income tax index text chapter eight tax two index accrual...

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Accrual Method

!!!! INCOMEAll Events TestPPPP Doubtful CollectibilityPPPP UnenforceabilityEarlier of TestPPPP History of the test

!!!!DEDUCTIONSAll Events Test§ 461(h): Economic PerformanceTestRelationship between accrual ofdeductions and the time value ofmoney

This is the difficult part.

The same issues arise withregard to accrual of income

and the “earlier of” test;however, they are better

illustrated with deductionsand the “economic

performance” test of § 461(h).

Income Tax Index

Tax Two Index

text Chapter Eight

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Accrual Method: Income

All Events Test

Include an amount when all events have occurred such that thetaxpayer has a right to the item and the amount thereof can bedetermined with reasonable accuracy.

This is the same rule as for Generally Accepted AccountingPrinciples [GAAP].

As seen in the next slides,courts have added

“collectibility” as a factor ofall events inclusion.

A similar rule exists fordeductions; however, the Code

also includes the “economicperformance” test for deductions.

Although common sense mightsuggest that “enforceability” isa precursor to accrual, it is notalways so!

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3

Spring City Foundry v. Comm’r, 292 U.S. 182, (1934)

!!!!FACTS:Accrual Taxpayer/seller in 1920Sold goods on open account, March to SeptemberLater in the year, the customer had financial troublePPPP customer filed for bankruptcy in December

!!!! ISSUE:Were the accounts receivable to be accrued?Was the debt deductible as worthless?

!!!!HOLDING:Yes as to income.PPPP At the time “all events” occurred, the doubt did not yet exist.No as to the deduction.PPPP The code then allowed a deduction only for wholly worthless

debts.

Collectibility is an element of the “all events” test. An item need not be included if it is not collectible.

4

Clifton Manufacturing Co. v. Comm’r, 137 F.2d 290 (4th Cir. 1943)

PPPP FACTS:Accrual taxpayer earned interest income in 1933 and 1934.At the time “all events” occurred, severe doubt existed as tocollectibility.By 1934, some hope of collection developed.By 1936, collection became certain.Taxpayer collected in 1937.Taxpayer never reported the income. All years prior to 1937 wereclosed.

PPPP ISSUE:When was the interest includible?

PPPP HOLDING:1936 - when collection became “assured.”

“The debt should be accrued and reported as income when its collectibility is assured.This procedure is in harmony with the principle of accrual accounting which regardsthe right to receive, accompanied by collectibility, as the criterion; and it accords withthe decisions which hold that as soon as the right to receive is fixed, as in cases wherethe taxpayer's claim is in litigation, the taxpayer must accrue and report the debt asincome even though it is not paid until a later date.”

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Jones Lumber Company v. Comm’r, 404 F.2d 764 (6th Cir. 1968)

!!!!FACTS:Home builder sold houses for two promissory notes.PPPP One note secured by a first mortgage.PPPP Second note secured by a second mortgage.TP typically sold the first notes and included theamount received.TP deferred accrual of the second notes untilcollection.PPPP It argued the notes were subordinate, conditioned on the

first notes being paid, and the financial condition of themakers was questionable.

!!!!HOLDING:TP had to include the face amount of the secondnotes.Insolvency is necessary for a finding that a note is souncollectible as to prevent accrual.Market value of the notes is irrelevant for an accrualtaxpayer, which must include the face amount.

“To prevent accrual because of doubtful collectibilitythere must be a definite showing that the insolvencyof the debtor makes receipt improbable.”

This treatment was notcorrect - but it wentunchallenged.Probably, the error wasinconsequential. TPshould have includedthe face amount andthen deducted a losson the factoring.

See also, Rev.Rul. 80-361, 1980-2 C.B. 164.

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Enforceability

PPPP Obligations of the United States are unenforceable without anappropriation by Congress.

Nevertheless, accrual of amounts due from the U.S. is appropriate.– Rev. Rul. 70-151

PPPP Gambling debts are generally unenforceableAn accrual taxpayer must nevertheless include winnings, even if the debt isunenforceable.– Desert Palace Inc. v. Comm’r, 698 F. 2d 1229 (9th Cir. 1982)– Flamingo Resort Inc. v. U.S., 664 F.2d 1387 (9th cir. 1982)But, the losing gambler has no discharge of indebtedness income if theunenforceable debt is discharged.– Zarin v. Comm’r, 916 F.2d 110 (3d Cir. 1990)An estate is not entitled to a debt deduction for an unenforceable gamblingdebt.– Estate of Chagra, 60 T.C.M. 104 (1990) (CCH)

PPPP Debts for future services are often unenforceable under state law.An accrual taxpayer must nevertheless include the amount of any notes forfuture services.– Schlude v. Comm’r, 372 U.S. 128 (1963)– Travis v. Comm’r, 406 F.2d 987 (6th Cir. 1969)

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“Earlier of” Test

All Events Test

Include an amount when all events have occurred suchthat the TP has a right to the item and the amount thereof

can be determined with reasonable accuracy.

Courts have modified the “all events test” to be:

Include at the earlier of the date the item is:

1. Due2. Paid3. Earned

The “earlier of”test retains the“all events” testas one of threetests.

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Factor 1 of “earlier of” test: Due

GAAP would either record nothing or would debit accounts receivableand credit a liability.

For tax accounting, however, debit accounts receivable and creditincome.

Client can avoid this by contractually providing a later due date; however,the client may not want to (they may need the money).

Include an item when it is “due” even if unpaid and unearned!

Factor 2 of “earlier of” test: Paid

Include when “paid” even if unearned!

! Imposes cash method on accrual TPs.

! Subject to “payment” versus “deposit” issues.

! “Constructive receipt” is a payment.

! “Cash equivalent” is a payment.

! “Economic benefit” is a payment.

Factor 3 of the “earlier of” test:Earned

This is just the traditional “allevents” test.

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History of Earlier of Test

1954 Code

! § 452 allowed deferral of pre-paid amounts up to six years.

! § 462 allowed reserves for estimated expenses to match withincome recognized early.

Sections 452 and 462 were repealed in 1955.

The idea was good and fair because it promoted matching.

But, it lost lots of revenue in the short run:

Many TPs deferred income and thus paid less tax.

Other TPs accrued expenses early and paid less tax.

Eventually, it would balance out because deferred incomewould get taxed and accrued deductions would not bededucted again in the future. But, in the short run, thetreasury could not afford it.

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Beacon Publishing Co. v. Comm’r, 218 F.2d 697 (10 Cir. 1955)

Schuessler v. Comm’r, 230 F.2d 722 (5th Cir. 1956)

FACTS:

TP received advance payment for obligation to turn gason and off over five years.

HOLDING:

Court required accrual of income.

But, permitted early accrual of expenses not yet incurred!

This satisfies matching; however, it permits deductionsprior to “all events.”

This is highlyunusual - itwould not bepermittedtoday. See§461(h).

!!!! FACTS:TP received prepaid amounts for newspaper subscriptions.

!!!! HOLDING:Court permitted deferral until the amounts were earned![later § 455 was added to do this]

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Automobile Club of Michigan v. Comm’r, 353 U.S. 180 (1957)

Ratably did not clearly reflectincome.Beacon & Schuessler involveddefinite dates for “earning”In this case, services were ondemand.

Congress enacted § 455 in 1958

To alleviate the harshness of the Auto Club decision, Congress enactedsection 455 to permit deferral of pre-paid subscription income.

They might never be demanded - or,they might be intermittent. Hence,ratable inclusion did not clearly reflectincome. Thus, the TP may as wellinclude it all on receipt.

!!!! FACTS:TP received pre-paid dues forservices.

Club deferred ratably: month bymonth.

!!!! HOLDING:Court required inclusion of theentire amount on receipt.

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Bressner, 267 F.2d 520 (2d Cir. 1959)

!!!! FACTS:TP sold TVs and service contracts.Received pre-paid amounts for future service.Used statistics to show when “earned” and thus distinguishedAuto Club (which sought to use ratable deferral).

!!!! HOLDING:Permitted deferral of pre-paid amounts.

While this case is historicallyinteresting, it was overruled by the 2d

Circuit in the RCA decision in 1980. It isuseful to illustrate the intensity of thedebate – and the general desire of the

courts to achieve matching.

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American Automobile Association v. U.S., 367 U.S. 687 (1961)

Same facts as Auto Club of Michigan case.

This taxpayer had statistics to show that deferral with “ratable”accrual accurately reflected true earning times.

Court required accrual on receipt.!Statistics were not good enough.

Auto Club of New York, 304 F.2d 781 (2d Cir. 1962)

Followed the S.C. in Auto Club of Michigan and AAA cases.

But, asserted that Bressner was still good law because it involved verygood statistics.

While this case is historically interesting, it was effectivelyoverruled by the 2d Circuit in the RCA decision in 1980. It is

useful to illustrate the intensity of the debate - and the generaldesire of the courts to achieve matching. The court was

willing to distinguish two Supreme Court decisions.

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Schlude v. Comm’r, 372 U.S. 128 (1963)

Cash:

Because the services were “on demand” and the TPcould show no “pinpoint accuracy” as to when earned.Relied on repeal of §§ 452 and 462.

!!!! FACTS:Arthur Murray Dance Studio

Received, in advance, for dance lessons:PPPP cashPPPP negotiable notesPPPP contract rights (non-negotiable and unenforceable)

TP wanted to defer income until earned: when lessonswere provided.

!!!! HOLDING:Court required inclusion of all three types of “payment”!(4 dissents)

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Schlude [continued]

Negotiable notes:

Essentially the Court put these accrual TPs on the cash method byincluding the notes.

The Court required inclusion of the fair market value of the notes.

The Court did not discuss traditional “cash equivalent” factors; hence,this may be a harsher rule than cash method TPS face!

And then theTax Court madeit even worse!

