In The

Supreme Court of the United States




Decided April 22, 1987

Justice O’Connor, Dissenting

Topic: Federal Taxation*Court vote: 6–3
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Joining O'Connor opinion: Justice BLACKMUN Justice BLACKMUN Justice STEVENS Justice STEVENS
Citation: 481 U.S. 239 Docket: 85–1385Audio: Listen to this case's oral arguments at Oyez

* As categorized by the Washington University Law Supreme Court Database

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Section 446(a) of the Internal Revenue Code of 1954 provides that taxable income

shall be computed under the method of accounting on the basis of which the taxpayer regularly computes his income in keeping his books.

The Code specifically recognizes the use of "an accrual method," 26 U.S.C. § 446(c)(2), under which a taxpayer is permitted to deduct an expense in the year in which it is "incurred," regardless of when it is actually paid. § 162(a). Under the "all events" test, long applied by this Court and the Internal Revenue Service, an expense may be accrued and deducted when all the events that determine the fact of liability have occurred, and the amount of the liability can be determined with reasonable accuracy. Treas.Reg. § 1.461-1, 26 CFR § 1.461-1(a)(2) (1986). Because the Court today applies a rigid version of the "all events" test that retreats from our most recent application of that test, and unnecessarily drives a greater wedge between tax and financial accounting methods, I respectfully dissent.

This case calls for the Court to revisit the issue addressed only last Term in United States v. Hughes Properties, Inc., 476 U. S. 593 (1986). At issue in Hughes Properties was whether a casino operator utilizing the accrual method of accounting could deduct amounts guaranteed for payment on "progressive" slot machines, but not yet won by a playing patron. A progressive slot machine has a jackpot whose size increases as money is gambled on the machine. Under Nevada law, a casino operator is prohibited from reducing the amount of the progressive jackpot. We concluded, therefore, that all the events had occurred that determine the fact of the casino operator's liability, despite the fact that the jackpot might not be won for as long as four years. We rejected the argument made by the United States that the casino operator's obligation to pay the jackpot arose only upon a winning patron's pull of the handle, even though it was conceivable that the jackpot might never be won:

There is always a possibility, of course, that a casino may go out of business, or surrender or lose its license, or go into bankruptcy, with the result that the amounts shown on the jackpot indicators would never be won by playing patrons. But this potential nonpayment of an incurred liability exists for every business that uses an accrual method, and it does not prevent accrual. See, e.g., Wien Consolidated Airlines, Inc. v. Commissioner, 528 F.2d 735 (CA9 1976). 'The existence of an absolute liability is necessary; absolute certainty that it will be discharged by payment is not.' Helvering v. Russian Finance & Constr. Corp., 77 F.2d 324, 327 (CA2 1935).

United States v. Hughes Properties, Inc., supra, at 476 U. S. 605 -606.

In my view, the circumstances of this case differ little from those in Hughes Properties. The taxpayer here is seeking to deduct the amounts reserved to pay for medical services that are determined to have been provided to employees in the taxable year, whether or not the employees' claims for benefits have been received. The taxpayer's various medical benefits plans provided schedules for the medical and hospital benefits, and created a contractual obligation by the taxpayer to pay for the covered services upon presentation of a claim. The courts below found that the obligation to pay became fixed once the covered medical services were received by the employee. See App. 25. Once the medical services were rendered to an employee while the relevant benefit plan was in effect, General Dynamics could not avoid liability by terminating the plan prior to the filing of a claim. Id. at 133-134. Neither could General Dynamics extinguish its liability by firing an employee before the employee filed a claim for benefits. Id. at 87.

