CSX Corporation v. United States

PUBLISHED
UNITED STATES COURT OF APPEALS
FOR THE FOURTH CIRCUIT
CSX CORPORATION,
Plaintiff-Appellee,
v. No. 96-2175
UNITED STATES OF AMERICA,
Defendant-Appellant.
Appeal from the United States District Court
for the Eastern District of Virginia, at Richmond.
Richard L. Williams, Senior District Judge.
(CA-95-1004)
Argued: July 10, 1997
Decided: September 11, 1997
Before NIEMEYER, MICHAEL, and MOTZ,
Circuit Judges.
_________________________________________________________________
Reversed by published opinion. Judge Motz wrote the opinion, in
which Judge Niemeyer and Judge Michael joined.
_________________________________________________________________
COUNSEL
ARGUED: Steven Wesley Parks, Tax Division, UNITED STATES
DEPARTMENT OF JUSTICE, Washington, D.C., for Appellant.
James Linwood Sanderlin, MCGUIRE, WOODS, BATTLE &
BOOTHE, L.L.P., Richmond, Virginia, for Appellee. ON BRIEF:
Loretta C. Argrett, Assistant Attorney General, Richard Farber, Helen
F. Fahey, United States Attorney, Tax Division, UNITED STATES
DEPARTMENT OF JUSTICE, Washington, D.C., for Appellant.
Courtney G. Hyers, CSX CORPORATION, Richmond, Virginia;
James D. Bridgeman, MCGUIRE, WOODS, BATTLE & BOOTHE,
L.L.P., Washington, D.C., for Appellee.
_________________________________________________________________
OPINION
DIANA GRIBBON MOTZ, Circuit Judge:
This case involves the now repealed "book income" provisions of
the alternative minimum tax applicable to corporate taxpayers. Proper
calculation of a corporation's "book income" is a somewhat esoteric
endeavor, but was critically important to corporations that had high
"book incomes" and low taxable incomes, as the millions of dollars
in tax refunds at issue in this case demonstrate.
I.
As part of the Tax Reform Act of 1986, Congress enacted the "al-
ternative minimum tax." See 26 U.S.C.A.§§ 55-59 (West 1988)
(amended 1988, 1989, 1990, 1992, 1993 and 1996). The alternative
minimum tax replaced the corporate minimum tax, which had been
passed in 1969 in response to the public perception that through
deductions and tax-planning many corporations were paying no taxes
at all. See Sandra G. Soneff Redmond, Comment, The Book Income
Adjustment in the 1986 Tax Reform Act Corporate Minimum Tax:
Has Congress Added Needless Complexity in the Name of Fairness,
40 Sw. L.J. 1219, 1221-22 (1987).
Congress concluded that the corporate minimum tax did not ade-
quately address this problem and so enacted the alternative minimum
tax as a more effective means of collecting taxes from taxpayers with
significant financial profits who were escaping tax liability through
tax preferences, deductions, or incentives. See S. Rep. No. 99-313, at
518-19 (1986); Staff of the Joint Comm. on Taxation, Explanation of
the Tax Reform Act of 1986 434 (1987); Ahron H. Haspel & Mark
Wertlieb, New Law Makes Sweeping Changes to Corporate Minimum
Tax, 66 J. Tax'n 22, 22-23 (1987).
2
The concept behind this alternative minimum tax as applicable to
corporate taxpayers was relatively simple. Corporations calculated
both their "regular tax for the taxable year," and a second, alternative
tax amount based upon a broader based definition of income, and
increased by their financial, or book income. 26 U.S.C.A. §§ 55-56(West 1988). In addition to its "regular tax" burden, a corporation
would pay the amount the second, financial-based tax exceeded its
"regular tax." By creating a second, alternative income measure that
did not include many tax preferences and took into account the profits
shown in a corporation's financial records, Congress hoped to remedy
the situation in which "major companies have paid no taxes in years
when they have reported substantial earnings." S. Rep. No. 99-313,
at 519.
The actual mechanics of this alternative minimum tax were, of
course, significantly more complex than the general concept. First, a
corporation would assess its "tentative minimum tax" for the year. 26
U.S.C.A. § 55(a)(1) (1988). The "tentative minimum tax" was figured
on the basis of the corporation's "alternative minimum taxable
income," a much broader based calculation of income than the calcu-
lation used for "regular" tax purposes. In addition to the broader base
for income calculation, the alternative minimum tax structure
included the book income provisions to guarantee that a corporation
with significant profits would not go untaxed. If a corporation's "ad-
justed net book income" -- the "net income or loss" of the corpora-
tion "set forth" in the corporation's "applicable financial statement"
-- exceeded the corporation's "alternative minimum taxable income,"
the amount of the minimum taxable income would be increased by
fifty percent of the "adjusted net book income." 26 U.S.C.A.
