installment obligations acquired in respect of property
(other than property described in subparagraph (A)) sold or
exchanged before the date of the adoption of such plan of
liquidation."
"(2) Notwithstanding paragraph (1) of this subsection, if
substantially all of the property described in subparagraph (A) of
such paragraph (1) which is attributable to a trade or business of
the corporation is, in accordance with this section, sold or
exchanged to one person in one transaction, then for purposes of
subsection (a) the term 'property' includes -- "
"(A) such property so sold or exchanged, and"
"(B) installment obligations acquired in respect of such sale or
exchange."
"(c) (1) This section shall not apply to any sale or exchange --
"
"(A) made by a collapsible corporation (as defined in section
341(b)), or"
"(B) following the adoption of a plan of complete liquidation,
if section 333 applies with respect to such liquidation."
[
Footnote 37]
Some commentators have argued that the correct measure of the
income that Bliss should include is the lesser of the amount it
deducted or the basis that the shareholders will take in the asset.
See Feld, The Tax Benefit of
Bliss, 62 B.U.L.Rev.
443, 463-464 (1982);
see also Rev.Rul. 74-396, 1974-2
Cum.Bull. 106. Since Bliss has not suggested that, if there is an
amount taken into income, it should be less than the amount
previously deducted, we need not address the point.
As JUSTICE STEVENS observes,
post at
460 U. S. 419,
n. 29, we do not resolve this question. His perception of
ambiguities elsewhere in our discussion of the amount recognized as
income is simply inaccurate. Our discussion of the tax consequences
on the sale of an expensed asset,
supra at
460 U. S. 395,
does not suggest that the entire amount of proceeds on sale is
attributable to the tax benefit rule. Instead, we illustrated that
the basis rules automatically lead to inclusion of the amount
attributable to the operation of the tax benefit rule. That is, the
proceeds will equal the cost plus any appreciation (or less any
decrease in value). The appreciation would be recognized as gain
(or the decrease as loss) in the ordinary sale, regardless of
whether the taxpayer had expensed the asset upon acquisition. The
reduction of the basis to zero when the item is expensed ensures
that, if it is sold, rather than consumed, the unwarranted
deduction will be included in income along with any appreciation,
and it is this amount that the tax benefit rule requires to be
recognized as income.
JUSTICE BRENNAN, concurring in No. 81-930 and dissenting in No.
81-485.
I join Parts I, II, and IV of the Court's opinion. For the
reasons expressed in
460 U. S.
however, I believe that a proper application of the principles set
out in
460 U. S.
rather than a reversal, in No. 81-485.
JUSTICE STEVENS, with whom JUSTICE MARSHALL joins, concurring in
the judgment in No. 81-485 and dissenting in No. 81-930.
These two cases should be decided in the same way. The taxpayer
in each case is a corporation. In 1972, each taxpayer made a
deductible expenditure, and in 1973, its shareholders received an
economic benefit. Neither corporate taxpayer ever recovered any
part of its 1972 expenditure. In my opinion, the benefits received
by the shareholders in 1973 are matters that should affect their
returns; those benefits should not give rise to income on the 1973
return of the taxpayer in either case.
Both cases require us to apply the tax benefit rule. This rule
has always had a limited, but important office: it determines
Page 460 U. S. 404
whether certain events that enrich the taxpayer -- recoveries of
past expenditures -- should be characterized as income. [
Footnote 2/1] It does not create income out
of events that do not enhance the taxpayer's wealth.
Today the Court declares that the purpose of the tax benefit
rule is "to approximate the results produced by a tax system based
on transactional, rather than annual, accounting."
Ante at
460 U. S. 381.
Whereas the rule has previously been used to determine the
character of a current wealth-enhancing event, when viewed in the
light of past deductions, the Court now suggests that the rule
requires a study of the propriety of earlier deductions, when
viewed in the light of later events. The Court states that the rule
operates to "cancel out" an earlier deduction if the premise on
which it is based is "fundamentally inconsistent" with an event in
a later year.
Ante at
460 U. S. 383.
[
Footnote 2/2]
The Court's reformulation of the tax benefit rule constitutes an
extremely significant enlargement of the tax collector's powers. In
order to identify the groundbreaking character of the decision, I
shall review the history of the tax benefit rule. I shall then
discuss the
Bliss Dairy case in some detail, to
demonstrate that it fits comfortably within
Page 460 U. S. 405
the class of cases to which the tax benefit rule has not been
applied in the past. Finally, I shall explain why the Court's
adventure in lawmaking is not only misguided, but does not even
explain its inconsistent disposition of these two similar
cases.
I
What is today called the "tax benefit rule" evolved in two
stages, reflecting the rule's two components. The "inclusionary"
component requires that the recovery within a taxable year of an
item previously deducted be included in gross income. The
"exclusionary component," which gives the rule its name, allows the
inclusionary component to operate only to the extent that the prior
deduction benefited the taxpayer.
The inclusionary component of the rule originated in the Bureau
of Internal Revenue in the context of recoveries of debts that had
previously been deducted as uncollectible. The Bureau sensed that
it was inequitable to permit a taxpayer to characterize the
recovery of such a debt as "return of capital" when in a prior year
he had been allowed to reduce his taxable income to compensate for
the loss of that capital. As one commentator described it,
"the allowance of a deduction results in a portion of gross
income not being taxed; when the deducted item is recouped, the
recovery stands in the place of the gross income which had not been
taxed before, and is therefore taxable. [
Footnote 2/3]"
This principle was quickly endorsed by the Board of Tax Appeals
and the courts.
See Excelsior Printing Co. v.
Commissioner, 16 B.T.A. 886 (1929);
Putnam National Bank
v. Commissioner, 50 F.2d 158 (CA5 1931).
Page 460 U. S. 406
The exclusionary component was not so readily accepted. The
Bureau first incorporated it during the Great Depression as the
natural equitable counterweight to the inclusionary component.
G.C.M. 18525, 1937-1 Cum.Bull. 80. It soon retreated, however,
insisting that a recovery could be treated as income even if the
prior deduction had not benefited the taxpayer. G.C.M. 22163,
1940-2 Cum.Bull. 76. The Board of Tax Appeals protested,
e.g.,
Corn Exchange National Bank & Trust Co. v. Commissioner,
46 B.T.A. 1107 (1942), but the Circuit Courts of Appeals sided with
the Bureau.
Helvering v. State-Planters Bank & Trust
Co., 130 F.2d 44 (CA4 1942);
Commissioner v. United States
& International Securities Corp., 130 F.2d 894 (CA3 1942).
