Eastman Kodak Co. v. United States

• Decision Date: 14 April 1976
• Docket Number: No. 517-71.,517-71.
• Citation: 534 F.2d 252
• Parties: EASTMAN KODAK COMPANY v. The UNITED STATES.
• Court: U.S. Claims Court

534 F.2d 252

EASTMAN KODAK COMPANY v. The UNITED STATES.

No. 517-71.

United States Court of Claims.

April 14, 1976.

COPYRIGHT MATERIAL OMITTED

Karl R. Price, Washington, D.C., Attorney of record for plaintiff. Ivins, Phillips & Barker, Washington, D.C., of counsel.

Kenneth R. Boiarsky, Washington, D.C., with whom was Asst. Atty. Gen. Scott P. Crampton, Washington, D.C., for defendant. Gilbert E. Andrews, Washington, D.C., of counsel.

Before COWEN, Chief Judge, DURFEE, Senior Judge, and DAVIS, SKELTON, KASHIWA, KUNZIG and BENNETT, Judges, en banc.

OPINION

KUNZIG, Judge.

This income tax refund case comes before the court on appeal from the Trial Division where findings and an opinion were filed April 1, 1975 by Trial Judge George Willi, pursuant to Rule 134(h). His decision has been reviewed on the briefs, exceptions, and oral argument of counsel. Upon consideration thereof, the court finds itself in agreement with portions of that recommended decision and reaches essentially the same result on major sections of the case, although we base our opinion on somewhat different legal reasoning. Most of the Trial Judge's findings of fact are adopted, but with some modifications we deem proper upon consideration of exceptions by the parties.

Plaintiff and defendant contest the proper timing for plaintiff's deduction of payroll tax expenses. Plaintiff is an accrual basis taxpayer using calendar year reporting periods. The tax expenses arose in connection with three different types of compensation payments made to plaintiff's employees in 1965: (1) "year-end" wages, (2) bonuses, and (3) vacation pay. Plaintiff attempts to deduct such tax expenses in 1964, the year that the underlying compensation obligations accrued. Defendant asks us to conclude that plaintiff could not deduct the tax expenses until this underlying compensation was actually paid in 1965. The classic "all events" test¹ must be applied in the instant case to determine the proper timing for plaintiff's tax expense deductions. Applying this test, we hold that plaintiff may deduct in its 1964 return those taxes corresponding to the "year-end" wages accrued in 1964, but plaintiff may not deduct payroll taxes on accrued bonuses and vacation pay until its 1965 return.

The payroll tax expenses at issue here involve Kodak's payments under the Federal Insurance Contributions Act (FICA),² the Federal Unemployment Tax Act (FUTA),³ and various state unemployment taxes.⁴

The compensation paid by plaintiff which gave rise to the taxes and, thus, the tax expense deductions involved in the instant action, takes three forms. The first type is "year-end" wages. Wages earned during the last week of 1964 "accrued" as of the end of 1964, but were not paid until the first week of 1965. Kodak wants to deduct the payroll taxes on such "year-end" accrued wages in 1964.

Second, at the end of each year, plaintiff declared cash bonuses in favor of its employees. The right to receive this special compensation vested in employees at the end of 1964, but the bonuses were not payable until March 1965. Again, plaintiff desires a 1964 tax expense deduction. Since liability accrued in 1964, reasons plaintiff, the liability for tax should similarly accrue and yield a 1964 payroll tax expense deduction.

Third, as of the end of 1964, various of plaintiff's employees had earned the right to paid vacations to be taken in 1965. An employee's right to vacation pay vested in 1964 despite the fact that payment would not take place until the following year. Again, since plaintiff's liability for the vacation pay accrued in 1964, it would like to deduct the corresponding payroll tax expense on its 1964 return.

Both parties agree that plaintiff properly accrued and deducted the three types of compensation at the time its liability for the payments became fixed in 1964. They disagree on the proper year for deducting the payroll tax payments made to Government agencies as a result of the compensation payments. Plaintiff argues that its liability for all three types of compensation accrued in 1964, and the tax payments should be deducted in the same return.

The Internal Revenue Service (IRS) concluded that plaintiff was not entitled to deduct the payroll tax expense on the 1964 tax return and assessed a deficiency. Plaintiff paid the deficiency, filed a refund claim and by timely petition in this court, brought the present action after the IRS disallowed the claim.

Kodak makes a "five prong" assault on defendant's denial of the 1964 payroll tax expense deductions. First, since it consistently matched wage expense and payroll tax expense without challenge by the IRS during prior years, plaintiff claims that defendant cannot now complain of its tax accounting treatment of the payroll tax expenses. Second, Kodak contends the generally accepted principles of accounting should be adopted in this case. The payroll tax expenses which arise from the wages should be "matched" with the wages for tax accounting purposes. Third, the matching and allocation principles enumerated in J. I. Case Co. v. United States, 65 F.Supp. 464, 106 Ct.Cl. 267 (1946) are, according to plaintiff, applicable in the present case to grant it a 1964 deduction. Fourth, Kodak relies upon the "all events" test to claim 1964 deductions for the payroll taxes at issue here. Finally, plaintiff claims that it will be the victim of a double denial of the payroll tax expenses at issue here if defendant's position is upheld.⁵

Of all five arguments, only number four, Kodak's advocacy of the "all events" test, is applicable here.

First, despite the fact that plaintiff has consistently matched compensation and the related payroll taxes in its tax accounting, it cannot assert any right to continue such treatment from the mere failure of the IRS to challenge such practice in past years. At best, plaintiff's consistency is inconclusive. Electric & Neon, Inc. v. Commissioner of Internal Revenue, 56 T.C. 1324, 1333 (1971); Mifflin v. