United States v. Foster Lumber Company, Inc

• Decision Date: 12 November 1975
• Docket Number: No. 74-799,74-799
• Citation: 97 S.Ct. 204,429 U.S. 32,50 L.Ed.2d 199
• Parties: UNITED STATES, Petitioner, v. FOSTER LUMBER COMPANY, INC
• Court: U.S. Supreme Court

50 L.Ed.2d 199

97 S.Ct. 204

429 U.S. 32

UNITED STATES, Petitioner,

v FOSTER LUMBER COMPANY, INC.

No. 74-799.

Argued Nov. 12, 1975.

Reargued Oct. 5, 1976.

Decided Nov. 2, 1976.

Syllabus

Section 172 of the Internal Revenue Code of 1954, as amended, provides that a "net operating loss" experienced by a corporate taxpayer in one year may be carried as a deduction to the preceding three years and the succeeding five years to offset taxable income of those years. The entire loss must be carried back to the earliest possible year and any of the loss not "absorbed" by that first year may then be carried to succeeding years, since "(t)he portion of such loss which shall be carried to each of the other taxable years shall be the excess, if any, of the amount of such loss over the sum of the taxable income for each of the prior taxable years to which such loss may be carried." § 172(b)(2). Proceeding under that provision respondent taxpayer carried back a net operating loss of some $42,000, which it had sustained in 1968, to 1966, in which year respondent had ordinary income of about $7,000 and a capital gain of about $167,000. After applying the "alternative tax" method of § 1201(a), which permits low capital gains taxation, respondent maintained that after subtracting the $42,000 loss deduction from the 1966 ordinary income, the negative balance of about $35,000 was still available to offset income for 1967, respondent taking the position that its 1968 loss had been "absorbed" in 1966 only to the extent of the $7,000 ordinary income. Respondent accordingly made a refund claim for the taxable year 1967, which the Commissioner disallowed but which the District Court upheld. The Court of Appeals affirmed. Held : In carrying back a net operating loss under § 172 to a year in which the taxpayer had both ordinary income and capital gains and employed the alternative tax computation method of § 1201(a), the loss deduction available for carryover to a succeeding year is the amount by which the loss exceeds the taxpayer's "taxable income" ordinary income plus capital gains for the prior year the loss carryover being "absorbed" by capital gains as well as ordinary income. Pp. 36-48.

(a) Absent any specific provision in the Code excluding capital gains from "taxable income," the Code's definitions of "taxable income" and gross income in §§ 63(a) and 61(a) require that both capital gain

and ordinary income must be included in the taxable income that § 172 directs must be offset by the loss deduction before any loss excess can be found available for transfer forward to the succeeding taxable year, and if Congress had intended to permit a loss deduction to offset only ordinary income when § 1201(a) is used, it could easily have said so. Pp. 36-41.

(b) The legislative history of the loss offset provisions does not support respondent's contention that they were designed to eliminate all consequences of the timing of the loss. Pp. 42-46.

(c) Had Congress intended substantially to eliminate timing accidents from the calculation of income on an average basis it would not have tolerated the departure from that purpose in § 172(c), under which a taxpayer cannot have a loss for a particular year unless its deductions exceed its ordinary income and its capital gains. Pp. 46-47.

8 Cir., 500 F.2d 1230, reversed.

Stuart A. Smith, Washington, D. C., for petitioner.

Russell W. Baker, Kansas City, Mo., for respondent.

Mr. Justice STEWART delivered the opinion of the Court.

Section 172 of the Internal Revenue Code of 1954, as amended, provides that a "net operating loss" experienced by a corporate taxpayer in one year may be carried as a deduction to the preceding three years and the succeeding five years to offset taxable income of those years.¹ The entire loss must be carried to the earliest possible year; any of the loss that is not "absorbed" by that first year may then be carried in turn to succeeding years. The respondent, Foster Lumber Co., sustained a net operating loss of some $42,000 in 1968, which it carried back to 1966. In 1966 the respondent had had ordinary income of about $7,000 and a capital gain of about $167,000. The question presented is whether a loss carryover is "absorbed" by capital gain as well as ordinary income or is instead limited to offsetting only ordinary income. The taxpayer filed a refund suit in Federal District Court challenging the Commissioner's disallowance of its claim that the $35,000 of the 1968 loss not used to offset its 1966 ordinary income survived to reduce its 1967 tax liability. The trial court and the Court of Appeals for the Eighth Circuit agreed with the taxpayer. We granted certiorari to resolve a Circuit conflict on a recurring question of statutory interpretation.²

