Supreme Court of the United States
HILLSBORO NAT'L BANK
Decided March 7, 1983
Justice O’Connor, For the Court
|Topic: Federal Taxation*||Court vote: 7–2|
Click any Justice for detailJoining O'Connor opinion: Chief Justice BURGER Justice POWELL Justice REHNQUIST Justice WHITE
|Joining opinion in part: Justice BRENNAN|
|Citation: 460 U.S. 370||Docket: 81–485||Audio: Listen to this case's oral arguments at Oyez|
* As categorized by the Washington University Law Supreme Court Database
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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.
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 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. 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 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 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).
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 ] 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 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, 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 ]
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 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. 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 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 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 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, 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 ]
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 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 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 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 ]
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.
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 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 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 State does not require the corporation to recognize income, and we reverse the judgment below. [ Footnote 30 ]
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 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 ]
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, 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 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 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 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 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 ]
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:
(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.
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