DocketNumber: Docket No. 25316-82.
Citation Numbers: 49 T.C.M. 376, 1984 Tax Ct. Memo LEXIS 3, 1984 T.C. Memo. 668
Filed Date: 12/27/1984
Status: Non-Precedential
Modified Date: 11/20/2020
MEMORANDUM FINDINGS OF FACT AND OPINION
COHEN,
Year | Deficiency |
1974 | $41,112 |
1975 | 210,667 |
1976 | 30,711 |
1977 | 10,401 |
Respondent filed an amendment to his answer in which he determined an additional deficiency for the year 1976 in the amount of $9,716.64. After concessions by petitioner, the sole issue for decision is whether petitioner may deduct certain accrued workers' compensation liabilities in the years 1975, 1976, 1977, and 1978. *5 1
FINDINGS OF FACT
Some of the facts have been stipulated and are so found. The stipulation of facts and exhibits attached thereto are incorporated herein by this reference.
Petitioner is a corporation and had its principal office in Worthington, Ohio, at the time it filed its petition herein. It filed income tax returns for the years 1975, 1976, 1977, and 1978 with the Internal Revenue Service Center in Cincinnati, Ohio.
Petitioner manufactured steel castings and plastic parts for the automotive industry. During each of the years in issue, petitioner reported its income on the calendar year and utilized the accrual method of accounting.
Petitioner was an employer subject to the Ohio Workers' Compensation Law,
Petitioner contracted with several insurance companies to*6 limit its liability as a self-insured employer. Depending on the year of employee injury, these contracts indemnified petitioner from liability in excess of either $50,000 or $100,000 per employee as the result of any single event of disaster.
During the years in issue, the Watson-Hill Company (Watson-Hill), an actuarial consultant, administered petitioner's self-insurance workers' compensation program. Watson-Hill's duties included reporting to and representing petitioner before the Ohio Industrial Commission (hereinafter sometimes referred to as the Industrial Commission or the Commission), which administers the state workers' compensation law, paying claims, and reporting back to petitioner.
Watson-Hill also estimated the amount of petitioner's liability for workers' compensation payments. Watson-Hill determined the expected payments to each employee that the Industrial Commission declared to be permanently and totally disabled by multiplying the annual compensation ordered by the Commission by the employee's remaining life expectancy in years. For a surviving spouse, Watson-Hill multiplied the annual compensation ordered by the Commission by the remaining life*7 expectancy of the spouse. In computing expected payments to a dependent child, Watson-Hill multiplied the ordered compensation by the number of years remaining until the child's 18th birthday. Where petitioner was entitled to a partial refund from the state insurance fund because a pre-existing disease or condition contributed toward the employee's injury or death, Watson-Hill reduced the expected payments by the percentage of each payment that the state had agreed to reimburse petitioner.
To determine the remaining life expectancies of injured employees and surviving spouses, Watson-Hill utilized the Commissioners 1958 Standard Ordinary Mortality Table (1958 CSO). Compiled by the insurance carrier industry, the 1958 CSO was based upon the length of life of life insurance policy holders and was commonly used to determine life insurance premiums.
On its income tax returns for the years in issue, petitioner deducted accrued liabilities for workers' compensation payments to permanently and totally disabled employees and the dependents of deceased employees. The amount deducted with respect to each employee equaled the lesser of Watson-Hill's estimate of petitioner's unreimbursed*8 liability or petitioner's maximum remaining liability under the various insurance arrangements. With respect to all but two employees, this latter figure was lower than petitioner's initial uninsured liability because of payments made by petitioner prior to accrual.
Petitioner also claimed a deduction with respect to one employee who was only partially disabled. Petitioner concedes on brief that such deduction was excessive.
With one exception, petitioner reported the deductions in the year in which the Industrial Commission issued its orders. In the one exceptional case, petitioner deducted the accrued liability upon petitioner's agreement to make payments to an employee without a determination by the Commission.
With respect to two employees, petitioner contested the Commission's orders through state court mandamus actions in subsequent years. Petitioner now concedes that accruing deductions with respect to these two employees while contesting its liability was improper.
Respondent determined that petitioner's liability to make workers' compensation payments to permanently and totally disabled employees and the dependents of deceased employees was contingent*9 upon the happening of future events and that the amount of the liability could not be determined with reasonable accuracy. He therefore denied petitioner's accruals in full. The adjustments to petitioner's taxable income in respondent's statutory notice of deficiency equaled the difference between the amount accrued each year by petitioner and denied by respondent and the amount the Revenue Agent believed petitioner actually paid to the employees and their dependents in that year.