§ 56(f)(1), (2) (West 1988) (repealed 1990). In short, if a corporate
taxpayer showed profits that outstripped its "alternative minimum tax-
able income," 50% of the profits above the originally calculated
income were added to the "alternative minimum taxable income."
This provision ensured that when a corporation showed a significant
"financial" profit, that amount would be reflected in the "alternative
minimum taxable income," and a corporation would be taxed on a
portion of its financial profit even if it had little or no "regular tax"
burden.
Once the "alternative minimum taxable income" was determined,
a corporation figured its "alternative minimum tax" by subtracting
3
two items -- (1) "the exemption amount," which was $40,000 for cor-
porations, and (2) a foreign tax credit, see 26 U.S.C.A. § 55(b)(1);
twenty percent of the remaining amount was the "tentative minimum
tax." 26 U.S.C.A. § 55(b)(1), (d)(2) (West 1988). The corporation
then subtracted its "regular tax" liability for the year from its "tenta-
tive minimum tax." The amount by which the "tentative minimum
tax" exceeded the corporation's "regular tax" liability was the amount
of the "alternative minimum tax," i.e., the amount of extra tax that the
corporation would have to pay. Thus, the alternative minimum tax uti-
lized two methods to ensure that corporations with significant profits
but low "regular taxes" would pay taxes: it used a broader based "al-
ternative minimum taxable income" and it added to that income a por-
tion of the corporation's "book income," or the profits shown on the
company's financial statements.
At issue in this case are the adjustments available to corporate tax-
payers in figuring their "book income" for the purposes of the alterna-
tive minimum tax in effect for tax years 1987 through 1989. See 26
U.S.C.A. § 56(f) (repealed 1990).* Congress granted the Secretary of
Treasury "authority to adjust" the definition of book income "to pre-
vent the omission or duplication of any item." 26 U.S.C.A.
§ 56(f)(2)(I).
The Secretary chose not to permit corporate taxpayers to allow
adjustments to book incomes for "timing differences." See Treas. Reg.
§ 1.56-1(d) (1990); Temp. Treas. Reg. § 1.56-1T(d) (1987). Timing
differences occur when a corporation takes a deduction (or loss) from
its taxable income in a different year than it counts the same deduc-
tion (or loss) against its income for financial accounting purposes.
Prior to 1987 "timing differences" had little effect on corporate taxes,
because there was no tax effect to taking a tax deduction in a different
year than the deduction was counted for financial accounting pur-
poses. Between 1987 and 1990, however, a timing difference could
have a significant effect because the alternative minimum tax was
based on a corporation's book income as shown on its financial state-
_________________________________________________________________
*The "book income" adjustment applied to tax years 1987 through
1989. For tax years after 1989, Congress retained the alternative mini-
mum tax, but provided for its calculation by other methods.
4
ments, and so any difference in timing between tax and financial
accounting could result in millions of dollars in additional taxes.
CSX Corporation seeks to deduct three separate amounts, all result-
ing from timing differences, from its 1987 book income to lower its
liability under the alternative minimum tax. The first, and largest,
amount arises from CSX's 1985 corporate restructuring plan. Under
the plan CSX was required by general accounting principles to take
a one time charge of $954 million against its 1985 financial earnings
to cover the projected costs of the restructuring. CSX could not
deduct the special charge on its 1985 corporate income tax return
because federal tax law requires that the costs be deducted as they
occur. In 1987 CSX actually incurred $109,916,780 in losses under
its restructuring plan, and deducted that amount from its taxable
income in that year. CSX did not deduct the $109 million from its
financial or book income in 1987, however, because it had already
deducted that amount for accounting purposes in 1985 as part of the
1985 $954 million charge. Thus, there was a timing difference, and
CSX's 1987 book income was $109 million higher than its taxable
income. As a result CSX faced a significant tax burden -- approxi-
mately $3,903,000 -- under the alternative minimum tax based upon
its book income.
The second timing difference occurred as a result of accounting
errors by CSX Realty, a subsidiary of CSX. After CSX's 1987 finan-
cial statements had been issued, and before the filing of CSX's 1987
tax returns, CSX discovered that CSX Realty had erroneously over-
stated its 1987 earnings by $13,437,764. Thus, CSX's reported 1987
financial earnings were inflated by this amount. For financial account-
ing purposes CSX recognized this error in 1988, but sought to apply
the error to its book income in 1987 for purposes of the alternative
minimum tax. Again, a timing difference occurred: CSX incurred a
loss in 1987 that it did not report for financial accounting purposes
until 1988, but nonetheless sought to apply the loss to its 1987 book
income for purposes of calculating the alternative minimum tax.