I

The dispute in this case centers on the meaning of "taxable income" as used in § 172(b)(2) to govern the amount of carrybacks and carryovers that can be successively transferred from one taxable year to another. In relevant part, § 172(b)(2) requires the net operating loss to be carried in full to the earliest taxable year possible, and provides: "The portion of such loss which shall be carried to each of the other taxable years shall be the excess, if any, of the amount of such loss over the sum of the taxable income for each of the prior taxable years to which such loss may be carried." Thus when the loss has been carried back to the first year to which it is applicable, the loss "survives" for carryover to a succeeding taxable year only to the extent that it exceeds the taxable income of the earlier year. "Taxable income" is defined in § 63(a) of the Code to mean "gross income, minus the deductions al- lowed by this chapter." Gross income is in turn defined by § 61(a) of the Code as "all income from whatever source derived," and specifically includes "(g)ains derived from dealings in property." On its face the concept of "taxable income" thus includes capital gains as well as ordinary income. In the absence of a specific provision excluding capital gains,³ it thus appears that both capital gain and ordinary income must be included in the taxable income that § 172 directs must be offset by the loss deduction before any loss excess can be found to be available for transfer forward to the succeeding taxable year.

The respondent argues that the Code's prescribed method for calculating the taxes due on its taxable income conflicts with this natural reading of § 172. The Code provides two methods for computing taxes due on corporate income, and a corporation is under a statutory duty to employ the method that results in the lower tax. 26 U.S.C. § 1201(a). Under § 11, the "regular method," ordinary income and capital gains income are added together to produce taxable income; during the period at issue a 22% tax rate was then imposed on the first $25,000 of taxable income and the remainder was taxed at a 48% rate. Section 1201(a) of the Code prescribes the "alternative tax," calculated in two steps and applied when resulting in a lower tax liability for the corporation. The first step computes a partial tax on the taxable income reduced by the net long-term capital gain ⁴ at the regular corporate rates imposed by § 11. This step effectively subjects only ordinary income to the partial tax. The second step imposes a 25% tax on the net long-term capital gain. The alternative tax is the sum of the partial tax and the tax on capital gain. In practical terms, the alternative tax does not redefine taxable income, but it does result in a much lower effective tax rate for corporations whose income is in whole or substantial part composed of capital gain. It thus extends to corporations the long standing statutory policy of taxing income from capital gain at a lower rate than that applicable to ordinary income.

The problem from the respondent's point of view is that the mechanics of the alternative tax work in such a way that the potential benefit of the loss deduction may not be fully reflected in reduced tax liability for the taxable year to which the loss is carried. The problem arises when, as in 1966 for the respondent, the "alternative method" governs the calculation of tax liability, and the ordinary income effectively subject to the partial tax under the first step is less than the loss deduction subtracted from it. The Code does not permit the excess loss to be subtracted from the capital gain income before the second step is carried out.⁵ Under the alternative method, therefore, the tax benefit of the loss deduction is effectively lost for the carryover year to the extent that it exceeds the ordinary income in that year. This can be seen simply by considering the taxpayer's circumstances in this case. Subtracting the loss deduction of $42,203.12 from the 1966 ordinary income of $7,236.05 under Step 1 ⁶ resulted in a negative balance of $34,967.07; no partial tax was imposed and the 25% rate on the $166,634.81 of capital gains under Step 2 produced a tax of $41,658.70. If the loss deduction had been merely.$7,236.05, and thus exactly offset the.$7,236.05 of ordinary income, however, the tax due would still have been $41,658.70. The taxpayer therefore asserts that only.$7,236.05 of the loss deduction was actually "used" in 1966 and that $34,967.07 remained to be carried forward to reduce its tax liability in 1967.

There can be no doubt that if the "regular method" had been applicable to the respondent's taxes in 1966, the loss deduction ($42,203.12) would have been fully "used" to offset capital gains ($166,634.81) as well as ordinary income ($7,236.05), leaving $131,667.74 to be taxed, and a tax bill of $58,200.52. ⁷ It is clear that the alternative tax produced the lower tax liability despite the inability to fully "use" the loss deduction; the lower tax resulted directly from the favorable rate of taxation of capital gain income prescribed by the alternative method. The question is whether the two "tax benefit"...