The following table lists, according to the year of deduction, each employee with respect to whom petitioner accrued a deduction that remains in issue; Watson-Hill's estimate of petitioner's unreimbursed liability to each employee; the related maximum remaining liability of petitioner under the insurance arrangements; and the amount actually deducted by petitioner.
Watson-Hill | Maximum Liability | ||
Employee | Estimate | With Insurance | Deduction |
1975 | |||
William Powers | $ 33,103 | $50,000 | $ 33,103 |
Claude Thompson | 6,831 | 50,000 | 6,831 |
John Bester | 95,458 | 24,851 | 24,851 |
Hazel Morton | 9,750 | 44,377 | 9,750 |
Joe Carroll | 117,470 | 33,618 | 33,618 |
Charles McDowall | 68,304 | 31,027 | 31,027 |
William Smith | 7,263 | 92,737 | 7,263 |
Billy Stiffler | 188,177 | 84,122 | 84,122 |
Wayne Neff | 101,978 | 88,360 | 88,360 |
Totals | $628,334 | $318,925 | |
1976 | |||
Charles Salyer | $ 29,081 | $87,812 | $ 29,081 |
Stewart Preece | 93,708 | 34,124 | 34,124 |
William Caldwell | 205,530 | 91,972 | 91,972 |
2 William Stafford | 41,531 | 91,945 | 41,531 |
Totals | $369,850 | $196,708 | |
1977 | |||
Francis Leonard | $146,906 | $25,606 | $ 25,606 |
328,557 | 91,945 | 48,698 | |
Totals | $475,463 | $ 74,304 | |
1978 | |||
Luther Bean | $ 87,498 | $83,509 | $ 60,509 |
Leroy Wiggins | 30,107 | 45,007 | 31,854 |
3 Leroy Wiggins | 115,728 | 83,078 | 40,540 |
Totals | $233,333 | $132,903 |
ULTIMATE FINDINGS OF FACT
All events that determined the fact of petitioner's liability to make workers' compensation payments with respect to the above employees had occurred in the years in which petitioner reported the deductions.
The amount of petitioner's liability was determinable with reasonable accuracy in the years in which petitioner reported the deductions.
OPINION
Both petitioner and respondent agree that workers' compensation payments to permanently and totally disabled employees and the dependents of deceased employees are ordinary and necessary expenses in carrying on a trade or business, deductible under section 162. 4 The issue before us is when such payments are deductible -- in the year in which the Ohio Industrial Commission ordered petitioner to make the statutory payments or in*11 the year in which petitioner actually makes the payments.
Section 461(a) requires that a taxpayer report a deduction in the taxable year that is proper under the method of accounting used in computing taxable income.
Under an accrual method of accounting, an expense is deductible for the taxable year in which all the events have occurred which determine the fact of the liability and the amount thereof can be determined with reasonable accuracy. * * * While no accrual shall be made in any case in which all of the events have not occurred which fix the liability, the fact that the exact amount of the liability which has been incurred cannot be determined will not prevent the accrual within the taxable year of such part thereof as can be computed with reasonable accuracy. * * *
This familiar "all events" test consists of two parts:
First, all events that determine the fact of liability*12 must have occurred as of the end of the year for which petitioner seeks to accrue the liability. * * * The second requirement is that as of the end of the year for which petitioner seeks to accrue the liability, petitioner must be able to estimate with reasonable accuracy the amount of the expenditure to be made in the subsequent year. * * * [
To prevail on the issue before us, petitioner must prove that the accruals for workers' compensation satisfy both requirements of the all events test. See
Respondent argues that petitioner has failed to satisfy this first prong of the all events test because petitioner's liability for workers' compensation payments was subject to various contingencies. He notes the possibilities that the recipients of the payments might die before receiving the full amounts accrued by petitioner; that dependent spouses*13 might remarry; that the Ohio Industrial Commission or a state court might subsequently reduce petitioner's liability; and that petitioner might be declared entitled to receive reimbursement from the state insurance fund subsequent to the year in which the Industrial Commission issued its order for payment in a particular case.