When it was not permitted to do this, it incurred an additional tax lia-
bility of approximately $477,000.
The third timing difference resulted from an accounting change at
Nashville and Decatur Railroad. This one-time adjustment resulted in
5
an addition of $11,331,015 to CSX's 1987 book income based upon
income actually earned in the years 1983-87. Thus, a timing differ-
ence occurred because Nashville and Decatur had earned, and paid
taxes on, the $11 million in 1983-87, but that same amount was added
to its 1987 financials, increasing CSX's 1987 tax burden under the
alternative minimum tax by $402,000.
CSX paid its 1987 taxes without regard to the three timing differ-
ences. The company later filed a claim for a refund, asserting that the
three timing differences should have been taken into account in com-
puting its book income, and consequently its alternative minimum
tax. CSX claimed its 1987 tax burden was overstated because of the
above three items, in the total amount of $4,783,029. CSX argued that
including these amounts in its book income for purposes of the alter-
native minimum tax overstated its earnings and resulted in an unfair
tax burden.
After the Internal Revenue Service rejected CSX's claim for
refund, the company filed this refund suit. On cross-motions for sum-
mary judgment, based on the undisputed facts set forth above, the dis-
trict court granted summary judgment to CSX. See CSX Corp. v.
United States, 929 F.Supp. 223, 224 (E.D. Va. 1996). The court inval-
idated Treasury Regulation § 1.56-1(d), which forbids adjustments to
book income based on timing differences. The court reasoned that this
regulation conflicted with the "clear language" of the governing stat-
ute, 26 U.S.C.A. § 56(f)(2)(I), which requires the Secretary of the
Treasury to adjust book income "``to prevent the omission . . . of any
item.'" Id. (quoting 26 U.S.C.A. § 56(f)(2)(I)). The district court
believed that timing differences came within the plain meaning of
"omission" in the statute. Id. at 225-26. Accordingly, the court
granted CSX the refund it requested. Id. at 226. The United States
appeals, and we now reverse.
II.
The single question before us is whether Treasury Regulation
§ 1.56-1(d)(4) constitutes a valid interpretation of 26 U.S.C.A.
§ 56(f)(2)(I). The validity of the regulation is a question of law, which
we review de novo. See United States v. Boynton, 63 F.3d 337, 342
(4th Cir. 1995).
6
Section 56(f)(2)(I) provides:
Secretarial Authority to Adjust Items. -- Under regulations,
adjusted net book income shall be properly adjusted to pre-
vent the omission or duplication of any item.
26 U.S.C.A. § 56(f)(2)(I).
The regulation promulgated pursuant to § 56(f)(2)(I) did not allow
corporations to adjust their book incomes to reflect timing differ-
ences. The preamble to the final regulation states the Secretary's posi-
tion on timing differences:
Numerous commentators stated that the proposed regula-
tions inappropriately prohibit an adjustment for timing dif-
ferences. A timing difference exists when an item of income
or deduction is recognized in different periods for purposes
of pre-adjustment alternative minimum taxable income and
financial statement income. Timing differences arise
because tax accounting and financial accounting principles
treat certain items as accruing in different periods.
...
The final regulations provide no adjustment for timing dif-
ferences. The specific grant of authority to the Secretary
under section [56(f)(2)(I)] to make adjustments to prevent
the omission or duplication of any item was intended to pre-
vent the omission of any item from adjusted net book income
and the duplication of any item in adjusted net book income.
Because income resulting from a timing difference is
reported in adjusted net book income only once, there is no
duplication of adjusted net book income to be adjusted
under section [56(f)(2)(I)].
55 Fed. Reg. 33,673 (1990) (emphasis added).
Example 1 of Temp. Treas. Reg. § 1.56-1T(d)(4)(v), also illustrates
the Secretary's interpretation of § 56(f)(2)(I):
7
Example (1). Corporation A uses a calendar year for both
financial accounting and tax purposes. In 1986, A's finan-
cial statement included a $100 financial accounting loss for
a plant shutdown. A could not deduct the loss on its 1986
Federal income tax return. In 1987, A deducts the loss from
the 1986 plant shutdown in its 1987 Federal income tax
return. As a result, A's 1987 adjusted net book income
exceeds its 1987 pre-adjustment alternative minimum tax-
able income by $100 (an amount equal to the deduction for
the 1986 plant shutdown). Pursuant to paragraph (d)(4)(I) of
this section, A cannot make an adjustment to net book
income.