Contract Rights:

The Court required inclusion of the contract rightseven though the amounts were:

unearnedunpaid

unenforceablenon-negotiable

unfunded

This is a very harsh rule.

See the next slide

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Schlude v. Comm’r, 22 T.C.M. 1617 (1963) (CCH)

Petitioners, in their brief, seem to be taking a footnote of the opinion out ofcontext and building their case on that footnote. If we accepted petitioners'interpretation of the Supreme Court's footnote 10 to its opinion, we wouldhave to say that an accrual basis taxpayer accrues negotiable notes at fairmarket value and not face value. This is not the law on this point . . .

Negotiable notes are regarded as the equivalent of cash receipts, to the extentof their fair market value, for the purposes of recognition of income. § 39.22(a)--4, Treas. Reg. 118, 1939 Code; § 1.61--2(d)(4), Treas. Reg., 1954 Code; Mertens,Federal Income Taxation (1961), § 11.07. See Pinellas Ice & Cold Storage Co. v.Commissioner, 287 U.S. 462, 53 S.Ct. 257, 77 L.Ed. 428.

The Supreme Court remanded the Schlude case for further determination ofthe amount of income. In footnote 10 of its opinion, the Court explained:

On remand, the taxpayer sought to include the fair market value of the notes;however, the Tax Court - in a memorandum opinion - found for thegovernment, disagreeing with the Supreme Court’s plain language:

The better view, however, is that the Supreme Court was correct: if anaccrual taxpayer is placed on the cash method with regard to the receipt ofnotes, then it should be on the full cash method for that item: thus itshould include notes at fair market value. The Tax Court is correctregarding the law for accrual taxpayers; however, for this item, Schludewas no longer an accrual taxpayer.

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Artnell Co. v. Comm’r, 400 F.2d 981 (7th Cir. 1968)

!!!! FACTS:Chicago White Sox sold tickets in advance.TP proved pinpoint accuracy of when it is earned.PPPP Typically the games were played the following year - in a matter

of months.

!!!! HOLDING:The court permitted deferral until the games were played.The court called the “earlier of” rule abusive in this case.

While this case is very interesting, it is an isolated example ofa Circuit Court being willing to distinguish the trilogy. It isnot a case to use for planning, unless the facts are verysimilar - and not without very clear disclosure to the client. Itdoes, however, make a good case to rely on for litigation.

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Hagan Advertising Displays, Inc. v. Comm’r, 407 F.2d 1105 (Ct. Cl. 1969)

!!!! FACTS:TP received advance payments for signs it manufactured.TP sought deferral until delivery of the signs.Deferral would match with recognition of the expense through costof goods sold.

!!!! HOLDING:The court denied deferral, relying on the trilogy.But, the court hinted strongly that it would approve a “deduction” forestimated cost of goods sold!PPPP But, because TP did not request the deduction, the court did not

allow it.PPPP Nevertheless, the court struggled for a way to achieve matching.

The early recognition of cost of goods sold would beunusual, but not unprecedented. It is now sometimespermitted by Treas. Reg. § 1.451-5.

Cost of goods sold is not a deduction; instead, it is areduction from gross receipts to determine gross income.

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Rev. Proc. 71-21, 1971-2 C.B. 549

Treasury issued this Revenue Procedure to partiallyalleviate the harshness of the trilogy.

If - and only if - all of the services are to be performedwithin the next year, a taxpayer may defer recognition ofan advance payment until the following year.

This undoes Schlude to a limited extent.

Note: It only applies to prepayments for services.It specifically applies to dance studios.

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Treas. Reg. § 1.451-5

Advance payments for the sale of goods.

Permits limited deferral of advance payments until the year they become“substantial.”

Permits limited early accrual of Cost of Goods Sold.

Per § 1.451-5(b)(1), advance payments for goods must be included in incomeeither (i) in the year of receipt, or (ii) in the year in which properly accruable forpurposes of financial accounting,

but, no later than the end of the second year following the year in which the TP(i) receives “substantial payments” and (ii) has on hand (or available) goods ofsubstantially similar kind and in sufficient quantify to satisfy the agreement.

Substantial payments exist if the cumulative advancepayments pursuant to an agreement “equal or exceedthe total costs and expenditures reasonably estimatedas includible in inventory with respect to suchagreement.”

Gift certificates are always “substantial payments.”

If the TP must includeadvance paymentsbecause they aresubstantial, then hemust also take intoaccount the relatedcost of goods sold.

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Automated Marketing System, Inc. v. U.S., 34 AFTR 2d 74-542 (Dist. Ill, 5/13/74)

In this relatively unimportant case, the District Court alloweddeferral for pre-paid amounts. The decision was appealable to

the 7th Circuit, which is the Artnell court.

While the case is not one to rely on for planning, it is something to addto a litigation position: so few cases permit deferral of prepaid amounts,a litigant ought not ignore any - even one from a District Court.

PPPP TP acquired a corporation midway through its taxable year. The acquired corporation was in the business of selling sales follow-upprograms to automobile dealers. Payment was made in advance for services to be rendered by theacquired corporation over a period of between twelve and thirty months.

PPPP At the time of acquisition, the acquired corporation had a largeamount of prepaid income.

In an unpublished order, the Seventh Circuit affirmed the District Courtdecision which held that the deferral of prepaid income in that caseclearly reflected income

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Boise Cascade Corp. v. U.S., 530 F.2d 1367 (Ct. Cl. 1976)

!!!! FACTS:TP received substantial advance payments for engineeringservices.PPPP Some were set for specific times.PPPP Some were on demand.

!!!! HOLDING:The court permitted deferral until performance.

!!!! WHY:Better matching with expenses.PPPP Services not solely “on demand.”PPPP Large sums of money were involved – customers would surely

eventually demand them.This is unlike the trilogy, in which the services might never havebeen demanded.

Note: this is a Claims Court case.

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Morgan Guaranty Trust Co. v. U.S., 585 F.2d. 988 (Ct. Cl 1978)

Note: §§ 1272-3 require this result since 1982.

!!!! FACTS:TP received interest “pre-paid” and sought deferral.The amounts were very small, compared to the size of the Bank.The time periods were quite short - less than one year.

!!!! HOLDING:The court permitted deferral.Why?PPPP Short term (till following year)PPPP De minimis amountsPPPP Pinpoint accuracy

Again, this is the Claims Court willing to distinguish the trilogy.

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Collegiate Cap & Gown Co. v. Comm’r, 37 T.C.M. 960 (1978) (CCH) (appealable to 7th Cir.)

!!!! FACTS:TP received advance payments for regalia rental.Time periods were short - generally about six months.Rental dates were fixed.

!!!! HOLDING:The court permitted deferral.Why:PPPP Pinpoint accuracyPPPP Short term.

Note that while this is a Tax Court decision, citation to it is problematic:

– It is a TCM.

– It is appealable to the 7th Circuit (the Artnell Circuit) andexplainable by the Golsen rule.

Golsen v. Commissioner, 54 T.C. 742 (1970), aff’d. 445 F.2d 985 (10thCir. 1971), cert. denied 404 U.S. 940 (1971) [The Tax Court is bound byauthorities of the Circuit to which the case is appealable].

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RCA Corp. v. U.S., 664 F.2d 886 (2d Cir., 1981)

!!!! FACTS:TP sole TVs and multi-year service contracts.TP received advance payments for service contracts. The District Court permitted deferral.PPPP It relied on Bressner.TP had extremely good statistics regarding when the serviceswould be earned.PPPP While some customers would not need any services and some

would require much, statistics could very accurately show - in amacro sense - when and of what type would be demanded.

!!!! HOLDING:2d Circuit reversed and required inclusion, relying on trilogy.The court overruled its prior decision in Bressner.

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Summary of Earlier of Test

With 5 limited court exceptions, and a few code and administrativeexceptions, an accrual TP must include income on the earlier of

receipt, the due date for receipt, or earning.

Majority view: — Automobile Club of Michigan (SC)— AAA (SC)— Schlude (SC)— RCA (2d Cir)

Exceptions: — Morgan Guaranty (CC)— Artnell(7th Cir)— Boise Cascade— Collegiate Cap & Gown (TCM)— Automated Marketing Systems (D. ILL)— Some services per Rev. Proc. 71-21— Some goods per Treas. Reg. §1.451-5— interest per §§ 1272-86

These

Greatlyoutweigh

These

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Accrual of DeductionsOverview and comparison with income accrual

Economic Performance

All Events

“Later of” TestDeductions

Earned(All Events)

Paid

Due

“Earlier of “TestIncome

Accrual Method

The premise behind deferred compplans is that deferral of receiving themoney - coupled with tax deferral - issuperior economically to receiving themoney currently with current tax.

Hence the Schlude rule is best avoided ifpossible - even with a change of facts –don’t accept advance payments.

The economic disadvantage fromdeferring deductions promptssimilar analysis: you are better offpaying now and deducting nowthan pay later and deduct later.

text slides on TVM and income Regulation Definition: 1.446-1(c)(1)(ii)

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Matching Principle

Touchstone for Accounting and GAAP

1998 1999 2000

FACTS: John mows Jane’s lawn in 1999. Jane paid John $100 in 1998.John buys $10 of fuel in 1999.John changes $5 mower filter in 2000

(as a result of 1999 use).

$100 (10) (5)$ 85

ProperMatching

Allin1999when earnedandincurred

$100 (5)

Even in this simpleexample, this part of theanalysis is debatable.

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Consequences of Matching

Clear Reflection of IncomePPPP John had no true accession to wealth in 1998 because he had not yet

earned the $100 and might have to refund it.But, he received the money and formed the contract. This gave him at leastsome of the elements of increased wealth, although not in the traditionalaccounting sense.

PPPP Also, in 2000 he suffered no loss [the $5] because that cost was reallyincurred or suffered in 1999 when the repair became necessary.