At that point, Congress intervened for the first and only time. It
enacted the forerunner of § 111 of the present Code, ch. 619, Title
I, § 116(a), Act of Oct. 21, 1942, 56 Stat. 812, using language
that, by implication, acknowledges the propriety of the
inclusionary component by explicitly mandating the exclusionary
component. [
Footnote 2/4]
The most striking feature of the rule's history is that, from
its early formative years, through codification, until the 1960's,
Congress, [
Footnote 2/5] the
Internal Revenue Service, [
Footnote
2/6] courts, [
Footnote 2/7]
Page 460 U. S. 407
and commentators [
Footnote 2/8]
understood it in essentially the same way. They all saw it as a
theory that appropriately characterized certain recoveries of
capital as income. Although the rule undeniably helped to
accommodate the annual accounting system to multi-year
transactions, I have found no suggestion
Page 460 U. S. 408
that it was regarded as a generalized method of approximating a
transactional accounting system through the fabrication of income
at the drop of a fundamentally inconsistent event. [
Footnote 2/9] An inconsistent event was always a
necessary condition, but, with the possible exception of the
discussion of the Board of Tax Appeals in
Barett v.
Commissioner, 39 B.T.A. 864, 867 (1939), inconsistency was
never, by itself, a sufficient reason for applying the rule.
[
Footnote 2/10] Significantly,
the first case from this Court dealing with the tax benefit rule
emphasized the role of a recovery. [
Footnote 2/11] And when litigants in
Page 460 U. S. 409
this Court suggested that a transactional accounting system
would be more equitable, we expressly declined to impose one,
stressing the importance of finality and practicability in a tax
system. [
Footnote 2/12]
Page 460 U. S. 410
In the 1960's, the Commissioner, with the support of some
commentators and the Tax Court, began to urge that the tax benefit
rule be given a more ambitious office. [
Footnote 2/13] In
Nash v. United States,
398 U. S. 1 (1970),
the Commissioner argued that the rule should not be limited to
cases in which the taxpayer had made an economic recovery, but
rather should operate to cancel out an earlier deduction whenever
later events demonstrate that the taxpayer is no longer entitled to
it. The arguments advanced, and rejected, in that case were
remarkably similar to those found in the Court's opinion today.
[
Footnote 2/14]
Page 460 U. S. 411
The
Nash case arose out of the sale of a partnership
business to a corporation. The partnership had taken deductions for
ledger entries in a "bad debt reserve" -- an account that reflected
the firm's estimate of its future losses from accounts receivable
that would
eventually become uncollectible. When the
partnership business was sold to a corporation, the Commissioner
sought to apply the tax benefit rule, arguing that, even though the
partnership had made no recovery of the amount in the bad debt
reserve, the deductibility of the presale additions to the
taxpayer's reserve had been justified on the basis of an assumption
that was no longer valid after the business was sold. [
Footnote 2/15]
This Court flatly rejected the Commissioner's position. Rather
than scrutinizing the premises of the prior deduction in the light
of subsequent events, the Court used the subsequent events
themselves as its starting point. Since the transfer of the bad
debt reserve did not enrich the taxpayer, there was no current
realization event justifying the application of the tax benefit
rule.
"[A]lthough the 'need' for the reserve ended with the transfer,
the end of that need did
Page 460 U. S. 412
not mark a 'recovery' within the meaning of the tax benefit
cases."
Id. at
398 U. S. 5.
[
Footnote 2/16]
Today, the Court again has before it a case in which the
Commissioner, with the endorsement of some commentators and a
closely divided Tax Court, is pushing for a more ambitious tax
benefit rule. [
Footnote 2/17]
This time, the Court accepts the invitation. Since there has been
no legislation since
Nash suggesting that our approach
over the past half-century [
Footnote
2/18] has been wrong-headed,
cf. 460
U.S. 370fn2/32|>n. 32,
infra the new doctrine that
emerges from today's decision is of the Court's own making.
II
In the
Bliss Dairy case, the Court today reaches a
result contrary to that dictated by a recovery theory. One would
not expect such a break with the past unless it were apparent that
prior law would produce a palpable inequity -- a clear windfall for
the taxpayer. Yet that is not the case in
Bliss Dairy.
Indeed, the tax economics of the case are indistinguishable from
those of the
Nash case.
Page 460 U. S. 413
Three statutory provisions, as interpreted by the Commissioner,
interact in
Bliss Dairy. First, pursuant to § 162(a),
[
Footnote 2/19] the Commissioner
allowed the corporation to deduct the entire cost of all grain
purchased in 1972. That deduction left it with a basis of zero in
that grain. Second, under the terms of § 336, [
Footnote 2/20] the corporation was not required to
recognize any gain or loss when it went through a § 333 liquidation
in 1973. And third, pursuant to the regulations implementing § 334,
[
Footnote 2/21] the shareholders
were allowed to assign some portion of their basis in the
corporation's stock to the grain they received in the liquidation.
Admittedly, this combination of provisions could, in some cases,
cause a "step-up" in the grain's basis that is not reflected in the
income of either the corporation or the shareholders. That
possibility figured strongly in the decision of the Court of
Appeals for the Sixth Circuit to endorse an inconsistent-event
theory in a precursor of this case.
See Tennessee-Carolina
Transportation, In. v. Commissioner, 582 F.2d 378, 382, and n.
14 (1978). And it is stressed by the Solicitor General in his
argument in this case. Brief for United States in No. 81-930 and
for Respondent in No. 81485, pp. 39-42. Yet close analysis reveals
that the potential untaxed step-up is not the sort of extraordinary
and inequitable windfall that calls for extraordinary measures in
this case.
Page 460 U. S. 414
As a factual matter, the record does not include the tax returns
of Bliss Dairy's shareholders. We have no indication of how much,
if any, step-up in basis actually occurred. And as a legal matter,
a § 333 liquidation expressly contemplates steps-up in basis that
are not reflected in income. Thus, even if the corporation had
behaved as the Court believes it should have, and had fed all the
grain to the cows before liquidating, whatever shareholder stock
basis was assigned to the grain in this case would have been used
to step up the basis of some other asset that passed to the
shareholders in the liquidation.
I suppose it might be argued that this sort of untaxed step-up
is acceptable if it happens accidentally, but not if a taxpayer
manipulates business transactions solely to take advantage of it.
Yet here again we have too little information to conclude that
there has been any such manipulation in the case of Bliss Dairy. To
begin with, the Government has never questioned the propriety of
the 1972 deduction, viewed in the light of 1972 events. [
Footnote 2/22] Moreover, the record
before us on appeal does not tell us how much feed the Dairy's
cattle consumed in 1972, whether 1972 consumption exceeded 1972
purchases, or how the volume purchased in 1972 compared with
purchases in prior years. Indeed, it is quite possible that, in
1971, the Dairy had made abnormally large purchases as a hedge
against a possible rise in the market price, and that its 1972
consumption of grain actually exceeded its $150,000 in purchases
during that year.