Under Ohio law, the occurrence of any one of the above events may terminate or reduce in amount an employer's liability to make workers' compensation payments. Compensation to a permanently and totally disabled employee or to the surviving dependent spouse of a deceased employee is payable only until the death of the employee or spouse. Although an employer generally is obligated to make payments to a dependent child until the child reaches 18 years of age, the employer's obligation similarly terminates upon the death of the child. If a surviving dependent spouse remarries, the spouse is entitled to a lump sum payment equal to 2 years of biweekly compensation payments, but the employer is relieved of liability for any further payments.
This Court considered the effect of potential beneficiary death and spousal remarriage upon the fact-of-liability determination in
In concluding that the taxpayer's liability was fixed as defined in the regulation despite the possibilities of death or remarriage, we distinguished
In
*17
In the present case, petitioner's obligation to make workers' compansation payments to its permanently and totally disabled employee and the dependents of its deceased employees was fixed in the years in which petitioner reported the deductions. The orders of the Ohio Industrial Commission were the culmination of an elaborate administrative procedure for determining employer liability. See
Although in
Respondent does not attempt to distinguish
The Supreme Court cases relied upon by respondent fall into two general fact patterns. In the first group, the taxpayer accrued the deduction while contesting the liability. See
With respect to the deductions remaining in issue, respondent does not contend that petitioner contested its liability to make workers' compensation payments after accrual of the deduction. Petitioner reported the accruals only in the year in which either petitioner entered into an agreement with the disabled employee or the Industrial Commission ordered petitioner to make payments. The line of "contested liability" cases is thus inapplicable to the present case.
In the second line of cases cited by respondent, an accrual basis taxpayer received a gross amount of income that might be reduced upon the occurrence of subsequent events. See
Our opinion in
*24 Respondent also contends that
The taxpayer in
*25 In denying the taxpayer's deduction, we noted that the taxpayer "was under no obligation to make any payment unless an overhaul was actually performed" and that "[u]ntil an * * * [aircraft] has flown the applicable number of flight-hours, no obligation to overhaul arises."
Petitioner's argument assumes that liabilitiy is fixed in the year of accrual. The pertinent question is not whether the contingency defeating liability occurs after the year of accrual, but whether it occurs after the time when liability is fixed. The term "condition subsequent" refers to an occurrence which might diminish or terminate an existing liability. Such a contingency would not necessarily prevent a fixed liability from being properly accrued.
* * * The occurrences of any of these contingencies [in the present case], however, would not relieve petitioner of an
*27 does not provide a workable standard for characterizing contingencies. He asserts that the conditions in the present case could easily be characterized as conditions precedent. For example, respondent states: "A disabled employee or a survivor of a decedent must be alive before petitioner is required to pay them."
While we do not doubt that it is possible to clothe a condition subsequent in language normally associated with conditions precedent, the true nature of the condition is unaffected by such a superficial recharacterization. Despite the language used by respondent, petitioner's liability came into existence upon the orders of the Industrial Commission. Death of the beneficiaries, as well as the other conditions in the present case, is an event which would subsequently terminate that liability. As
We find the distinction between conditions precedent and conditions subsequent to be a most logical interpretation of the fact-of-liability requirement.With respect to this first*28 prong of the all events test,
*29 Respondent's regulation provides a two-part test and clearly distinguishes between the fact of liability and payment on the liability. As long as the liability exists in the year of accrual, uncertainty as to the amount of ultimate payment is irrelevant for purposes of the first requirement of the all events test. 8
We note that our holding herein that the orders of the Ohio Industrial Commission (and petitioner's agreement to make payments, in the one exceptional case) fixed petitioner's liability is significantly narrower than the decision of the Ninth Circuit Court of Appeals in
Although petitioner has satisfied the first requirement for accrual of a deduction, petitioner must also prove that the amount of workers' compensation liability could, at the end of the years of accrual, be determined with reasonable accuracy.
Where a deduction is properly accrued on the basis of a computation made with reasonable accuracy and the exact amount is subsequently determined in a later taxable year, the difference, it any, between such amounts shall be taken into account for the latter taxable year*32 in which such determination is made.
"The question of whether the amount of liability can be determined with reasonable accuracy is a question which must be resolved by the trial court upon evidence presented in the trial court."