A substantial question exists as to whether John should deduct, in 1999, the predicted cost of $5 to replace the filter, or whether he should, in 2000,deduct the cost of the last filter installed.

PPPP In 1999, he really profited $85 from the mowing — he earned $100 andincurred related costs of $15.

Reporting $90 profit or a $10 loss in 1999 might lead to managementmistakes: the year was profitable, but not to that degree. Likewise, reportinga profit of $100 in 1998 could lead to huge mistakes: he made a profitwithout providing any services. Hence, perhaps he could do without anyworkers? Of course not, but you only know that because of informationprovided by the matching principle.

PPPP Hence GAAP and the matching principle provide him with usable andreasonably accurate information regarding each year.

This differs significantly from what the cash method would determine to beincome for each year.

More on this issue, later.

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Tax Accounting

Aims more to raise revenue rather than to match income andexpenses

1998 1999 2000

$100 $(10) $(5)

Schlude “Earlier of”

Test

GAAP“All Events”

Test

461(h)“Economic

Performance”Test

Include whenpaid Deduct when

incurredDelay until

performance

$100

(5)

Hence, income is recognized earlier and deductions later thanper GAAP.

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Tax Accounting

Caution to Accountants and General Practitioners

PPPP As the prior slides show, tax accounting differs from financialaccounting.

Income is sometimes recognized earlier than GAAP providesper the Schlude “earlier of” test.– but, remember the many exceptions, e.g., Rev. Proc. 71-21; Treas.

Reg. § 1.451-5; I.R.C. §§ 455, 456, 1272-86, Artnell, Boise Cascade,Collegiate Cap & Gown

expenses are sometimes deducted later than GAAP providesper the §461(h) economic performance test

The point is to raise revenue, rather than to “clearly reflectincome” (although courts and the government insist that isstill the goal).

Remember, most – if not all – accrual taxpayers will have multiple sets ofbooks and financial statements: one for tax, one for GAAP, and othersfor particular contractual or regulatory audiences. Be careful which yourely on for family law and other such legal purposes: tax books are notprimarily intended to “clearly reflect income” and thus may not.

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Historic Cases

PPPP Mooney Aircraft, Inc. v. U.S., 420 F.2d 400 (5th Cir. 1969)A manufacturer/seller may not currently deduct the cost of future rebates due whenthe planes are retired from service. The due dates are too imprecise and too far intothe future.

PPPP Lawyers’ Title Guarantee Fund v. U.S., 508 F.2d 1 (5th Cir. 1975)A title insurance fund may currently deduct the future cost of payments to attorneysfor work performed currently and to be paid in seven years. See also, WashingtonPost Co. v. U.S., 405 F.2d 1279 (Cl. Ct. 1969).

PPPP World Airways, Inc. v. Comm’r, 62 T.C. 786 (1974), aff’d 564 F.2d 886 (9th Cir.1977)

An airline may not currently deduct the estimated future cost of repairs necessitatedby current flights.

PPPP U. S. v. Hughes Properties, Inc., 476 U.S. 593 (1986)A casino may currently deduct the future cost of paying a progressive slot jackpot.

PPPP Ford Motor Co. v. Comm’r, 71 F.3d 209 (6th Cir. 1995) [involving years priorto the enactment of § 461(h)]

Contrary to custom, a tortfeasor may only deduct the present value of futurepayments.

Prior to the enactment of the economic performance test, several cases were important inthe accrual of deductions. While mostly of historic importance now, these cases are worthreviewing as illustrations of the climate in which Congress enacted § 461(h). In somecases, the result was different than that later enacted; in others, the result was the same.

text

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Historic Cases

The cases on the prior slide each involve the same essential facts: an item forwhich “all events” – according to GAAP – has occurred, but for which thegovernment sought to disallow a deduction.

Sometimes, the government won these cases – and sometimes it lost.

Distinctions existed and the different holdings were arguably defensible;however, a better argument was that the distinctions were ultimatelymeaningless and thus the cases resulted in unfair treatment for some taxpayers.

Much more consistency exists today under § 461(h) . . .

. . . but it is paid for at the cost of “unfairness” to many moretaxpayers . . .

. . .arguably resulting in significant economicdistortions.

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I.R.C. § 461(h)

Economic Performance Requirement for Accrual of Deductions

PPPP For accrual method Taxpayers to deduct an amount, boththe “all events” and “economic performance” tests mustbe satisfied.

PPPP This section does not apply to cash method taxpayers.

PPPP Treasury Regulations interpret the statute aggressively,so read the examples carefully.

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Section 461(h)(2)

Time when economic performance occurs

P (A) Services and Property provided to the TP

P (B) Services and property provided by the TP

P (C) Workers Compensation and Tort liabilities of the TP

P (D) Other Items — In the case of any other liability of theTP, economic performance occurs at the time determinedunder regulations prescribed by the Secretary.

The Code provides 4 categories of economic performancerules:

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Examples of the categories

The four categories are really seven - if we includethe three subparts of (A) plus the recurring itemsexception.

As you read each category, you should contemplatean example that illustrates the provision. Ideally,the example should be one which delays adeduction beyond the occurrence of “all events.”

If the example provides for “economicperformance” prior to “all events,” a deductionwill not be appropriate until “all events”occurs; hence, the example will not illustratethe code section having any consequence.

Also, if the example provides for “economicperformance” occurring in the same year as“all events,” the example will not illustrate thecode section having any consequence.

This is not alwayspossible; hence, youmay be frustrated bythe code section.

Beware: the categoriesoverlap - or at least appearto do so. Hence, keepingthem separate is not easy.

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1. Examples of § 461(h)(2)(A)(i)

(A) If the liability of the TP arises out of

(i) the providing of services to the TP by anotherperson, economic performance occurs as such personprovides such services

In year one , taxpayer plans aconcert to be held in year two. Inpreparation, it arranges for designand logistical services, which areperformed in year one. When mayhe deduct the planning costs?

In year two, taxpayer holds theconcert. Patrons create quite amess, which the taxpayer must paysomeone to clean up in Year Three.When may he deduct the cost ofclean-up?

Under the cash method, TP may deduct the planning costs when paid inyear one, subject to the capitalization rules of Treas. Reg. § 1.461-1,Zaninovich , and Grynberg. He may deduct cleanup in year three, whenpaid.

Under the accrual method, TP may not deduct the planning costs untilyear two, when both all events and economic performance are met. hemay not deduct the cleanup costs until year three when economicperformance occurs, even though all events occurred in year two.

Note the “arises out of” language.

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Summary

PPPP 461(h)(2)(A)(i) sometimes makes a difference. If all events haveoccurred necessitating a service to be provided by another, economicperformance will not occur until the services are provided.

In year one , taxpayer plans aconcert to be held in year two. Inpreparation, it arranges for designand logistical services, which areperformed in year one. When mayhe deduct the planning costs?

461(h) has no effect: EP isprobably met in year oneand AE in year two.

In year two, taxpayer holds theconcert. Patrons create quite amess, which the taxpayer mustpay someone to clean up inYear Three. When may hededuct the cost of clean-up?

461(h) has an effect: EPoccurs in year three, butAE occurred in year two.

But, even this did not change the “law” as theWorld Airways case required the same resultprior to 461(h)’s enactment.

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2. Example of § 461(h)(2)(A)(ii)

Under the cash method, TP could deduct the supplies in yearone, subject to the capitalization rules.

Pursuant to the accrual method, “all events” would not occuruntil the supplies were used in year two. “Economicperformance” in an earlier year would thus be irrelevant.


(ii) the providing of property to the TP by another person, economicperformance occurs as such person provides such propertyExample:

The concert promoter purchasesand consumes substantial suppliesin year two in connection with theconcert. When may he deduct thecost of supplies?

Or, he bought the supplies in yearone and used them in year two.

How does this reconcile with section179? Does it apply to accrual taxpayers,or does section 461(h) override itwhenever it involves property providedby another?

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2. Example of § 461(h)(2)(A)(ii) [continued]

Caution: The prior slide is a poor example (but the best Ihave, for now) for two reasons:

!!!! the regs provide no guidance or exampleexplaining clause (ii)

!!!! Promoter’s deduction for supplies expense hasnothing to do with his acquisition of the supplies; rather ithas to do with his use and consumption of them; hencethe “arising out of” language can seem confusing.

Query: what is thepurpose for this clause? Can you think of a goodexample - in which therule has consequences?

You need to think of an example inwhich “economic performance” follows- rather than precedes or coincides with- “all events.” Only in such a case doesthe provision matter.

In a later slide, I’llprovide anexample which, Ibelieve, illustratesthe provision: onein which “allevents” occursprior to theacquisition of theproperty.

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3. Example of § 461(h)(2)(A)(iii)


(iii) the use of property by the taxpayer, economic performance occurs asthe taxpayer uses such property

Query: what is thepurpose of this clause?

Can you think of an example to which it appliesand to which economic performance occurs in ayear later than “all events.” Without such anexample, the provision is meaningless, is it not?

Under the cash method, TPcould deduct the lease payments ashe made the payments, subject to the capitalization rules ofZaninovich and Grynberg, as well as § 467.

Under the accrual method,TP could not deduct the leasepayments until year two - the year he uses the property.

The concert promoter inrents the stadium in which heholds the concert. When may hededuct the rental expense?

42

3. Example of § 461(h)(2)(A)(iii) [continued]

The example on the prior slide is consistent with reg examples 6 - 9 ofTreas. Reg. § 1.461-4(d)(7). Example 6 deals with rental of a plane, 7deals with an exclusive use contract, 8 with rental of a copy machine, and9 with the use of some other product.

Each has both a fixed and variable rent component. Economicperformance occurs with regard to both types of rent as the TP uses therented property (as opposed to pays for it).