It is no doubt for these reasons that the Court never relies on
the untaxed step-up argument in its opinion today. [
Footnote 2/23] Unfortunately,
Page 460 U. S. 415
the only argument the Court offers in its place is an
ipse
dixit: it seems wrong for a taxpayer not to realize income if
it fails to use up an asset, when it was allowed to deduct the
value of that asset in a prior year. We rejected that precise
proposition in
Nash. In both
Nash and
Bliss
Dairy, the transfer of the business in a subsequent year
revealed that a business asset matching a prior deduction
(
i.e., grain matching the expense deduction, or the
account receivable matching the bad debt deduction) would not be
used up (
i.e., consumed or become uncollectible) until it
had passed to a different taxpayer. [
Footnote 2/24] The only explanation for today's
decision to detach the tax benefit rule from the recovery mooring
appears to be the challenge to be found in an open sea of
troublesome and inconclusive hypothetical cases. [
Footnote 2/25]
Page 460 U. S. 416
III
Because tax considerations play such an important role in
decisions relating to the investment of capital, the transfer of
operating businesses, and the management of going concerns, there
is a special interest in the orderly, certain, and consistent
interpretation of the Internal Revenue Code. Today's decision
seriously compromises that interest. It will engender uncertainty,
it will enlarge the tax gatherer's discretionary power to reexamine
past transactions, and it will produce controversy and
litigation.
Any inconsistent-event theory of the tax benefit rule would make
the tax system more complicated than it has been under the recovery
theory. [
Footnote 2/26]
Inconsistent-event analysis
Page 460 U. S. 417
forces a deviation from the traditional pattern of calculating
income during a given year: identify the transactions in which the
taxpayer was made wealthier, determine from the history of those
transactions which apparent sources of enrichment should be
characterized as income, and then determine how much of that income
must be recognized. Of course, in several specific contexts,
Congress has already mandated deviations from that traditional
pattern, [
Footnote 2/27] and the
additional complications are often deemed an appropriate price for
enhanced tax equity. But, to my knowledge, Congress has never even
considered so sweeping a deviation as a general inconsistent-event
theory.
Nonetheless, a general inconsistent-event theory would surely
give more guidance than the vague hybrid established by the Court
today. The dimensions of the Court's newly fashioned "fundamentally
inconsistent event" version of the
Page 460 U. S. 418
tax benefit rule are by no means clear. It obviously differs
from both the Government's "inconsistent event" theory and the
familiar "recovery" theory, either of which would require these two
cases to be decided in the same way. I do not understand, however,
precisely why the Court's theory distinguishes between these cases,
or how it is to be applied in computing the 1973 taxes of Bliss
Dairy, Inc.
The Government describes its test as whether "subsequent events
eliminate the factual premise on which the deduction was originally
claimed." Brief for United States in No. 81930 and for Respondent
in No. 81-485, p. 18. The Court describes its test as whether "the
later event is indeed fundamentally inconsistent with the premise
on which the deduction was initially based."
Ante at 383.
One might infer that the difference between these tests is a
difference between "inconsistent events" and "fundamentally
inconsistent events." The Court attempts to place the line more
precisely "between merely unexpected events and inconsistent
events."
Ante at
460 U. S. 383,
n. 15. I am afraid the attempt fails because, however it is
described, the line does not cleanly and predictably separate the
Court's position from the Government's.
The Court presents its test as whether "the occurrence of the
[later year's] event in the earlier year would have resulted in the
disallowance of the deduction."
Ante at
460 U. S. 389.
But in
Hillsboro, the Court rejects the Government's
claim. The Court holds that, if this Court had decided
Lehnhausen v. Lakeshore Auto Parts Co., 410 U.
S. 356 (1973), in 1972, the Bank would still have been
entitled to deduct a dividend that was not used for the payment of
taxes. It attempts to read the legislative history of § 164(e) as
establishing that Congress did not care about the use to which the
dividend payment was put, but only about the Bank's reason for the
dividend. I would simply note that I find JUSTICE BLACKMUN's
interpretation of § 164(e) far more plausible.
The Court's analysis of
Bliss Dairy is equally
unsatisfying. Without any mention of a same-year principle, the
Court resolves
Page 460 U. S. 419
the case in a single sentence: a § 336 liquidation is
assimilated to a dividend distribution, which is deemed "the analog
of personal consumption," and therefore "it would seem that it
should take into income the amount of the earlier deduction."
Ante at
460 U. S. 396,
and n. 31. [
Footnote 2/28] It is
not obvious to me why the change in ownership of a going concern is
more "the analog of personal consumption" than the gift of an
asset.
The new rule will create even more confusion than that which
will accompany efforts to reconcile the Court's disposition of
these two cases. Given that
Nash is still considered good
law by the Court, it is not clear which prior expenses of Bliss
Dairy, Inc., will give rise to income in 1973. Presumably, all
expenses for the purchase of tangible supplies will be treated like
the cattle feed. Thus, all corporate paper towels, paper clips, and
pencils that remain on hand will become income as a result of the
liquidation. It is not clear, however, how the Court would react to
other expenses that provide an enduring benefit. I find no limiting
principle in the Court's opinion that distinguishes cattle feed and
pencils from prepaid rent, prepaid insurance, accruals of employee
vacation time, advertising, management training, or any other
expense that will have made the going concern more valuable when it
is owned directly by its shareholders.
The Court's opinion also leaves unclear the amount of income
that is realized in the year in which the fundamentally
inconsistent event occurs. In most of its opinion, the Court
indicates that the taxpayer is deemed to realize "the amount of his
earlier deduction,"
ante at
460 U. S. 383,
but from time to time the Court equivocates, [
Footnote 2/29] and at least once suggests that,
when
Page 460 U. S. 420
an expensed asset is sold, only the "amount of the proceeds on
sale,"
ante at
460 U. S. 395,
is income. [
Footnote 2/30] Even
in
Bliss Dairy, which involves a revolving inventory of a
fungible commodity, I am not sure how the Court requires the "cost"
of the grain,
ante at
460 U. S. 403,
to be computed. If the corporation's 1972 consumption matched its
1972 purchases, one might think that the relevant cost was that in
the prior years, when the surplus was built up. I cannot tell
whether or why the fundamentally inconsistent-event theory prefers
LIFO accounting over FIFO.
IV
Neither history nor sound tax policy supports the Court's
abandonment of its interpretation of the tax benefit rule as a tool
for characterizing certain recoveries as income. If Congress were
dissatisfied with the tax treatment that I believe Bliss Dairy
should be accorded under current law, it could respond by changing
any of the three provisions that bear on this case.
See
supra at
460 U. S. 413
. It could modify the manner in which deductions are authorized
under § 162. [
Footnote 2/31] It
could
Page 460 U. S. 421
legislate another statutory exception to the annual accounting
system, much as it did when it made the depreciation recapture
provisions, §§ 1245, 1250, apply to § 336 liquidations. [
Footnote 2/32] Or it could modify the
manner in which basis is allocated under § 334. [
Footnote 2/33] But in the absence of legislative
action, I cannot join in the Court's attempt to achieve similar
results by distorting the tax benefit rule. [
Footnote 2/34]
Page 460 U. S. 422
Accordingly, I concur in the Court's judgment in No. 81485 and
respectfully dissent in No. 81-930.