Temp. Treas. Reg. § 1.56-1T(d)(4)(v) (1987).
The Secretary asserts that the words "omission" or "duplication" in
§ 56(f)(2)(I) do not in any way require inclusion of timing differences
but rather are directed only to the elimination of miscalculations of
book income, for example, to prevent a corporation from excluding
or double counting an item in a way contrary to general accounting
principles. In contrast, CSX argues that Treasury Regulation 1.56-
1(d) is an impermissible interpretation of § 56(f)(2)(I) because it con-
flicts with the plain meaning of the statute, i.e. Congress directed that
the regulations "shall" prevent "the omission" of "any item," and "any
item" must include timing differences.
The fundamental problem with CSX's argument is that it seeks to
apply a deduction from taxable income to book income. Nothing in
the statute or its legislative history supports this interpretation. In fact,
the whole idea of an alternative minimum tax is that corporations with
many deductions from taxable income will pay taxes partially based
upon the "net income or loss of the taxpayer set forth on the taxpay-
er's applicable financial statement," or the taxpayer's "adjusted net
book income." 26 U.S.C.A. § 56(f)(2)(A) (West 1988). Thus, the stat-
ute provides for an alternative minimum tax based on a corporation's
"financial statement." Id. In the case of a timing difference the corpo-
ration's financial statement does not reflect a tax deduction, because
that deduction is included for financial accounting purposes in a dif-
ferent year. As such, there is no "omission" in the case of a timing dif-
8
ference, rather the deduction to taxable income is simply reflected in
a different year for financial accounting purposes.
Notwithstanding CSX's claims, the plain language of the statute
supports this conclusion. Section 56(f)(2)(I) directs establishment of
regulations "to prevent the omission . . . of any item." The dictionary
defines "omission" as "apathy toward or neglect of duty: lack of
action." Webster's Third New Int'l Dictionary 1574 (1993); see also
Black's Law Dictionary 1086 (6th ed. 1990) ("The neglect to perform
what the law requires."). The statute thus directs that regulations
ensure that corporations do not "neglect" items in calculating book
income. It does not, as CSX argues, require that the regulations pro-
vide for the addition or subtraction of various tax deductions from
"adjusted net book income," or change the definition of how to calcu-
late "adjusted net book income."
Moreover, § 56(f)(2)(A) defines "adjusted net book income" as
"the net income or loss of the taxpayer set forth on the taxpayer's
applicable financial statement, adjusted as provided in this
paragraph." 26 U.S.C.A. § 56(f)(2)(A) (emphasis added). Thus, the
statute itself establishes that any alterations to"adjusted net book
income" are to be determined by "this paragraph." Nothing in "this
paragraph" or anywhere else in § 56(f) requires alteration of "adjusted
net book income" to include timing differences. Certainly,
§ 56(f)(2)(I) does not suggest, let alone mandate, that "adjusted net
book income" be "adjusted" to include timing differences; the word
"omission" does not shrink or enlarge the statutory definition of "ad-
justed net book income." Instead, it requires regulations to ensure that
book income is calculated according to the statutory definition, with-
out any omissions or duplications.
Thus, the plain language of the statute does not lend support to the
claim that a timing difference is an "omission or duplication of any
item" that rightfully should be included in "adjusted net book
income." 26 U.S.C.A. § 56(f)(2)(I). Rather, the statute's language
simply states Congress's direction that regulations be established to
prevent corporations from miscalculating "adjusted net book income"
to omit or duplicate any item that would be included under the statu-
tory definition of book income.
9
The legislative history of § 56(f)(2)(I) also supports the Secretary's
interpretation. The Senate Report states that regulations under
§ 56(f)(2)(I) will be used "to prevent the recording of items directly
to the financial statement asset, liability, or equity accounts that are
properly included as items of financial statement income or expense."
S. Rep. No. 99-313, at 534. Congress thus voiced its concern that cor-
porations would hide book income in "asset, liability, or equity
accounts," and designed § 56(f)(2)(I) to ensure that these items not be
omitted from book income. Congress similarly foresaw that regula-
tions promulgated under § 56(f)(2)(I) would"require adjustments be
made to book income where the principles of this provision . . . would
be avoided through the disclosure of financial information through the
footnotes and other supplementary statements." H.R. Conf. Rep. No.
99-841, at II-274 (1986), reprinted in 1986 U.S.C.C.A.N. 4075, 4362.