SO WHAT! “All events” and “economic performance” occur as theTP uses the property in nearly all cases. These examples- and allthat I think of - add very little, if anything.

The next slide looks at some details of these examples.

Also, several later slides refer to them. Facially, the examples seemfine; however, on close examination, do they add anything?

43


Examples: As an airline uses a plane, it incurs liabilities under FAArules to overhaul the plane. Arguably, for each mileflown it should accrue some portion of the futuremaintenance costs – which arise from its use of theplane. GAAP would require this.

Or, as an oil company uses leases property fordrilling, it incurs contractual liability to repair damageand to dismantle the rig. This substantial liabilityarguably “arises from” its use of the oil lease. GAAPwould require accrual.

The prior clause – § 461(h)(2)(A)(iii) – would make sense if it applied toliabilities other than the payment of rent “arising out of” a Taxpayer’suse of his own or leased property

The regulationinterpretationmay be fairlycriticized;however, it isquite clear.

Treas. Reg. Ex. 6 deals with airline recommissioning costs on rentedplanes and Ex. 1 with oil rig dismantling costs on leased property. Ineach case, the reg views the costs [as opposed to the fixed rent] aseither § 461(h)(2)(A)(i) [services provided to the TP] or (h)(2)(B)[services provided by the TP] and thus defers the deduction until theservices are provided.

The taxpayermust use

supplies orother propertyto provide the

repair ordismantlingservices.

Wouldeconomic

performanceoccur as the

Taxpayerpurchased thesupplies or asit used them orwhen it usedthe plane or

rig?

44


!!!! 461(h)(2)(A) has an “arises out of” relationship test

!!!! 461(h)(2)(B) has no such test – it applies if a liability requires ataxpayer to do something

!!!!But, a liability to do something may itself arise out of a taxpayer’suse of property.

For example, the airline repair costs arise out of the use of the plane. But, they also constitute a liability requiring the taxpayer to dosomething – the repair.Thus, both provisions appear to apply, although they define economicperformance differently.PPPP (A)(iii) defines economic performance as the use of the property –

when the plane is flown.PPPP (B) defines economic performance as the provision of the repair –

which may be years after the related flights.

45


The Treasury Regulations choose (B) as the model for such repaircosts which arise from the use of property.

Logically, all that is left of (A)(iii) is rent expense arising from the use ofproperty provided by another. In fact, all regulation examples illustrating(A)(iii) involve such facts. Also, the regulation itself uses the phrase “the useof property provided to the taxpayer,” suggesting that (A)(iii) does not apply tocosts arising from the use of the taxpayer’s own property.

This further leads to the conclusion that (A)(iii) only applies to rent. But, this conclusion is odd because in such cases “all events” and“economic performance” would seem to be simultaneous. As a result,the provision appears to serve no purpose.

Note: at this point, I have concluded that (A)(i)sometimes has a real effect, (A)(ii) has no apparenteffect, and (A)(iii) has no apparent effect.

46

4. Example of § 461(h)(2)(C)

Tort Liability and Worker’s Compensation Costs — defer until payment

Without the last sentence, such costs would appear to arise from (A)(i) [employeesproviding services] or (B) [taxpayer providing property or services]. If that werethe case, a deduction might be appropriate as the services were provided. However, the code clearly defers such deductions until payment.

(C) — If the liability of the taxpayer requires a payment to another person and

(i) arises under any workers compensation act, or(ii) arises out of any tort,

economic performance occurs as the payments to such person are made. Subparagraphs (A) and (B) shall not apply to any liability described in thepreceding sentence.

Economic Performance occursas payments are made.

All Events occurs whenthe tort or injury occurs.

Under the cash method, the tortfeasor could deduct as payments are made.

Under the accrual method, the answer is the same: deduct as payments are made.

This rule diverges significantly from GAAP, whichwould likely require deducting in the year of the tort.

47

4. Tort Liabilities - old custom [continued]

Pre-1986 customary treatment unfairly favored tortfeasors.

PPPP Hypo: airline crashes plane in 1982 and settles the tort case, agreeing to pay $4million/year for 25 years. Total liability equals $100,000,000.

PPPP Present value, discounted at 8%, equals $46,115,033.13.Using begin mode, 8% nominal annual interest, and one payment per year.

PPPP GAAP recognized an expense equal to present value— to match with therevenue from the flight, as well as the year of low maintenance (though notperfectly), plus the interest over time.

Hence taxpayer would deduct $46,115,033.13 currently for financial purposes and$53,884,966.87 over time, as interest.

PPPP Tax tradition permitted a deduction of $100,000,000 for tax purposes despitethe GAAP treatment.

PPPP TP would save 46% [old corporate rate] or $46,000,000. Tax savings producedsufficient interest income (measured by the airline’s cost of capital or return oninvestment) to amortize the liability.

PPPP TP could then keep the principal.

PPPP Hence it was more profitable to crash planes than to fly them

Willis Article Three

48

4. Tort Liability - current law [continued]

The rule now favors the government.

PPPP TP tortfeasor can only deduct payments, includinginterest, as they are made.

This is inconsistent with GAAP - but now defers to a periodlater than GAAP, while the old rule accrue prior to GAAP. Itis really just as unfair - only in the opposite direction.

PPPP This causes two problems:1. It mis-matches income and related costs.2. It deprives TP of a significant part of the “value” of thededuction.

PPPP Nevertheless, this is clearly the rule adopted byCongress in § 461(h)(2)(C). Click Here to see my

Albertson’s discussion forproof.If you are viewing this electronically,

click here for the proof. Otherwise,see the outlines on my web site

Willis ArticleThree

49

5. Example of § 461(h)(3) Recurring Items

The Economic Performance test is not applicable.

PPPP (A) — Notwithstanding paragraph (1) an item shall be treated asincurred during any taxable year if--

(i) the all events test with respect to such item is met during suchtaxable year . . .(ii) economic performance . . . occurs within the shorter of– (I) a reasonable period after . . . such . . . year, or– (II) 8 ½ months after the close of such taxable year, (iii) such item is recurring in nature and the taxpayer consistentlytreats items as incurred in the . . . year in which . . . (i) are met, and(iv) either —– (I) such item is not a material item, or– (II) the accrual of such item . . . results in a more proper match. . . than .

. . economic performance.

Query: when would itnot be a better match?

50

5. Example of a Recurring Item [continued]

Treas. Reg. § 1.461-5PPPP The regulation provides two examples – each dealing with

rebates on items sold. §1.461-5(e)

PPPP If the rebates are recurring and within 8-1/2 months of the yearend, they are deductible in the year of sale if that provides abetter match regardless whether they are material.

Of course they will provide a better match – and GAAP wouldrequire accrual in the year of sale. Without accrual, thefinancial statements would be inaccurate.

What is this an exception to? The examples do not fit within§§ 461(h)(2)(A), (B), or (C). Thus they are examples of (D) -other items.

In general, the regulations provide that if none ofthe categories fit, then economic performanceoccurs with payment. The recurring item provisionis an exception to that rule. But, what is the pointof a statutory exception to a regulatory exception?

I thus conclude thatthis portion of thecode section servesno real purpose.

51

6. Example of § 461(h)(2)(B)

(B) — If the liability of the TP requires the TP toprovide property or services, economic performanceoccurs as the TP provides such property or services.

Note: this has no “arisesout of” language.

The concert promoter uses hisown employees and property toprovide the clean-up services -rather than hiring independentservice providers. He does so inyear three. When may he deductthe clean-up costs?

Under the cash method, TP could not deduct the cleanup until paid.

Pursuant to the accrual method, “all events” occurs in year two, but “economicperformance” occurs in year three, delaying the deduction until that year.

52

6. Example of § 461(h)(2)(B) [continued]

If a taxpayer purchases property which he uses in the providing of services orproperty to another, an accrual deduction is appropriate as the services areprovided.

This is consistent with GAAP.

Whether we view this as an example of (A)(ii) or (A)(iii) or (B) does not matter.

The regulations apparently view it as an example of (B); however, that is notentirely clear.

A restatement of the rule might be:

Economic performance with respect to costs directly associated with theprovision of services or property to another occurs as the services areprovided.

For this type of example, the provision is meaningless because itresults in the same answer as the traditional “all events” test.

53


Frequently, the use of property necessitates periodic repairs which occur in yearsother than those involving use of the property. This presents an accounting problem.

For example, an airplane may require a major overhaul every three years. Hence aplane first used in 1995 must be overhauled in 1998 and again in 2001 and again in2004.

Do the 2001 repair costs apply to the period 2001 through 2004 [forward] or do theyapply to the period 1998 through 2001 [backward]? In other words, do we amortizethe costs [forward application] or do we anticipate them [backward]?

In the example, after 1998, it matters little because every year has costs matched to it. The only significance would be the amount: in inflationary times, the amountresulting from a forward rather than backward match might differ [unless we accountfor that with the time value of money sections].

But, in the period 1995 through 1998, as well as in the last years of the airplane’s life,the choice matters greatly. The backward (anticipatory or reserve)approach wouldproperly match, while the forward approach would produce no expense.

Hence, GAAP would usually require the backward approach – the anticipation of thefuture costs to match with current revenues from current use. This not only matchesa cost to all years, but it also matches costs with the use that necessitated thatparticular cost.

See the illustration on the next slide.

54


1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005

Repair Repair Repair

Repair Repair Repair

Both Forward Amortization and Backward (reserve anticipation)result in a matchfor most years – although the amounts may differ. The Backward approach ispreferable because it provides a match for the initial years.

As seen in later slides, the 461(h)(2)(B) approach provides for deduction in theyear of the repair, which will always be a mis-match for such non-annual repairs.

55

Oil Rig Dismantling Costs

Treas. Reg. § 1.461-4(d)(7) Ex. 1

P An oil company with an offshore lease must dismantle rigs at theend of the lease, per the contract. The costs are very substantial.