[
Footnote 2/1]
Cf. H. Simons, Personal Income Taxation 50 (1938)
(defining income as net accumulation of property rights over the
course of a year, plus consumption during that year).
[
Footnote 2/2]
Notwithstanding this focus on the legitimacy of the 1972
deductions, scrutinized with the aid of hindsight after the
completion of a multi-year transaction, the Court is careful not to
require that "transactional inequities" be dealt with in the most
"precise way" imaginable.
Ante at
460 U. S. 378,
n. 10. It rejects JUSTICE BLACKMUN's suggestion that the 1972 tax
returns be reopened, quite properly noting our past observations
that
"'[i]t would be disruptive of an orderly collection of the
revenue to rule that the accounting must be done over again to
reflect events occurring after the year for which the accounting is
made, and would violate the spirit of the annual accounting
system.'"
Ante at
460 U. S. 380,
n. 10, quoting
Healy v. Commissioner, 345 U.
S. 278,
345 U. S. 285
(1953).
See also ante at
460 U. S.
380-381, n. 12.
[
Footnote 2/3]
Plumb, The Tax Benefit Rule Today, 57 Harv.L.Rev. 129, 131, n.
10 (1943).
Accord, Estate of Collins v. Commissioner, 46
B.T.A. 765, 769 (1942),
rev'd sub nom. Harwick v.
Commissioner, 133 F.2d 732 (CA8),
rev'd sub nom. Dobson v.
Commissioner, 320 U. S. 489
(1943).
[
Footnote 2/4]
Section 111(a) provides:
"Gross income does not include income attributable to the
recovery during the taxable year of a bad debt, prior tax,
or delinquency amount, to the extent of the amount of the recovery
exclusion with respect to such debt, tax, or amount."
(Emphasis added.)
[
Footnote 2/5]
Ibid. See also the detailed provisions of ch.
619, Title I, § 156(a) of the Act of Oct. 21, 1942, 56 Stat. 852,
amended, Act of Aug. 16, 1954, ch. 736, 68A Stat. 343, repealed,
Pub.L. 94-455, Title XIX, § 1901(a)(145)(A), Act of Oct. 4, 1976,
90 Stat. 1788, establishing a mechanism for including the
recoveries of previously claimed war losses in current income to
the extent of tax benefit.
[
Footnote 2/6]
Consider the following passages from the regulations under §
111.
"
General. Section 111 provides that income attributable
to the
recovery during any taxable year of bad debts,
prior taxes, and delinquency amounts shall be excluded from gross
income to the extent of the 'recovery exclusion' with respect to
such items. The rule of exclusion so prescribed by statute applies
equally with respect to all other losses, expenditures and accruals
made the basis of deductions from gross income for prior taxable
years, including war losses . . . but not including deductions with
respect to depreciation, depletion, amortization, or amortizable
bond premiums. . . ."
* * * *
"
Definition of 'recover.' Recoveries result from the
receipt of amounts in respect of the previously deducted or
credited section 111 items, such as from the collection or sale of
a bad debt, refund or credit of taxes paid, or cancellation of
taxes accrued."
Treas.Reg. § 1.111-1(a), 26 CFR 1.111-1(a) (1982) (emphasis
added).
Consider also:
"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."
Treas.Reg. § 1.165-1(d)(2)(iii), 26 CFR § 1.165-1(d)(2)(iii)
(1982).
[
Footnote 2/7]
E.g., National Bank of Commerce v. Commissioner, 115
F.2d 875 (CA9 1940);
South Dakota Concrete Products Co. v.
Commissioner, 26 B.T.A. 1429 (1932).
[
Footnote 2/8]
See Costigan, Income Taxes on Recoveries from Civil
Litigation, Proceedings of the U.S.C. Tax Inst. 559, 567-570
(1954); Atlas, Tax Free Recoveries: The Tax Benefit Rule, N.Y.U.
9th Inst. on Fed.Tax. 847 (1951); Tye, The Tax Benefit Doctrine
Reexamined, 3 Tax L.Rev. 329 (1948); Plumb, The Tax Benefit Rule
Today, 57 Harv.L.Rev. 129, 131, n. 10, 176 (1943); Lassen, The Tax
Benefit Rule and Related Problems, 20 Taxes 473, 475 (1942)
(statute of limitations not a problem because "all these cases have
a new element, namely, a recovery or increment in value or decrease
of liability in the year in which income was determined by the
Commissioner to have been received"); Note, 56 Harv.L.Rev. 434, 436
(1942); Zysman, Income Derived From the Recovery of Deductions, 19
Taxes 29 (1941); Ayers, Bad Debts -- Deductions and Recoveries, 18
Taxes 549 (1940).
[
Footnote 2/9]
Except for
Barnett v. Commissioner, 39 B.T.A. 864
(1939), all of the early cases cited by the Court,
ante at
460 U. S.
386-387, involved a recovery. In
Estate of Block v.
Commissioner, 39 B.T.A. 338, 341 (1939), the Board of Tax
Appeals made the following statement:
"When recovery or some other event which is inconsistent with
what has been done in the past occurs, adjustment must be made in
reporting income for the year in which the change occurs. No other
system would be practical in view of the statute of limitations,
the obvious administrative difficulties involved, and the lack of
finality in income tax liability, which would result. The foregoing
principles, which have been established by the following cases,
require that the refund here be included in the income of this
estate for the year of recovery."
Notwithstanding the general reference to an inconsistent event
in the first quoted sentence, it is obvious from the two succeeding
sentences that the Board was not intending to lay the groundwork
for a new theory of the tax benefit rule. Rather, it was attempting
to respond to the suggestion that the adjustment be made in the
year of deduction, rather than the year of recovery. This
conclusion is confirmed by the fact that the third quoted sentence
speaks of "the year of recovery," not "the year of inconsistent
event," and by the fact that each of the 14 cases cited by the
Board following the conclusion of the quoted passage, like
Estate of Block itself and like
South Dakota Concrete
Products Co. v. Commissioner, supra, involved recoveries in
the traditional sense.
[
Footnote 2/10]
It should be noted that, even in
Barnett, the Board of
Tax Appeals included its discussion of inconsistent events only
after emphasizing that the inclusion in income of a prior oil
depletion deduction was required by Treasury Regulations that had
been ratified by Congress. 39 B.T.A. at 867.
[
Footnote 2/11]
In
Dobson v. Commissioner, 320 U.
S. 489 (1943), the taxpayer had bought stock, sold it at
a loss, and then claimed a deductible loss on his tax return. Eight
years later, the taxpayer had sued for rescission of the stock
purchase, claiming fraud; he settled the suit and received
approximately $30,000 for the stock on which he had sustained the
loss. We upheld the Tax Court's determination that the $30,000
recovery did not need to be reported as income, since the earlier
deductible losses had not reduced the taxpayer's taxes in the year
he had claimed them. For present purposes, the holding in
Dobson was less significant than the way it endorsed the
Tax Court's analysis:
"The Tax Court has not attempted to revise liability for earlier
years closed by the statute of limitation, nor used any expense,
liability, or deficit of a prior year to reduce the income of a
subsequent year.