Based on the evidence presented herein, we find the present case indistinguishable from
Respondent asserts that various factors prevented petitioner from computing the amount of its liability with reasonable accuracy. He first argues that the orders of the Ohio Industrial Commission might be modified, and petitioner's liability reduced, by subsequent decisions of the Commission or a state court. Respondent further argues that the 1958 CSO did not produce reasonably accurate life expectancies of disabled employees and surviving spouses because the table reflected the expected lives of insurance policy owners, "a group of relatively affluent individuals of average health," and because the table ignored "differences in life expectancy caused by racial or sexual differences." With respect to disabled employees, respondent contends that the various disabilities will probably shorten the employees' lives. With respect to surviving spouses, respondent notes that Watson-Hill made no adjustment for the possibility of remarriage, which would terminate petitioner's liability to make periodic payments.
We*34 conclude that petitioner has satisfied its burden of proof on this issue. At trial petitioner called three witnesses -- James R. Hagans, president of Watson-Hill and experienced in Ohio workers' compensation procedures, James B. Hughes, Jr., vice president of the firm that became petitioner's actuarial consultant beginning in 1980, and Robert James Finger, an expert in actuarial science. The testimony of each of these witnesses supports the accuracy of the amounts accrued by petitioner and provides specific evidence to rebut respondent's assertions. Respondent, by contrast, presented virtually no evidence in support of his contentions.
The evidence of record contradicts respondent's assertion that the possibility of the Ohio Industrial Commission or a state court reducing petitioner's liability subsequent to the year of accrual precluded petitioner from calculating the amount of its liability with reasonable accuracy. Hagans testified that Watson-Hill made no adjustment to petitioner's estimated liability for a possible redetermination by the Commission because he "had never seen" the Commission make a redetermination. Hagans further stated that the determination of*35 an employer's entitlement to reimbursement from the state fund (due to the employee's suffering from a pre-existing condition) almost always occurs before the Industrial Commission issues its order. 9 Although petitioner could have challenged the Commission's orders in state court and thereby possibly reduced its liability, the mere existence of this avenue of appeal did not render uncertain petitioner's liability as ordered by the Commission in cases where petitioner did not further contest its liability.
Hagans, Hughes, and Finger all testified that use of the 1958 CSO produced a reasonably accurate estimate of petitioner's liability. Hughes stated that the life expectancy table used by his firm prior to*36 1980 produced higher life expectancy values than the 1958 CSO.
Respondent's speculation concerning the effect of disability upon life expectancy is unsupported by the record. Hagans testified that the injuries suffered by the employees in the present case would probably have little effect upon life expectancies. Finger prepared for the State of Ohio a table of life expectancies of persons declared permanently and totally disabled. The remaining life expectancy of an individual age 31 years was only 4 years lower in Finger's table than in the 1958 CSO, and this differential between the two tables decreased with the individual's age.
Moreover, Hagans testified that where a disabled employee dies of causes related to the injury, the chances of the employee's dependents successfully asserting a death claim would be "very, very strong." Thus the premature death of an employee might merely result in petitioner making payments to the dependents instead of the employee. Cf.
We held in
The insurance arrangements carried by petitioner support the accuracy of petitioner's accruals with respect to the other beneficiaries as well. During the 4-year period in issue, Watson-Hill's estimates totaled $1,706,980, whereas the insurance contracts limited petitioner's deductions to a total of $722,840. The insurance arrangements thus substantially limited petitioner's liability and rendered the amount of liability estimable with reasonable accuracy.
Because petitioner introduced evidence in support of the accuracy of those estimates, respondent cannot prevail merely by asserting that petitioner could have computed the estimates with greater accuracy. Respondent must present evidence of his own indicating that the amounts deducted by petitioner would have been significantly different had petitioner utilized a "more accurate" method of estimation. Respondent did not attempt to do this in the present case.
Respondent raises several arguments which indicate*39 his dissatisfaction with the accrual method of tax accounting. Respondent asserts, for example, that petitioner has attempted to deduct a reserve and that "[i]n the absence of specific statutory authorization, federal income tax deductions for reserves for future liability are not permitted." We agree that a taxpayer may not deduct estimated future expenses for which liability does not exist. See, e.g.,
Respondent similarly asserts that petitioner did not actually set aside money in a sinking fund and that the full amounts accrued by petitioner have not yet been paid. Although respondent's assertions are accurate, these facts do not preclude accrual under the all events test. Indeed, the separation in time of the deduction of*40 an expense and its actual payment is an inherent characteristic of the accrual method of accounting.