P GAAP requires a deduction for a portion of the estimated futurecosts during the years of production – this would match with theproper income.

P This might appear to be covered by § 461(h)(2)(A)(ii) – the futuredismantling costs “arise out of” the taxpayer’s use of the lease.

P The regs classify it as § 461(h)(2)(B) — the liability requires thetaxpayer to provide services — thus economic performanceoccurs as the taxpayer performs the dismantling.

This results in a mis-match of income and expenses; but,it raises additional tax revenue, which was its purpose.

56

Airline Recommissioning Costs

Treas. Reg. § 1.461-4(d)(7) Ex. 6

P TP uses an airplane to fly passengers. For each hour/mile flown,FAA rules require specified maintenance – some deferred until afuture year [e.g., every 1000 flights].

P GAAP would require recognition of an estimated expense for eachhour/mile flown — to match with passenger revenues.

P This might appear to be a § 461(h)(2)(A)(iii) situation, but it is not (inthe government’s view).

P Economic performance occurs as the repairs are made per§461(h)(2)(A)(i) or (h)(2)(B).

This results in a mis-match of income and relatedexpenses; however, it does increase tax revenues.

57

Slot Machine Progression Costs

Treas. Reg. § 1.461-4(g)(8) Example 4

P A progressive slot machine promises a larger future jackpot foreach pull lost [e.g., you put in a dollar and lose, the pot increases25 cents]. Large payoffs are often deferred for 1-3 years.

P GAAP requires the deduction of an expense for each jackpotincrease — to match with casino winnings.

P This might appear to be a § 461(h)(2)(B) situation – the jackpotliability “arises out of” TP providing services; but thegovernment disagrees. Thus, economic performance occurs asthe jackpot is paid.

This is a § 461(h)(2)(D) - other item.The reg results in a mis-matchof income and expenses.

Note: while § 461(h)(2)(A) begins with an “arising out of” trigger, § 461(h)(2)(B) hasno such language. This reading supports the regulation. However, a legitimate -but shaky - argument stems from the “with respect to” language of § 461(h)(1): isthe jackpot liability “with respect to” the “item” of providing gambling services,for which economic performance occurs in the year of gambling?

58

Summary

PPPP 461(h)(2)(A)(i) sometimes makes a difference. If all events have occurred necessitating aservice to be provided by another, economic performance will not occur until theservices are provided.

PPPP 461(h)(2)(A)(ii) initially appears to be meaningless. The regulations provide no clearexample.

PPPP 461(h)(2)(A)(iii) appears to be meaningless. All regulation examples illustrating it involvethe payment of rent for the use of property owned by another. In no such example doeseconomic performance diverge from all events. Hence, the provision makes nodifference.

PPPP 461(h)(2)(C) makes a difference – it reverses prior customs. Accrual of deductions arisesfrom a tort or worker’s compensation is appropriate as payments are made.

PPPP 461(h)(3) sometimes makes a difference, although it is an exception to a regulation [anodd role for a statute]. All regulation examples illustrating it involve the payments ofrebates. In such cases, an accrual deduction is appropriate in the year of sale -ratherthan the year of payment - if the amounts are paid within 8-1/2 months of the year end. This resolves some confusion under prior law.

PPPP 461(h)(2)(B) is meaningless in many common examples. It also applies if TP uses hisown property in the provision of services which results in needed repairs: economicperformance then occurs as he repairs. This differs from GAAP and thus has significantconsequences.

PPPP 461(h)(2)(D) has real consequences in that in cases such as the Progressive Slot Machineexample, economic performance - and thus accrual deduction -occurs later than GAAPwould provide.

59

Other Provisions for Deferred but Incurred Costs

PPPP Deferred Rental Agreements — § 467(a)

PPPP Solid Waste Reclamation Costs — § 468

PPPP Nuclear Power Decommissioning Costs — § 468A

PPPP Designated Settlement Funds — § 468B

PPPP Deferred Compensation in General — §§ 404 and 467(g)

PPPP Deferred Compensation of State/local and TEOs — § 457

PPPP Deferred interest expense — §§ 1272-86; 7872

PPPP Deferred Tax liability on installment obligations — § 453A(c)[reverse theoretical situation]

Each of the following provisions deals with thesame theoretical situation – deferred incurred costs– but achieves a different economic answer. Why?

60

Interest Costs

In general, economic performance for interest accrues overtime.

P Economically, interest accrues over time.

P Per GAAP, interest accrues over time.

P Per § 1.461- 4(e), interest accrues [and economic performance occurs]over time.

But, be careful about what constitutes interest and when the regulationapplies.

P Per the regs, interest related to a tort settlement is not deductible until paid.

P Per the Albertson’s, 42 F.3d 537 (9th Cir. 1994), case, interest on deferredcompensation is not really interest (and thus is deferred per § 404).

On first impression,this might appearhugely important.

Whenever this applies, it will permit an interestdeduction prior to payment. This is consistent with thevarious time value of money provisions, e.g. § 163(e).

Query: will the regulation ever apply if “allevents” but not “economic performance” hasoccurred as to the underlying liability?

I cannot think of anexample. Can you?

http://nersp.nerdc.ufl.edu/~acadian/tax2/outline/outline.htm

Alb

ertson

's v. Co

mm

ission

er

bySteven J. W

illis(c) 1996

Sources:

Daniel I. H

alperin, "Ninth's C

ircuit's Decision in A

lbertson's is Outrageous," T

ax Notes, February 21,

1994, p. 1083.

Steven J. Willis, "L

eave Albertson's

Alone,"

Tax N

otes, June 13, 1994, p. 1481.

Daniel H

alperin, "Albertson's: M

ore 'Outrage,'" T

ax Notes, June 27, 1994, p. 1771.

Steven J. Willis, "A

lbertson's:A

Little L

ess Em

otion, Please," T

ax Notes, A

ugust 15, 1994, p. 961.

Jasper L. C

umm

ings, Jr., "Statutory Interpretation and Albertson's," T

ax Notes, January 23, 1995, p. 559.

Deborah A

. Geier, "Interpreting T

ax Legislation: T

he Role of Purpose," T

ax Notes, M

ay 8, 1995, p. 822.

I. Narrow

View

of the Case: D

eferred Com

pensation Issues

A. F

acts of the Case

Albertson's, Inc., an accrual m

ethod taxpayer, adopted a deferred compensation arrangem

ent with 8 top

executives and 1 outside director, each of them cash m

ethod taxpayers. The vested plan provided for

substantial future payments of "com

pensation" plus additional amounts labeled "interest," w

hich were a

function of market rates of interest. In 1983, the I.R

.S. acceded to Albertson's request for current

deduction, under § 163, of the "interest" component of the arrangem

ent. Pursuant to § 404, Albertson's

could not deduct the "compensation com

ponent" until such time as the recipients included it. A

s cash


(1 of 20) [3/26/02 9:13:05 AM

]


method taxpayers, the recipients did not include any portion of the am

ounts - neither the "compensation"

nor the "interest" until they received them. For 1983, the perm

itted "interest" deduction was $667,142.00.

In 1987, the government w

ithdrew its ruling perm

itting Albertson's to take the interest deduction. T

his litigation follow

ed.

B. T

he 1983 Statute: Section 404

The relevant provisions, at the tim

e Albertson's filed its 1983 tax return, w

ere as follows: Sec. 404.

Deduction for ... com

pensation under a deferred-payment plan. (a) G

eneral rule.--.... [I]f compensation is

paid or accrued on account of any employee under a plan deferring the receipt of such com

pensation, such ... com

pensation shall not be deductible under section 162 (relating to trade or business expenses) or section 212 (relating to expenses for the production of incom

e); but if they satisfy the conditions of either of such sections, they shall be deductible ... (5) .... in the taxable year in w

hich an amount attributable to

the contribution is includible in the gross income of em

ployees participating in the plan.... (d) D

eductibility of payments of deferred com

pensation, etc., to independent contractors.--If a plan would be

described [as above].... [the] compensation-- (1) shall not be deductible by the payor thereof under

section 162 or 212, but (2) shall ... be deductible under this subsection for the taxable year in which an

amount attributable to the ... com

pensation is includible in the gross income of the persons participating

in the plan.

C. T

he Statute Today

The 1986 am

endment to § 404 rem

oved the statutory cross-references to sections 162 and 212, substituting a reference to "this chapter."

Arguably, the 1983 statute m

erely limited section 162 and 212 deductions but not section 163 deductions

(interest); however, the argum

ent goes, the amendm

ent effectively limited all chapter one deductions,

which includes section 163.

As explained below

, other credible explanations for the amendm

ent exist.

D. Issues1. In 1983, did § 404 apply to both the "com

pensation" and "interest" com

ponents of a non-qualified deferred compensation arrangem

ent? Or, did it

merely apply to the "com

pensation" component?

2. Were the am

ounts labeled "interest" actually "interest" or were they m

ere additional am

ounts of deferred compensation?


(2 of 20) [3/26/02 9:13:05 AM

]


E. H

istory

1. Tax C

ourt

a. Citation: 95 T

.C. 415 (1990)

b. Holding: F

or the Governm

ent

The m

ajority (nine judges) held that all the amounts constituted "com

pensation" and none were

"interest." As a result, § 404 required A

lbertson's to defer deduction of the entire amount until paid.

The concurring opinion (four judges) recognized the "interest" com

ponent as "interest" but nevertheless interpreted § 404 as applying to both the "com

pensation" and "interest" components of non-qualified

deferred compensation.

The dissents (five judges) believed that § 404 did not apply to the "interest" com

ponent of non-qualified deferred com

pensation.

2. Ninth C

ircuit

a. Citation: 38 F

.3d 1046 (9th Cir. 1993)

b. Holding: F

or the Taxpayer, reversing the T

ax Court

The three judge panel decided that the am

ounts labeled "interest" were

indeed interest. In addition, they held that § 404, as written in 1983, did not

affect the deduction of the interest component of non-qualified deferred

compensation.