It went to prior years only to determine the
nature of the recovery, whether return of capital or
income."
Id. at 493 (emphasis added). The tax benefit question
was not one of inconsistent events, but whether a recovery should
be characterized as return of capital or as income.
[
Footnote 2/12]
Burnet v. Sanford & Brooks Co., 282 U.
S. 359 (1931), was a mirror image of this case. The
taxpayer argued that a recovery of previously deducted funds should
not be income because, seen from a transactional view, no net
profits had been realized. The Court framed the issue as whether
net profits are to be determined
"on the basis of fixed accounting periods, or . . . on the basis
of particular transactions of the taxpayer when they are brought to
a conclusion."
Id. at
282 U. S. 363.
The answer was unanimous and unflinching:
"A taxpayer may be in receipt of net income in one year and not
in another. The net result of the two years, if combined in a
single taxable period, might still be a loss; but it has never been
supposed that that fact would relieve him from a tax on the first,
or that it affords any reason for postponing the assessment of the
tax until the end of a lifetime, or for some other indefinite
period, to ascertain more precisely whether the final outcome of
the period, or of a given transaction, will be a gain or a
loss."
"The Sixteenth Amendment was adopted to enable the government to
raise revenue by taxation. It is the essence of any system of
taxation that it should produce revenue ascertainable, and payable
to the government, at regular intervals. Only by such a system is
it practicable to produce a regular flow of income and apply
methods of accounting, assessment, and collection capable of
practical operation. It is not suggested that there has ever been
any general scheme for taxing income on any other basis. . . .
While, conceivably, a different system might be devised by which
the tax could be assessed, wholly or in part, on the basis of the
finally ascertained results of particular transactions, Congress is
not required by the amendment to adopt such a system in preference
to the more familiar method, even if it were practicable."
Id. at
282 U. S.
364-365.
Healy v. Commissioner, 345 U.
S. 278 (1953), dealt with a more extreme effort to
approximate a transactional accounting system -- more closely
analogous to JUSTICE BLACKMUN's approach than to the Court's today.
In that case, a taxpayer received money under a claim of right in
an early year and was forced to disgorge it in a later year. The
Government was perfectly willing to allow the taxpayer to take a
deduction in the year of disgorgement (presumably under a "tax
detriment" theory, since repayments of loans are usually not
deductible), but the taxpayer wanted to be able to go back and
reopen the prior year, in which he had included the receipt in
income. The Court refused to allow the reopening, extolling the
virtues of an annual accounting system.
Id. at
345 U. S.
284-285.
See 460
U.S. 370fn2/2|>n. 2,
supra.
[
Footnote 2/13]
See Rev.Rul. 62-128, 1962-2 Cum.Bull. 139; Note, 21
Vand.L.Rev. 995 (1968);
Estate of Schmidt v. Commissioner,
42 T.C. 1130 (1964),
rev'd, 355 F.2d 111 (CA9 1966).
[
Footnote 2/14]
For example:
"The [tax benefit] rule rests on the notion that a taxpayer
should not be permitted to retain the tax benefit of a deduction
when later events demonstrate that he no longer is entitled to it.
. . . To limit application of the rule to cases in which there has
been an economic recovery would frustrate its purpose, which is to
insure that a taxpayer not retain the benefit of a deduction to
which he is no longer entitled. Fulfillment of that purpose
requires application of the rule, whether the lack of need for a
bad debt reserve arises from a sale or collection of accounts
receivable, or merely by reason of the termination of the existence
of the owner of the receivables. . . . The proper analysis of the
transaction where accounts receivable are sold for their net value
by a reserve method taxpayer is to restore the reserve to his
income and accord him a loss on the sale of property. That this
loss (face value less amount realized) equals the amount of the
restoration to income does not militate against the basic principle
that the reserve must be restored to income when it is no longer
needed, irrespective of whether there has been an economic
recovery."
Brief for United States in
Nash v. United States, O.T.
1969, No. 678, pp. 8-14.
[
Footnote 2/15]
The Commissioner argued that (a) an accrual basis taxpayer is
normally only allowed to deduct accounts receivable that are
uncollectible, (b) the taxpayer had been allowed to take a
deduction because the taxpayer was being allowed to represent that
it would eventually find some presently collectible accounts to be
uncollectible, and (c) those accounts had
not in fact
become uncollectible at the time they left the taxpayer's hands.
The Commissioner asserted that the earlier deduction had been
allowed on the assumption that it fairly represented the taxpayer's
continuing "need" for bad debt deductions across taxable years. He
argued that, once the accounts receivable left the taxpayer's
hands, it had no further "need" for the bad debt reserve, and that
the premise for the prior deduction had become invalid.
See
ibid.
[
Footnote 2/16]
The taxpayer's receipts from the sale of the business was not a
recovery because, to the extent the accounts receivable were offset
by the bad debt reserve, the corporation had not paid the taxpayer
a penny for them. It was this fact that distinguished
Nash
and
Schmidt from earlier cases applying the tax benefit
rule to bad debt reserves such as
Arcadia Savings & Loan
Assn. v. Commissioner, 300 F.2d 247 (CA9 1962),
Citizens
Federal Savings & Loan Assn. v. United States, 154 Ct.Cl.
305, 290 F.2d 932 (1961),
West Seattle National Bank v.
Commissioner, 288 F.2d 47 (CA9 1961), and
S. Rossin &
Sons, Inc. v. Commissioner, 113 F.2d 652 (CA2 1940).
[
Footnote 2/17]
See Rev.Rul. 74-396, 1974-2 Cum.Bull. 106; Feld, The
Tax Benefit of
Bliss, 62 B.U.L.Rev. 443 (1982);
Tennessee-Carolina Transportation, Inc. v. Commissioner,
65 T.C. 440 (1975),
aff'd, 582 F.2d 378 (CA6 1978),
cert. denied, 440 U.S. 909 (1979).
Contra,
O'Hare, Application of Tax Benefit Rule in New Case Threatens
Certain Liquidations, 44 J. Taxation 200 (1976); Broenen, The Tax
Benefit Rule and Sections 332, 334(b)(2) and 336, 53 Taxes 231
(1975).
[
Footnote 2/18]
Nash and
Dobson are the only tax benefit rule
cases ever decided in this Court. On one other occasion, the Court
invoked the tax benefit rule by analogy.
United States v.
Skelly Oil Co., 394 U. S. 678,
394 U. S. 688,
and n. 5 (1969).
[
Footnote 2/19]
In relevant part, 26 U.S.C. § 162(a) provides that
"[t]here shall be allowed as a deduction all the ordinary and
necessary expenses paid or incurred during the taxable year in
carrying on any trade or business. . . ."