Again, through § 56(f)(2)(I) Congress sought to prevent corporations
from "omitting" income by use of footnotes in their financial state-
ments.
Furthermore, the Secretary's interpretation is consistent with Con-
gress' stated purpose for enacting the alternative minimum tax. The
Senate Finance Committee explained that an alternative minimum tax
based on financial accounting concepts was necessary to "address
concerns of both real and apparent fairness . . . that whenever a com-
pany publicly reports substantial earnings . . . that company will pay
some tax." S. Rep. No. 99-313, at 520; see also id. at 518 (The "over-
riding objective" of the alternative minimum tax was "to ensure that
no taxpayer with substantial economic income can avoid significant
tax liability by using exclusions, deductions and credits."). Congress
was concerned with the "perception" of unfairness that arose in "in-
stances in which major companies have paid no taxes in years when
they reported substantial earnings, and may even have paid substantial
dividends to shareholders." Id. at 519. Hence, the alternative mini-
mum tax was designed to eliminate situations where corporations
show substantial financial or book income, and yet pay little or no
taxes because their taxable income is lowered by tax credits or deduc-
tions. Allowing corporations to include timing differences in calculat-
ing their adjusted net book income could create the exact problem
Congress sought to remedy: corporations reporting significant profits
in their financial statements could pay little or no taxes based on
losses reported in an earlier or later years' financial statements.
10
Finally, even if the plain language and legislative history of § 56(f)
did not require the Secretary's interpretation, they certainly did not
prohibit it. There can be little question that the Secretary's interpreta-
tion of the statute is at least permissible, and that alone is sufficient
to uphold Treas. Reg. § 1.56-1(d)(4). See Commissioner v. Portland
Cement Co., 450 U.S. 156, 169 (1981) ("Treasury Regulations ``must
be sustained unless unreasonable and plainly inconsistent with the
revenue statutes.'") (quoting Commissioner v. South Texas Lumber
Co., 333 U.S. 496, 501 (1948)).
III.
In addition to its statutory argument, CSX presses several other
contentions. They are equally unpersuasive.
The company maintains that "omission . . . of any item" must
include timing differences, because any other result overstates its
"book income" and thus its tax burden. What CSX fails to understand,
however, is that its book income for 1987 is not overstated without
the timing differences. In fact, to allow CSX to subtract the timing
differences from its 1987 book income would result in an impermissi-
ble "duplication," because each of these items were included in CSX's
financial earnings statements for another year. See 26 U.S.C.A.
§ 56(f)(2)(I). Thus, the items would literally be duplicated, because
they would be included in CSX's financial earning statements for one
year, and then again in CSX's financials in 1987 in order to calculate
"adjusted net book income" for that year. Far from requiring CSX's
interpretation, § 56(f)(2)(I), by authorizing the Secretary to formulate
regulations to prevent "duplication," actually compels precisely the
interpretation formulated by the Secretary in the challenged regula-
tion.
CSX also contends that the Secretary's position is inconsistent with
Example (5) of Treasury Regulation § 1.56-1(d)(4)(viii), which illus-
trates that a corporation owning 10 percent (or more) of the stock of
a foreign corporation must include in its book income the amount of
the "Subpart F" income realized by the foreign corporation. See 26
U.S.C.A. § 951 (West Supp. 1997) (defining"Subpart F" income).
Because "Subpart F" income is not typically included under account-
ing principles in a corporation's financial statement until a dividend
11
is received, CSX argues that this example establishes that "book
income" is not limited to a corporation's financial statement, and tim-
ing differences and other adjustments should be allowed to better
reflect true corporate earnings. The difficulty with this argument is
that Example (5) of Treasury Regulation § 1.56-1(d)(4)(viii) is explic-
itly required by the statute itself. See 26 U.S.C.A. § 56(f)(2)(C)(ii)
(West 1988); S. Rep. No. 99-313, at 532; Staff of the Joint Comm.
on Taxation, General Explanation of the Tax Reform Act of 1986 453
(1987). As noted above, there is no statutory requirement, or even
support, for adjusting for the timing differences at issue here, and
therefore Example (5) is readily distinguishable.
Finally, CSX relies on the extensive negative public comments
generated in response to Treasury Regulation § 1.56-1(d). These com-
ments only demonstrate that the regulation was unpopular, not imper-
missible. It is true that Congress' decision to pass the alternative
minimum tax stripped CSX of a tax benefit, but that does not change
the definition of "omission" or of "adjusted net book income."
IV.
For all of these reasons, the judgment of the district court is
REVERSED.
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