3. Ninth C

ircuit on Rehearing

a. Citation: 42 F

.3d 537 (9th Cir. 1994)

b. Holding: F

or the Governm

ent, reversing its earlier opinion

All three judges reversed them

selves reluctantly. They did not specifically hold that the extra am

ounts constituted "interest"; how

ever, they again acknowledge that they resem

ble "interest." In any event, the court found that: "In sum

, we decline to adopt A

lbertson's interpretation of I.R.C

. s 404. Whether or not

the additional amounts constitute interest, allow

ing Albertson's to deduct them

prior to their receipt by their em

ployees would contravene the clear purpose of the taxation schem

e governing deferred com

pensation agreements." 42 F.3d at 546 (1994).


(3 of 20) [3/26/02 9:13:05 AM

]


The court stressed its reluctance to reverse itself: "W

e have now changed our m

inds about the result we

reached in our original opinion and conclude that our initial decision was incorrect. T

he question is not an easy one, how

ever. We have struggled w

ith it unsuccessfully at least once, and it may, indeed,

ultimately turn out that the U

nited States Supreme C

ourt will tell us that it is this opinion w

hich is in error. T

his is simply one of those cases--and there are m

ore of them than judges generally like to adm

it--in w

hich the answer is far from

clear and in which there are conflicting rules and principles that w

e are forced to try to apply sim

ultaneously. Such accomm

odation sometim

es proves to be impossible. In som

e cases, as here, convincing argum

ents can be made for both possible results, and the court's decision w

ill depend on w

hich of the two com

peting legal principles it chooses to give greater weight to in the

particular circumstance. L

aw, even statutory construction, is not a science. It is m

erely an effort by hum

an beings, albeit judges, to do their best with im

perfect tools to arrive at a correct result."

F. A

nalysis

1. Willisa. 1983 L

aw

(1) Literal R

eading of the Code

The code generally perm

itted the accrual method (as it continues to) and never restricted it w

ith regard to interest on deferred com

pensation. The only restrictions applied to "com

pensation" deductions under sections 162 or 212 and not to "interest" under section 163.

Arguably, how

ever, this limited statutory application w

as unwise, as it perm

itted the employer to accrue

a deduction for the interest component of the deferred paym

ents, while it perm

itted the recipient to defer inclusion until receipt.

Such an argument is correct: that is precisely w

hat the section then permitted. B

ut then, that is why the

code was later am

ended to preclude the divergence in accounting methods. A

s explained below,

considerable disagreement exists regarding the w

ay the later amendm

ents require conformity in

accounting methods betw

een the payor and the payee.

One view

is that the section 404 and 404A am

endments require deferral of the interest deduction

attributable to the deferred payments until inclusion by the recipient. I disagree. I believe section 467

requires accrual of the interest income by the recipient to m

atch the accrual of the interest deduction by the em

ployer.

How

ever, under either view, the existence of a later am

endment to correct the lack of conform

ity in accounting m

ethods supports the existence of the divergence in 1983. That w

as a problem dem

anding a solution. H

owever, it w

as for Congress to am

end the code to provide the solution, not for the court to do


(4 of 20) [3/26/02 9:13:05 AM

]


so. The N

inth Circuit w

ere by reversing its Albertson's decision, effectively am

ended the statute prior to the tim

e Congress chose to do so.

(2) Custom

I would view

the customary treatm

ent of a statute relevant, though not conclusively to its meaning. I

suspect that in 1983 most taxpayers interpreted section 404 as deferring the interest com

ponent of deferred com

pensation. How

ever, significantly Albertson's and the governm

ent each agreed, in 1983, to do otherw

ise. This indicates, to m

e, that the custom of deferral w

as not as entrenched as some w

ould have us believe.

(3) Legislative H

istory

The L

egislative History of section 404, prior to 1983, is largely silent as to its effect on interest. A

t the tim

e of the original enactment of section 404, the code w

as unsophisticated in its treatment of the tim

e value of m

oney. Even by 1983, the rules governing this topic w

ere in their infancy. Thus, the history of

the statutes gives us little guidance.

How

ever, the subsequent changes in the statute are instructive of the 1983 meaning, as discussed below

.

(4) Context

As explained below

, other code sections denying deductions refer both to the "interest" and the substantive com

ponents of the item involved. T

his at least shows that C

ongressional drafters know how

to specifically refer to "interest" w

hen they want to.

(5) Econom

ic Reality

The reason em

ployers pay more for deferred com

pensation than for comparable current com

pensation involves the tim

e value of money. T

he difference is interest. Whether it is taxed as interest is an issue of

tax policy, discussed below. b. C

urrent Law

Section 467 applies to the interest component of substantial deferred com

pensation arrangements -- those

involving over $250,000. That is clear on the face of section 467(g). Section 467 does not apply to the

compensation portion of deferred com

pensation payments; that is covered by sections 404, 404A

, and 419(e). T

his, too, is clear from the face of the statute.

At least som

e of the comm

entators discussing Albertson's have suggested that section 467 applies to


(5 of 20) [3/26/02 9:13:05 AM

]


neither the compensatory nor the interest com

ponent of deferred compensation for services if that

compensation is covered by either section 404 or 404A

. They are w

rong.

Section 404 (dealing with deferred com

pensation for employees), section 404(d) (dealing w

ith deferred com

pensation for independent contractors), section 404A (dealing w

ith some deferred foreign

compensation), and section 419(e) (dealing w

ith deferred welfare benefits) com

prise nearly the entire universe of deferred paym

ents for services. I can think of no other significant forms of deferred

compensation for services that exist.

How

ever, if the myriad anti-A

lbertson's comm

entators are correct, those provisions trump section 467 as

to both the compensatory and interest elem

ents of deferred compensation paym

ents. If so, then to what is

section 467(g) applied? Well, essentially nothing. U

nder the anti-Albertson's argum

ents, section 467(g) applies only to deferred service paym

ents not covered by sections 404 and 404A; but no such paym

ents exist.

To m

e, such a superfluous reading of section 467(g) is preposterous. The section m

ust mean exactly w

hat it says: it applies to the interest com

ponent of substantial deferred compensation paym

ents and requires accrual of that interest by both the payor and the payee. B

ut, if I am correct, then sections 404, 404(d),

404A, and 419(e) m

ust trump section 467 only as to the com

pensation portion of payments. A

nd that m

eans that most of the criticism

of Albertson's is w

rong, at least as to how it w

ould apply under current law

.

I draw these conclusions from

three places: the face of the statute, the legislative history, and sound tax policy.

(1) Literal R

eading of the Code

As stated above, section 467(g) clearly applies to the interest com

ponent inherent in deferred com

pensation payments. N

ote that it does not apply to the "payments for services" them

selves; instead, it m

erely imputes interest "in the case of" such paym

ents.

Thus, w

henever a taxpayer defers substantial payments for services -- in such a case -- section 467

imputes interest.


(6 of 20) [3/26/02 9:13:05 AM

]


How

ever, section 467(g) clearly does not apply to the extent that sections 404 and 404A apply. T

his is consistent w

ith the statement above, because sections 404 and 404A

do not apply to "interest," but m

erely to "compensation" due em

ployees and independent contractors. This m

ay not be entirely clear to everyone, because sections 404 and 404A

affirmatively apply to "com

pensation," but do not affirm

atively exclude "interest" (which could be term

ed compensation for the use of m

oney). Logically,

however, (in m

y mind) "com

pensation" to employees and independent contractors refers to com

pensation or paym

ents for services and not for the use of money (interest).

My argum

ent regarding the face of the statute is subject to the criticism that it renders the second

sentence of section 467(g) superfluous. If the first sentence of section 467(g) applies only to "interest" and sections 404 and 404A

apply only to compensation, then w

hat is the need for the second sentence, w

hich causes sections 404 and 404A to trum

p section 467? At first blush, there w

ould appear to be no such need, as no overlap exists under m

y argument. H

owever, I defend the second sentence of section

467(g) on the following three grounds:

1. Ordering. Situations undoubtedly w

ill occur in which interest is disguised as com

pensation or vice versa. If section 467 applies to the interest com

ponent and section 404 to the compensation com

ponent, then som

e standard must be used to apportion any unclear paym

ent. I read the second sentence of section 467(g) as sending us to section 404, its history, and its regulations for such a standard of categorization. T

his will prevent double counting.

2. Em

phasis. Section 467(a)(1) requires accrual of deferred rent. Section 467(a)(2) requires accrual of interest on unpaid accrued rent. T

he drafters arguably meant to say -- in section 467(g) -- that "rules

comparable to the rules of subsection (a)(2) and not subsection (a)(1) shall also apply in the case of

payments for services." B

ut, rather than saying "and not subsection (a)(1)," they added the second sentence. It arguably says the sam

e thing. Just as arguably, it is unnecessary because an affirmative

reference to (a)(2) does not require an exclusion of (a)(1). The sentence w

as not artfully drafted and is perhaps superfluous. So w

hat; it is not the first time that can be said of a sentence in the code. In any

event, my reading of the sentence at least gives significant effect to the first sentence; the m

ore popular view

essentially precludes application of both sentences.

3. Cross-R

eference. Aw

kward as it m

ay be, the sentence is an effective cross-reference to sections 404 and 404A

.

(2) Legislative H

istory

To bolster their argum

ents, several comm

entators have mistakenly relied on a 1986 am

endment to

sections 404 and 404A as evidence that the sections apply to both com

pensation and interest.

Prior to the amendm

ent, sections 404, 404A, and 419 denied deductions "under section 162 (relating to

trade or business expenses) or section 212 (relating to expenses for the production of income). . . ." T

he


(7 of 20) [3/26/02 9:13:05 AM

]


amendm

ent struck the references to sections 162 and 212, substituting a denial of deductions "under this chapter."