[
Footnote 2/20]
In relevant part, 26 U.S.C. § 336 provides that "no gain or loss
shall be recognized to a corporation on the distribution of
property in partial or complete liquidation."
[
Footnote 2/21]
In relevant part, 26 U.S.C. § 334 provides that,
"[i]f . . . property was acquired by a shareholder in the
liquidation of a corporation in cancellation or redemption of
stock, and . . . the extent to which gain was recognized was
determined under § 333, then the basis shall be the same as the
basis of such stock cancelled or redeemed in the liquidation,
decreased in the amount of any money received by the shareholder,
and increased in the amount of gain recognized to him."
The relevant implementing regulations are found at Treas.Reg. §
1.334-2, 26 CFR § 1.334-2 (1982).
[
Footnote 2/22]
The Court's partial quotation of Treas.Reg. § 1.162-3, 26 CFR
1.162-3 (1982),
ante at
460 U. S. 395,
suggests that it may regard the deduction for unconsumed feed as
improper because the feed was not "
actually consumed and used
in operation in the taxable year,"
ibid. Of course,
if the Court really believed that such a deduction should not be
allowed, the proper course of action would be to modify the rules
authorizing the deduction,
see 460
U.S. 370fn2/31|>n. 31,
infra, rather than to modify
the tax benefit rule.
[
Footnote 2/23]
It should also be noted that the potential for an untaxed
step-up, which may give rise to a second deduction in cases such as
this, is analytically the same as the potential for a double
deduction that was present in
Nash. See Brief for
United States in
Nash v. United States, O.T. 1969, No.
678, pp. 20-31.
[
Footnote 2/24]
The Solicitor General made this timing point explicit in
Nash.
"Since a reserve for bad debts represents losses that are
estimated will be sustained in subsequent taxable years, . . . any
unabsorbed amounts in such a reserve must be restored to income
when . . . it becomes clear that the taxpayer will not suffer some
or all of the estimated losses as a result of the uncollectibility
of accounts receivable."
Id. at 8-9.
[
Footnote 2/25]
The flaws in the Court's approach are exemplified by its
discussion,
ante at
460 U. S.
384-385, of a hypothetical situation involving a tenant
who has paid the entire cost of a 30-day lease that straddles two
taxable years on December 15 of the first year.
The Court first invites consideration of what tax consequences
would result if the premises burn down in January of the second
year. I would think it obvious that a taxpayer does not realize
income under such circumstances, and the Court manages to
accommodate this result to its theory. Even though the original
explanation for the deduction (the business would make use of the
premises) is no longer valid, the Court finds no fundamental
inconsistency because "the loss is attributable to the
business."
The Court goes through this exercise in order to reach the next
hypothetical, wherein the taxpayer
voluntarily stops using
the leasehold for a business purpose during the second year. Having
assumed that the entire cost of the lease was deductible during the
first year, the Court now declares that the tax benefit rule must
be invoked to prevent a tax inequity. The Court's methodology in
this regard is quite revealing. It has presumed the validity of the
deduction in the first year, citing
Zaninovich v.
Commissioner, 616 F.2d 429 (CA9 1980). Yet
Zaninovich
is still being debated in the lower courts, in part because of
hypothetical cases such as this one, and has not been endorsed by
either the Commissioner or the Tax Court.
See Keller v.
Commissioner, 79 T.C. 7, 40, n. 24 (1982);
Dunn v. United
States, 468 F.
Supp. 991, 994, and n. 17 (SDNY 1979) (Weinfeld, J.).
See
also Van Raden v. Commissioner, 71 T.C. 1083, 1107 (1979)
(suggesting a distinction between "period" costs and "product"
costs),
aff'd, 650 F.2d 1046 (CA9 1981). Thus, the Court
creates its own problem by blithely allowing a deduction in the
initial period, with the intention of continuously second-guessing
that decision in subsequent years. I do not see the advantage of
this approach over JUSTICE BLACKMUN's suggestion, which is
criticized by the Court
ante at
460 U. S.
378-380, n. 10. Instead, I would prefer to think
carefully about whether or not the deduction should be allowed in
the first place (taking into account such factors as the ease with
which a lease can be prorated, the likelihood of nonbusiness uses,
and the bright-line recovery rule) and, if that results in a
decision to grant the deduction, to abide by whatever consequences
follow from the application of traditionally accepted tax
principles.
[
Footnote 2/26]
The Court suggests,
ante at
460 U. S.
381-383, that a recovery requirement is both too narrow
and too broad to give certain guidance. The Court suggests it is
too narrow because the Court believes that the cancellations of
indebtedness found in
Mayfair Minerals, Inc. v.
Commissioner, 456 F.2d 622 (CA5 1972),
Bear Manufacturing
Co. v. United States, 430 F.2d 152 (CA7 1970),
Haynsworth
v. Commissioner, 68 T.C. 703 (1977), and
G. M. Standifer
Construction Corp. v. Commissioner, 30 B.T.A. 184 (1934),
"[do] not fit within any ordinary definition of
recovery.'"
Ante at 460 U. S. 382.
I disagree. As the Court concedes, ibid., cancellation of
a legally enforceable liability quite obviously increases the
taxpayer's net worth. The Code therefore explicitly requires a
discharge of indebtedness to be included in income. § 61(a)(12).
Cf. § 108. It does no damage to the English language to
say that a taxpayer who has previously incurred an expense by
assuming a liability recovers that expense when the liability is
canceled.
The Court suggests that the term "recovery" is too broad,
because two courts have claimed to find a recovery in situations
the Court finds surprising.
Tennessee-Carolina Transportation,
Inc. v. Commissioner, 582 F.2d 378 (CA6 1978) (alternative
holding);
First Trust and Savings Bank of Taylorville v. United
States, 614 F.2d 1142 (CA7 1980). Since I believe both cases
were wrongly decided (
Tennessee-Carolina applied the tax
benefit rule to a case closely analogous to
Bliss Dairy,
and
First Trust applied the rule to a case closely
analogous to
Hillsboro Bank), I do not find the Court's
criticism any more persuasive than I would find a suggestion that
someone might incorrectly think there was a "recovery" in the cases
before us today.
[
Footnote 2/27]
E.g., §§ 1245, 1250 (mere dispositions of certain
depreciable property and certain depreciable realty may give rise
to income).
[
Footnote 2/28]
It is noteworthy that the Court cites no authority for the
assumption -- critical under its interpretation of the tax benefit
rule -- that, if the liquidation of Bliss Dairy, Inc., had occurred
in 1972, the deduction for purchased but unconsumed cattle feed
would have been disallowed.
[
Footnote 2/29]
In a footnote,
ante at
460 U. S. 402,
n. 37, the Court suggests that it is not addressing the issue of
whether some figure less than the amount previously deducted might
be appropriate. Two possibilities have been suggested:
lesser-of-prior-deduction-and-current-fair market value,
see
Tennessee Carolina Transportation, Inc. v. Commissioner, 65
T.C. 440, 448 (1975), and
lesser-of-prior-deduction-and-shareholder's-basis,
see
Feld, The Tax Benefit of
Bliss, 62 B.U.L.Rev. 443 (1982).