We note that Congress has recently amended section 461 to accord with respondent's views. 10 Congress did not, however, make the amendment retroactive to the years in issue. Tax Reform Act of 1984, Pub. L. 98-369, sec. 91(g), 98 Stat. 494, 608. The legislative history surrounding the amendment indicates that Congress intended to
The courts generally have held that the length of time between accrual and performance does not affect whether an amount is properly accruable. * * *
* * *
The committee believes that the rules relating to the time for accrual of a deduction by a taxpayer using the accrual method of accounting should be changed to take into account the time value of money. * * * [S. Rept. No. 169, 98th Cong., 2d Sess. 265, 266 (1984); H. Rept. No. 432, 98th Cong., 2d Sess. 1253, 1254 (1984).]
*41
1. The deduction for 1978 is in issue because of a claimed net operating loss carryback to 1975.↩
2. In 1976 the Ohio Industrial Commission ordered petitioner to make payments to one of Stafford's daughters. In 1977 the Commission ordered petitioner to make payments to Stafford's widow and a second daughter. ↩
3. Wiggins suffered two separate injuries for which the Industrial Commission entered separate orders for permanent and total disability payments.↩
4. Unless otherwise indicated, all statutory references are to the Internal Revenue Code of 1954, as amended and in effect during the years in issue.↩
5. In
6. Although
7.
8. Preserving the distinction between the two requirements of the all events test also properly precludes the taxpayer from accruing a deduction where the fact of liability is not yet established, although the taxpayer can estimate with reasonable accuracy future payments that will occur after the liability is fixed. See
9. According to Hagans, Ohio law does not mandate that the reimbursement determination be made before the order of the Industrial Commission. Hagans testified, however, that his clients' interest in maximum cash flow necessitated Watson-Hill's securing reimbursement from the state as early as possible. Moreover, with respect to the accruals in issue, there is no evidence of the reimbursement determination ever being made after the order of the Commission.↩
10. In the Tax Reform Act of 1984, Pub. L. 98-369, sec. 91(a), 98 Stat. 494, 598, Congress added sec. 461(h) to the Code, which provides in pertinent part:
(h) Certain Liabilities Not Incurred Before Economic Performance.--
(1) In general.--For purposes of this title, in determining whether an amount has been incurred with respect to any item during any taxable year, the all events test shall not be treated as met any earlier than when economic performance with respect to such item occurs.
(2) Time when economic performance occurs.--Except as provided in regulations prescribed by the Secretary, the time when economic performance occurs shall be determined under the following principles:
* * *
(C) Workers compensation and tort liabilities of the taxpayer.--If the liability of the taxpayer requires a payment to another person and--
(i) arises under any workers compensation act, or
(ii) arises out of any tort,
economic performance occurs as the payments to such person are made. * * *↩
Rca Corporation v. United States , 664 F.2d 881 ( 1981 )
Lukens Steel Company v. Commissioner of Internal Revenue , 442 F.2d 1131 ( 1971 )
Harrold v. Commissioner of Internal Revenue. Cromling v. ... , 192 F.2d 1002 ( 1951 )
Bennett Paper Corporation and Subsidiaries v. Commissioner ... , 699 F.2d 450 ( 1983 )
Trinity Construction Co., Inc. v. United States , 424 F.2d 302 ( 1970 )
Henry Hilinski v. Commissioner of Internal Revenue, Steven ... , 237 F.2d 703 ( 1956 )
Commissioner v. Milwaukee & Suburban Transport Corp. , 367 U.S. 906 ( 1961 )
Brown v. Helvering , 54 S. Ct. 356 ( 1934 )
Security Flour Mills Co. v. Commissioner , 64 S. Ct. 596 ( 1944 )
Schulde v. Commissioner , 83 S. Ct. 601 ( 1963 )
Kaiser Steel Corporation v. United States , 717 F.2d 1304 ( 1983 )
Crescent Wharf & Warehouse Company v. Commissioner of ... , 518 F.2d 772 ( 1975 )
wien-consolidated-airlines-inc-formerly-wien-alaska-airlines-inc-v , 528 F.2d 735 ( 1976 )
Supermarkets General Corp. v. United States , 537 F. Supp. 759 ( 1982 )
Dixie Pine Products Co. v. Commissioner , 64 S. Ct. 364 ( 1944 )
Lucas v. American Code Co. , 50 S. Ct. 202 ( 1930 )
Thor Power Tool Co. v. Commissioner , 99 S. Ct. 773 ( 1979 )
Commissioner v. Hansen , 79 S. Ct. 1270 ( 1959 )
American Automobile Assn. v. United States , 81 S. Ct. 1727 ( 1961 )