It is true, of course, that it was theoretically possible that some employees might not file claim forms. In my view, however, this speculative possibility of nonpayment differs not at all from the speculation in Hughes Properties that a jackpot might never be paid by a casino. As we observed in Hughes Properties, the potential of nonpayment of a liability always exists, and it alone does not prevent accrual. The beneficiary of a liability always has the option of waiving payment, but a taxpayer is still unquestionably entitled to deduct the liability. An injured employee entitled absolutely to reimbursement for medical services under a workers' compensation statute, for example, may fail to utilize the medical services. The employer, however, has been held to be entitled to deduct the expected medical expenses, because the workers' compensation law creates liability. See Wien Consolidated Airlines, Inc. v. Commissioner, 528 F.2d 735 (CA9 1976) (holding that accrual basis taxpayer may deduct expected workers' compensation payments in year of injury even though injured workers may not utilize medical benefits). Similarly, any business liability could ultimately be discharged in bankruptcy, or a check might never be cashed by its recipient. There can be no doubt, however, that these remote possibilities alone cannot defeat an accrual basis taxpayer's right to deduct the liability when incurred.

The Claims Court found that the processing of the employees' claims was "routine," and "ministerial in nature," 6 Cl.Ct. 250, 254 (1984), and the majority does not question that finding. Ante at 481 U. S. 244, n. 4. Instead, the majority holds that "as a matter of law, the filing of a claim was necessary to create liability." Ibid. Even if, in a technical sense, the Court is correct that the filing of a claim is a necessary precondition to liability as a matter of law, the failure to file a claim is, at most, a "merely formal contingenc[y], or [one] highly improbable under the known facts," that this Court has viewed as insufficient to preclude accrual and deductability. 2 J. Mertens, Law of Federal Income Taxation § 12.62, p. 241 (M. Weinstein, R. Donovan, P. Gaveras, H. Piech, & R. Neeld rev.1985). Indeed, in the very case that first announced the "all events" test, United States v. Anderson, 269 U. S. 422 (1926), this Court concluded that a taxpayer should deduct a federal munitions tax before the year in which the tax was even assessed -in effect before the Government had made a claim for the tax. The Court recognized that, "[i]n a technical legal sense, it may be argued that a tax does not accrue until it has been assessed and becomes due," but concluded that otherwise all the events that determined the liability for the munitions tax had occurred. Id. at 269 U. S. 441. Similarly, in Continental Tie & Lumber Co. v. United States, 286 U. S. 290 (1932), the Court held that an accrual basis taxpayer should immediately include as income a federal payment to railroads created by statute, but neither claimed by the taxpayer nor awarded by the Federal Government until years later. The Court explained that, although no railroad had any vested right to payments under the statute until a claim was made by the railroad and awarded by the Interstate Commerce Commission,

[t]he right to the award was fixed by the passage of the Transportation Act. What remained was mere administrative procedure to ascertain the amount to be paid.

Id. at 286 U. S. 295. Clearly, the right to reimbursement for medical benefits under any of the medical benefits plans at issue in this case arises once medical services are rendered; the filing and processing of a claim is purely routine and ministerial, and in the nature of a formal contingency, as correctly perceived by the courts below.

The holding of the Court today unnecessarily burdens taxpayers by further expanding the difference between tax and business accounting methods without a compelling reason to do so. Obviously, tax accounting principles must often differ from those of business accounting. The goal of business accounting "is to provide useful and pertinent information to management, shareholders, and creditors," while "the responsibility of the Internal Revenue Service is to protect the public fisc." United States v. Hughes Properties, Inc., 476 U.S. at 476 U. S. 603. Therefore, while prudent businesses will accrue expenses that are merely reasonably foreseeable, for tax purposes, the liability must be fixed. But Congress has expressly permitted taxpayers to use the accrual method of accounting, and from its inception in United States v. Anderson, supra, the "all events" test has been a practical adjustment of the competing interests in permitting accrual accounting and protecting the public fisc. Unfortunately, the Court today ignores the pragmatic roots of the "all events" test, and instead applies it in an essentially mechanistic and wholly unrealistic manner. Because the liability in this case was fixed with no less certainty than the range of expenses both routinely accrued by accrual method taxpayers and approved as deductible for tax purposes by this Court and other courts in a variety of circumstances, I respectfully dissent.

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