Given the uniform tenor of the Court's theory that the tax benefit
rule serves to "
cancel out' an earlier deduction,"
ante at 460 U. S. 383,
I think it unlikely that it would endorse either
possibility.
[
Footnote 2/30]
This view, of course, conforms to what a recovery theory would
dictate.
See Rosen v. Commissioner, 611 F.2d 942 (CA1
1980) (taxpayer realizes the value of recovered asset, determined
at time of recovery).
[
Footnote 2/31]
If it were so inclined, it could modify § 162(a) to provide that
no deduction would be allowed for the purchase of materials and
supplies; instead, a deduction would be allowed only at the time of
consumption. Such a sentiment clearly underlies the Court's
statement,
ante at
460 U. S. 395,
that "[t]he deduction is predicated on the consumption of the asset
in the trade or business."
Alternatively, it could provide that a purchase of materials and
supplies not be considered an "ordinary and necessary expense" to
the extent it includes items that will probably not be consumed
during the taxable year. As the Solicitor General notes in his
brief before this Court, "income might be more accurately reflected
through the use of inventory accounting for such supplies," Brief
for United States in No. 81-930 and for Respondent in No. 81-485,
pp. 37-38. It bears mention that the Commissioner presently takes
the position that an expenditure for feed that will be consumed in
a subsequent year will not be allowed unless three tests are
satisfied: it must be a payment (not a refundable deposit), it must
be made for a business purpose, and not merely for tax avoidance,
and the deduction must not result in a material distortion of
income. Rev.Rul. 79-229, 1979-2 Cum.Bull. 210.
Cf.
Treas.Reg. 1.162-12, 26 CFR § 1.162-12 (1982). The courts have
divided over whether the Commissioner's position is consistent with
the present § 162(a).
Compare Clement v. United States,
217 Ct.Cl. 495, 580 F.2d 422 (1978),
cert. denied, 440
U.S. 907 (1979);
Dunn v. United States, 468 F.
Supp. 991 (SDNY 1979) (Weinfeld, J.) (supporting the
Commissioner),
with Frysinger v. Commissioner, 645 F.2d
523 (CA5 1981);
Commissioner v. Van Raden, 650 F.2d 1046
(CA9 1981) (supporting the taxpayer).
[
Footnote 2/32]
In 1975, Congress had before it, but was unable to pass, such
legislation. H.R. 10936, 94th Cong., 1st Sess. (1975).
[
Footnote 2/33]
In particular, it could prohibit the allocation of any
shareholder basis to an expensed asset, thereby completely
eliminating the possibility of the step-up discussed
supra
at
460 U. S. 413.
Indeed, the Internal Revenue Service could do so consistently with
the present text of § 334 by modifying Treas.Reg. § 1.334-2, 26 CFR
§ 1.334-2 (1982).
[
Footnote 2/34]
Because I disagree with the Court's conclusion that Bliss Dairy,
Inc., realized income upon liquidation, I obviously do not reach
the issue of how § 336, the nonrecognition provision, should be
construed. I would observe, however, that in order to justify its
conclusion, the Court is forced to override the plain language of §
336.
See ante at
460 U. S.
397-402; n. 20,
supra. The Court justifies this
course of action by invoking the lower court decisions that have
held the nonrecognition language of § 337 superseded by the tax
benefit rule in the context of recoveries.
E.g., Commissioner
v. Anders, 414 F.2d 1283 (CA10),
cert. denied, 396
U.S. 958 (1969);
Anders v. United States, 199 Ct.Cl. 1,
462 F.2d 1147,
cert. denied, 409 U.S. 1064 (1972). Those
cases are relevant because when Congress enacted § 337, it hoped to
allow taxpayers to enjoy some of the tax benefits of § 336 even
when they do not precisely satisfy the formal prerequisites for
applying that section. But assuming that the
Anders
construction of § 337 is correct (a point this Court has never
decided), I would think the tail wags the dog if one construes §
336 in light of § 337, rather than vice versa.
Cf.
Tennessee-Carolina Transportation, Inc. v. Commissioner,
supra, at 453 (Tannenwald, J., dissenting) ("Section 337 was
designed to be a shield for taxpayers, and not a sword to be used
against them in applying other sections of the Code").
JUSTICE BLACKMUN, dissenting.
These consolidated cases present issues concerning the so-called
"tax benefit rule" that has been developed in federal income tax
law. In No. 81-485, the Court concludes that the rule has no
application to the situation presented. In No. 81-930, it concludes
that the rule operates to the detriment of the taxpayer with
respect to its later tax year. I disagree with both
conclusions.
I
In No. 81-485, the Court interprets § 164(e) of the Internal
Revenue Code of 1954, 26 U.S.C. § 164(e).
See ante at
460 U. S.
392-395. It seems to me that the propriety of a 1972
deduction by the Bank under § 164(e) depended upon the payment by
the Bank of a state tax on its shares. This Court's decision in
Lehnhausen v. Lake Shore Auto Parts Co., 410 U.
S. 356 (1973), rendered any such tax nonexistent and any
deduction therefore unavailable. I sense no "focus of Congress . .
. on the act of payment rather than on the ultimate use of the
funds by the State."
Ante at
460 U. S. 394.
The focus, instead, is on the payment of a tax. Events proved that
there was no tax. The situation, thus, is one for the application,
not the nonapplication, of some tax benefit rule.
I therefore turn to the question of the application of a proper
rule in each of these cases.
Page 460 U. S. 423
II
The usual rule, as applied to a deduction, appears to be this:
whenever a deduction is claimed, with tax benefit, in a taxpayer's
federal return for a particular tax year, but factual developments
in a later tax year prove the deduction to have been asserted
mistakenly in whole or in part, the deduction, or that part of it
which the emerging facts demonstrate as excessive, is to be
regarded as income to the taxpayer in the later tax year. With that
general concept (despite occasionally expressed theoretical
differences between "transactional parity" or "transactional
inconsistency," on the one hand, and, on the other, a need for a
"recovery") I have no basic disagreement.
Regardless of the presence of § 111 in the Internal Revenue Code
of 1954, 26 U.S.C. § 111 (1976 ed. and Supp. V), it is acknowledged
that the tax benefit rule is judge-made.
See, e.g., 1 J.
Mertens, Law of Federal Income Taxation § 7.34, p. 114 (J. Doheny
rev. ed.1981); Bittker & Kanner, The Tax Benefit Rule, 26 UCLA
L.Rev. 265, 266 (1978). It came into being, apparently, because of
two concerns: (1) a natural reaction against an undeserved and
otherwise unrecoverable (by the Government) tax benefit, and (2) a
perceived need, because income taxes are payable at regular
intervals, to promote the integrity of the annual tax return. Under
this approach, if a deduction is claimed, with some justification,
in an earlier tax year, it is to be allowed in that year, even
though developments in a later year show that the deduction in the
earlier year was undeserved in whole or in part. This impropriety
is then counterbalanced (concededly in an imprecise manner,
see
ante at
460 U. S. 378,
n. 10, and
460 U. S.
380-381, n. 12) by the inclusion of a reparative item in
gross income in the later year.