Several comm

entators have stressed that section 163 (dealing with interest deductions) appears in

Chapter 1 of the Internal R

evenue Code, the sam

e chapter that contains sections 404 and 404A.

Therefore, their argum

ent goes, Congress intended for sections 404 and 404A

to deny interest deductions, as w

ell as ordinary and necessary business expenses and production of income expenses.

Initially, the argument appears to have m

erit. How

ever, it is subject to two criticism

s: one of drafting style, and the other arising from

a comm

ittee report.

1. Style. Tw

o comparable code provisions dem

onstrate Congress's ability and w

illingness to refer to interest separately from

compensation and sim

ilar related items.

Section 457 is similar to sections 404 and 404A

, except that it deals with "D

eferred Com

pensation Plans of State and L

ocal Governm

ents and Tax-exem

pt Organizations." B

ut, it is critically different in its w

ording:

What does this teach us about sections 404 and 404A

? It shows that those sections, w

hich refer only to deferred com

pensation and not to any "other" amounts, m

ust, as I suggest, apply only to compensation

and not to interest.

Section 267 also is comparable to sections 404 and 404A

in that it forces related persons on the same

method of accounting as to specified item

s. The sim

ilarity, however, is only general. W

hile both sections


(8 of 20) [3/26/02 9:13:05 AM

]


deny deductions "under this chapter," specifically, they apply to different items. Section 267 specifically

refers to "losses," "expenses," and "interest," while section 404 specifically applies only to

"compensation." C

learly, Congress know

s how to say "com

pensation and interest" when it w

ants to. Its failure to do so w

ith regard to section 404 suggests that it did not contemplate expanding the m

eaning of "com

pensation" to include interest.

2. Report. T

he Senate Com

mittee R

eport accompanying the sections 404 and 404A

amendm

ents explains the reason for the change:

"Capitalizable com

pensation expenses" arise in situations governed by Idaho Pow

er v. Com

missioner. In

Idaho Pow

er, the Supreme C

ourt required capitalization of otherwise deductible expenses attributable to

the construction of a taxpayer-built building. The decision effectively deferred deductions by denying

them under sections 162, 212, or 167 (for short-term

assets) and allowing them

instead over the lives of long-term

assets under section 167.

The case, how

ever, also could accelerate some deductions prior to the section 404 am

endment. D

eferred com

pensation, otherwise deductible under either section 162 or section 212, w

as not deductible under sections 404 or 404A

until the recipient included it. That deferral could last for m

any years. How

ever, if the com

pensation were capitalizable, it w

as then deductible under section 167 or 168 over the life of the asset to w

hich it was attributable. A

t least some, if not all, deductions attributable to that depreciation

would precede the ultim

ate payment of the com

pensation. As a result, the Idaho Pow

er capitalization requirem

ent sometim

es accelerated the deduction for deferred compensation. A

ccording to the Joint C

omm

ittee Report, the am

endment to sections 404 and 404A

was intended to prevent this acceleration.

Thus, the "under this chapter" language w

as designed with sections 167 and 168 in m

ind, rather than section 163.

(3) Sound Tax P

olicy

It is my observation that C

ongress prefers qualified deferred compensation to unqualified (the

Albertson's type), and I believe it is proper policy. In a sense, that is the general point of all those

complicated provisions dealing w

ith qualified plans; if a plan does not discriminate and does not violate

myriad restrictions, then it receives favorable treatm

ent. The contributor m

ay deduct contributions currently, the plan is exem

pt, and the beneficiaries may defer the reporting of incom

e. Unqualified plans,

however, appear to be disfavored in that the contributor cannot deduct com

pensation until the recipient includes it.


(9 of 20) [3/26/02 9:13:05 AM

]


But, w

ithout the Albertson's case, nonqualified deferred com

pensation actually would receive m

ore favorable treatm

ent than would qualified deferred com

pensation. I cannot believe that is wise policy, let

alone consistent with C

ongress's intentions.

My proof of this rests in the follow

ing points:

(1) Em

ployers pay nonqualified deferred compensation to em

ployees they wish to benefit,

particularly highly paid employees.

(2) To the extent the em

ployer suffers from the deferral of the deduction, the em

ployee benefits from

the deferral of the inclusion. If the two are in the sam

e tax bracket and use the same year, the

government should be financially indifferent as to w

hether policy allows current or deferred treatm

ent.

(3) The loss to the em

ployer and the benefit to the employee are easily calculable.

(4) Because the deduction deferral required by section 404 hurts the em

ployer and is easily calculable, an inform

ed employer easily can pass it on to the em

ployee, wiping out his benefit. T

heem

ployer simply w

ould pay the employee less than fair com

pensation, if the compensation is deferred.

The discount w

ould equal the tax detriment to the em

ployer and the tax savings to the employee. O

r, an em

ployer who especially w

ants to benefit a particular employee can refrain from

discounting the deferred com

pensation by the amount of the section 404 effect and can thereby m

ask its extra benefit to the em

ployee. It simply w

ould pay the amount of fair com

pensation, plus interest for the deferral, with no

discount for the tax effect. Shareholders -- and the government for purposes of excessive com

pensation -- w

ould not likely catch on.

(5) As a result, the caps and antidiscrim

ination provisions affecting qualified deferred com

pensation are thwarted. T

he employer suffers no real penalty from

sections 404 and 404A. B

y effectively assum

ing part of its employee's tax liability, the em

ployer pays what it w

ants to pay and suffers the proper net consequences. T

hus, what appears to be disfavored -- nonqualified deferred

compensation -- actually is favored; it avoids all those com

plications (especially the caps) applicable to qualified plans.

(6) But then com

es section 467(g) and Albertson's. A

s a result, the employee m

ust pay taxes currently on the interest com

ponent of the deferred payments and the em

ployer currently may

deduct the same am

ount. Again, the governm

ent is financially indifferent between this approach and a

deferral of the interest. How

ever, under this approach, the employee suffers a true disincentive to seek

nonqualified deferred compensation. T

he disincentive is fair -- the employee pays taxes on interest that

really accrues -- but it is nevertheless discouraging to such compensation arrangem

ents. And that is as it

should be.

If my reasoning is correct, w

hy would the governm

ent want to w

in the Albertson's case? I think it w

ould


(10 of 20) [3/26/02 9:13:05 AM

]


not want to, and I fear that it has not fully considered the consequences of a reversal.

c. Critique of R

ehearing

My prior published argum

ents apply to the re-hearing opinion: I have not changed my analysis.

How

ever, I find three aspects of the new opinion to be particularly disturbing:

1. The reference to the alleged $7 B

illion cost of the original opinion. The court quoted the

government's argum

ent that a failure to reverse would cost the taxpayers approxim

ately $7 Billion. T

he court, how

ever, did not explain the source for this number, how

it was com

puted, or its relevance. While

the relevance may appear obvious, I believe it is not. C

ongress, and not the courts, has the obligation to consider the financial im

pact of a taxing statute. This is particularly true today.

Prior to the reversal, several comm

entators alleged that a reversal was inevitable - either in the courts or

in Congress, w

hich apparently was already considering a clarifying am

endment closing the loophole

opened by the original opinion. Since those comm

ents appeared, however, and shortly before the reversal

was announced, W

ashington experienced a political earthquake. Others m

ay disagree, but I am not

confident that the current Congress w

ould have closed the $7 Billion loophole; to the contrary, I suspect

it would not have. T

his would have been a tax increase at a tim

e when tax increases are not politically

popular. Whatever the w

isdom of that econom

ic policy, I certainly believe it is for Congress to decide,

and not for the Ninth C

ircuit.

2. The use of the "m

atching principle." Much of the court's opinion discusses the "m

atching principle" and the controlling concept behind section 404 and m

uch of the Code. T

his portion of the opinion is, I believe, nonsense. It relies on several com

mentators - H

alperin, Lokken, and B

ittker, among others - for

support. Those com

mentators, how

ever, did not speak of "the matching principle" as the controlling

doctrine; instead, they each used terms such as "a m

atching concept" to describe section 404. The

difference is critical.

"The m

atching principle" is the most im

portant principle of accounting, for it requires that income and

the costs of producing that income be reported (m

atched) in the same year. O

therwise, an incom

e statem

ent would not clearly reflect incom

e. This is part of generally accepted accounting principles and

not necessarily tax principles. It is relevant to tax law because of the general code requirem

ent that a m

ethod of accounting "clearly reflect income."

It is not, however, w

hat Halperin, L

okken, and others were speaking about. T

hey were m

erely describing the w

ay in which section 404 m

atches the employer cost to the em

ployee income. B

y no means is that a

"principle" of tax law. It applies in som

e narrow instances - such as sections 404 and 267. If a "principle"

affects this area, it is that "each taxpayer is different and one persons tax consequences do not affect another."


(11 of 20) [3/26/02 9:13:05 AM

]


In short, there is no "matching principle" of tax law

. To create one w

ould either repeal the cash method

or the accrual method: it could certainly not perm

it both. Unfortunately the N

inth Circuit m

odified H

alperin's language from "a m

atching concept" to "the matching principle" - a giant change. I suspect

that somew

here in the back of the minds of the judges w

as some notion that "the m

atching principle" exists and is very im

portant and, after all, "principles" should be followed. I am

not surprised that non-accountants m

ight use such flawed reasoning. I am

nevertheless disturbed by it.

3. The court's reference to the unfairness of accrual by the recipients. T

he court asserted that if its original opinion w

ere to continue, then recipients of deferred compensation m

ight be required to accrue the unpaid interest. T

his, the court stated, would be unfair.

Perhaps that is true; however, I believe that is exactly the point C

ongress had in mind w

hen it enacted section 467(g) - to require otherw

ise cash method taxpayers to accrue the interest com

ponent of substantial non-qualified deferred com

pensation. As I have argued, that w

ould effectively discourage such arrangem

ents in ways that deferral of the deduction does not. So w

hat, then, if it is unfair.