See Burnet v. Sanford &
Brooks Co., 282 U. S. 359
(1931);
Healy v. Commissioner, 345 U.
S. 278 (1953).* In
Page 460 U. S. 424
Nash v. United States, 398 U. S.
1,
398 U. S. 3
(1970), the Court succinctly phrased it this way: "[A] recovery of
an item that has produced an income tax benefit in a prior year is
to be added to income in the year of recovery."
I have no problem with the rule with respect to its first
underlying concern (the rectification of an undeserved tax
benefit). When a taxpayer has received an income tax benefit by
claiming a deduction that later proves to be incorrect or, in other
words, when the
premise for the deduction is destroyed, it
is only right that the situation be corrected so far as is
reasonably possible, and that the taxpayer not profit by the
improper deduction. I am troubled, however, by the tendency to
carry out the second concern (the integrity of the annual return)
to unnecessary and undesirable limits. The rule is not that
sacrosanct.
In No. 81-485, Hillsboro National Bank, in its 1972 return, took
as a deduction the amount of assessed state property taxes the Bank
paid that year on its stock held by its shareholders; this
deduction, were there such a tax, was authorized by the unusual,
but nevertheless specific, provisions of § 164(e) of the Code, 26
U.S.C. § 164(e). The Bank received a benefit by the deduction, for
its net income and federal income tax were reduced accordingly.
Similarly, in No. 81-930, Bliss Dairy, Inc., which kept its books
and filed its returns on the cash receipts and disbursements
method, took a deduction in its return for its fiscal year ended
June 30, 1973, for cattle feed it had purchased that year. That
deduction was claimed as a business expense under § 162(a) of the
Code, 26 U.S.C. § 162(a). The Dairy received a tax benefit, for its
net income and federal income tax for fiscal 1973 were reduced by
the deduction. Thus far, everything is clear and there is no
problem.
In the Bank's case, however, a subsequent development, namely,
the final determination by this Court in 1973 in
Page 460 U. S. 425
Lehnhausen, supra, that the 1970 amendment of the
Illinois Constitution, prohibiting the imposition of the state
property taxes in question, was valid, eliminated any factual
justification for the 1972 deduction. And, in the Dairy's case, a
post-fiscal year 1973 development, namely, the liquidation of the
corporation and the distribution of such feed as was unconsumed on
June 30, 1973, to its shareholders, with their consequent ability
to deduct, when the feed thereafter was consumed, the amount of
their adjusted basis in that feed, similarly demonstrated the
impropriety of the Dairy's full-cost deduction in fiscal 1973.
I have no difficulty in favoring some kind of "tax benefit"
adjustment in favor of the Government for each of these situations.
An adjustment should be made, for in each case the beneficial
deduction turned out to be improper and undeserved because its
factual premise proved to be incorrect. Each taxpayer thus was not
entitled to the claimed deduction, or a portion of it, and this
nonentitlement should be reflected among its tax obligations.
This takes me, however, to the difficulty I encounter with the
second concern, that is, the unraveling or rectification of the
situation. The Commissioner and the United States in these
respective cases insist that the Bank and the Dairy should be
regarded as receiving income in the very next tax year when the
factual premise for the prior year's deduction proved to be
incorrect. I could understand that position, if, in the interim,
the bar of a statute of limitations had become effective or if
there were some other valid reason why the preceding year's return
could not be corrected and additional tax collected. But it seems
to me that the better resolution of these two particular cases and
others like them -- and a resolution that should produce little
complaint from the taxpayer -- is to make the necessary adjustment,
whenever it can be made, in the tax year for which the deduction
was originally claimed. This makes the correction where the
correction is due, and it makes the amount of net income for each
year a true amount and one that accords with the facts, not
Page 460 U. S. 426
one that is structured, imprecise, and fictional. This normally
would be accomplished either by the taxpayer's filing an amended
return for the earlier year, with payment of the resulting
additional tax, or by the Commissioner's assertion of a deficiency
followed by collection. This actually is the kind of thing that is
done all the time, for when a taxpayer's return is audited and a
deficiency is asserted due to an overstated deduction, the process
equates with the filing of an amended return.
The Dairy's case is particularly acute. On July 2, 1973, on the
second day after the end of its fiscal year, the Dairy adopted a
plan of liquidation pursuant to § 333 of the Code, 26 U.S.C. § 333.
That section requires the adoption of a plan of liquidation; the
making and filing, within 30 days, of written elections by the
qualified electing shareholders; and the effectuation of the
distribution in liquidation within a calendar month. §§ 333(a),
(c), and (d). It seems obvious that the Dairy, its management, and
its shareholders, by the end of the Dairy's 1973 fiscal year on
June 30, and certainly well before the filing of its tax return for
that fiscal year, all had conceived and developed the July 2, 1973,
plan of liquidation and were resolved to carry out that plan with
the benefits that they felt would be afforded by it. Under these
circumstances, we carry the tax benefit rule too far and apply it
too strictly when we utilize the unconsumed feed to create income
for the Dairy for fiscal 1974 (the month of July, 1973), instead of
decreasing the deduction for the same feed in fiscal 1973. Any
concern for the integrity of annual tax reporting should not demand
that much. I thus would have the Dairy's returns adjusted in a
realistic and factually true manner, rather than in accord with an
inflexibly administered tax benefit rule.
Much the same is to be said about the Bank's case. The decisive
event, this Court's decision in
Lehnhausen, occurred on
February 22, 1973, within the second month of the Bank's 1973 tax
year. Indeed, it took place before the Bank's calendar year 1972
return would be overdue. Here again, an accurate
Page 460 U. S. 427
return for 1972 should be preferred over inaccurate returns for
both 1972 and 1973.
This, in my view, is the way these two particular tax
controversies should be resolved. I see no need for anything more
complex in their resolution than what I have outlined. Of course,
if a statute of limitations problem existed, or if the facts in
some other way prevented reparation to the Government, the cases
and their resolution might well be different.
I realize that my position is simplistic, but I doubt if the
judge-made tax benefit rule really was intended, at its origin, to
be regarded as applicable in simple situations of the kind
presented in these successive-tax-year cases. So often a judge-made
rule, understandably conceived, ultimately is used to carry us
further than it should.
I would vacate the judgment in each of these cases and remand
each case for further proceedings consistent with this
analysis.
* In
Sanford & Brooks, the earlier tax years were
1913-1916 and the later year was 1920. In
Healy, the
earlier year was 1945 and the later years were 1947 and 1948. In
Healy, the Court specifically noted the probable
complicating factor of a statute of limitations barrier. 345 U.S.
at
345 U. S.
284.