And, w

hat about Albertsons, the litigant. D

oes not the court's opinion force it to defer the deduction of interest beyond the years to w

hich it is attributable? Does this not m

ean that Albertsons m

ust accrue incom

e in those years (which is unpaid) but that is cannot sim

ilarly deduct incurred but unpaid expenses used to produce that incom

e? Isn't this just as unfair, in the exact same dollar am

ounts? Of course it is.

Thus the court's argum

ent is almost hum

orously inane.

Also, does not the required deferral of the interest violate the very "m

atching principle" upon which the

court bases its opinion? Of course it does.

2. Halperin

After generally denom

inating my article "outrageous," "profoundly disturbing," "deeply disturbing," and

at times "ridiculous," he labels m

y discussion of documented legislative history (preferring his ow

n m

emory) as "revisionist," "unrealistic," "troubling," and "not believable."

His articles, how

ever, speak for themselves, and I do not sum

marize them

here.

II. Broader V

iew of the C

ase: Effect on Statutory Interpretation

A. M

y View

of Statutory Interpretation

I believe we should read Internal R

evenue Code sections, in the context of other code sections, for w

hat they say. Initially, that involves a literal reading. I have no problem

then examining other code sections

for consistent or inconsistent use of language and style to aid in this exegesis. Failure to do so would be,

in my opinion, irresponsible. N

aturally, such comparisons are, at tim

es, not enlightening: the best explanation for inconsistent language m

ay simply be that the conflicting provisions w

ere poorly drafted.


(12 of 20) [3/26/02 9:13:05 AM

]


In such a case, a proper analysis at least would be prepared w

ith an explanation for the reasonable view

point that people are entitled to rely on law and should not be expected to ignore provisions sim

ply because they are troublesom

e.

Hence I m

ove to a second step: an examination of docum

ented legislative history. Although I tend to

agree with Justice Scalia in his general criticism

of such authority, I believe it can nevertheless provide som

e guidance for conflicting interpretations and constructions, which are each based on literal readings.

If this does not resolve the matter, I w

ould then consider judicial opinion (known in civil law

jurisdictions as jurisprudence) as evidence of learned opinion and custom

. Scholarly analysis might also

be helpful at this point.

Lastly, I w

ould consider equity, as that is ultimately w

hat a judge must do in difficult situations.

In my analysis, I found the A

lbertson's opinion to be supported by a literal reading of the statutes. I found further support in the context of other provisions, as w

ell as documented legislative history, judicial

opinion, and sound policy.

B. H

alperin's View

Professor Halperin (G

eorgetown) has w

ritten extensively regarding the Albertson's decision. H

e criticized m

y analysis, accusing me of "trying to get into the m

inds of legislators." While that criticism

of m

e is inaccurate - I just want to hold them

to what they say they m

eant - Halperin raises som

e interesting points regarding statutory interpretation.

Naturally, his articles speak best for them

selves. As I understand them

, he believes that we should apply

the law based on w

hat legislators meant to say, w

ithout paying too close attention to what they actually

said - either in the statute or in published legislative history. To determ

ine such intent he consults his ow

n knowledge of the legislative process and the drafters them

selves. As a form

er Deputy Secretary and

holder of other high level Washington jobs, this is a natural m

ethodology for him and others sim

ilarly situated. For the rest of us, how

ever, I believe my m

ethod is more just.

The N

inth Circuit, on rehearing, how

ever, cited Professor Halperin as the authority to follow

.

C. G

eier's View

s

Professor Geier (C

leveland-Marshall) has w

ritten extensively regarding legislative interpretation in the tax field. A

summ

ary of her work is located at:

Deborah A

. Geier, "Interpreting T

ax Legislation: T

he Role of Purpose," T

ax Notes, M

ay 8, 1995, p. 822.

While not in any of her published w

ork (at least none that I have found) her approach is well illum

inated


(13 of 20) [3/26/02 9:13:05 AM

]


by comm

ents she agreed with at the last A

.A.L

.S conference for tax professors (the above cited com

mentary is a sum

mary of her presentation at the conference). In a panel discussion, led by Professor

Halperin and joined by Judge H

alpern (of the Tax C

ourt Albertson's m

ajority), she and others asserted that tax law

is not really written for the com

mon m

an because it is and must be so com

plex. Instead, it is w

ritten for the educated lawyers and judges, w

ho are capable of applying the law as it w

as "meant to be."

As such, tax law

should not be read literally and Congress should not be held to m

ore traditional notions of statutory interpretation.

That is an interesting philosophy, how

ever, it is not one I subscribe to. The com

ments are particularly

interesting in light of their venue: the conference was held in N

ew O

rleans, Louisiana - a civil law

jurisdiction w

hich subscribes to the world-w

ide majority approach that law

is written for the com

mon

man, rather than for the elite, and can be w

ritten clearly.

III. Broadest V

iew of the C

ase: The T

ax Treatm

ent of Deferred but Incurred E

xpenses

Deferred (unpaid) expenses w

hich have nevertheless been incurred under the "all events test" are com

monplace. N

o one scheme exists, how

ever, to treat them; instead, the C

ode provides myriad m

ethods of doing so, w

ith inconsistent results. I discuss ten of those methods, how

ever, others exist.

To illustrate the relative values of the ten deduction approaches, assum

e the following:

●A

n annual percentage rate of 10.25% for all periods and term

s.

●A

33.33% tax rate for all years.

●A

6.8333333% after tax annual percentage rate for all years.

●T

he amount to be paid is $10,000 and is due 12/31/00.

●A

calendar year taxpayer.

●T

he amount w

as earned on 1/1/94.

Accounting and econom

ic computations based on the all events test (not the tax econom

ic performance

test) would result in a current deduction for the present value of $10,000 in seven years. T

hat would

equal $5,050.68. In addition, accounting deductions would be appropriate for the interest obligation

accrued over time. A

ssuming sem

i-annual accrual, interest would accrue and w

ould be deductible on the follow

ing dates:


(14 of 20) [3/26/02 9:13:05 AM

]


The $5,050.68 initial deduction w

ould combine w

ith the $4,949.32 interest deduction over time to equal

the total sum of $10,000.00.

The ten tax m

ethods for deduction of deferred payments, how

ever, do not all conform w

ith the accounting and econom

ic reality of the accruals. Thus, it is helpful to m

easure the relative tax benefits resulting form

the various methods. B

ecause much of the criticism

of Albertson's stem

s from its alleged

undue tax benefit to the taxpayer, I find some perspective in order.

A. D

educt the Future V

alue Currently

1. Authority: L

awyer's T

itle Guarantee F

und v. U.S., 508 F

.2d 1 (5th Cir.

1975) appears to use this method. F

ord Motor C

o. V. C

omm

issioner, 102 T.C

. 87 (1994) rejects it. A

lso, section 461(h) generally prohibits it.

2. Exam

ple


(15 of 20) [3/26/02 9:13:05 AM

]


B. D

educt the Present V

alue Currently

1. Authority: Section 468 uses this m

ethod for solid waste reclam

ation costs. It perm

its no additional amount for interest.

2. Exam

ple

C. D

educt the Present V

alue Currently P

lus an Additional A

mount W

hen Paid

1. Authority: Section 461(h), dealing w

ith contested liabilities, uses this m

ethod. It unreasonably times the interest deduction; but, then, that w

as congress's choice.

2. Exam

ple


(16 of 20) [3/26/02 9:13:05 AM

]


D. D

educt the Present V

alue Currently P

lus the Interest Elem

ent Over T

ime

1. Authority: Section 467(a) uses this m

ethod with respect to deferred

payments for rent.

2. Exam

ple

E. D

educt the Future V

alue Upon P

ayment

1. Authority: Section 461(h) arguably uses this m

ethod, at least that is what the

regulation examples appear to im

ply. Treas. R

eg. Section 1.461-4(g) Exam

ple 1. B

ut see, Treas. R

eg. Section 1.461-4(c), which arguably w

ould permit

deduction of the interest element over tim

e plus the present value upon paym

ent. That alternative view

of section 461(h) is consistent with the original

Albertson's decision.

2. Exam

ple


(17 of 20) [3/26/02 9:13:05 AM

]


F. D

educt the Present A

fter tax Value C

urrently, Fund the A

mount, E

xclude the Interest E

arned by the Fund (but have the fund pay taxes).

1. Authority: Section 468A

uses this method for N

uclear Pow

er D

ecomm

issioning Costs.

2. Exam

ple

G. D

educt the Interest Com

ponent Over T

ime P

lus the Rem

ainder at the End

1. Authority: Section 467(g) and the original A

lbertson's opinion adopt this m

ethod.

2. Exam

ple


(18 of 20) [3/26/02 9:13:05 AM

]


H. D

educt the Interest Com

ponent Over T

ime P

lus the Future V

alue at the End

1. Authority: Section 453(A

)(c) adopts this method in a m

irror situation. I do not suggest that it is authority for the deduction; how

ever, a discussion of fairness com

pels consideration of this approach, which is undoubtedly fair, as

demonstrated below

.

2. Exam

ple

I. Deduct the P

resent Value C


mount, H

ave the Fund Include the

Income F

rom the F

und, and Have the F

und Deduct any E

xtra When P

aid


(19 of 20) [3/26/02 9:13:05 AM

]


1. Authority: Section 468B

adopts this method fro structured settlem

ent plans.

2. Exam

ple

J. Deduct the P

resent Value C


mount, and M

ake the Fund T

ax E

xempt1. A

uthority: Section 404 and 501 adopt this method for qualified deferred

compensation plans and arrangem

ents.

2. Exam

ple


(20 of 20) [3/26/02 9:13:05 AM

]

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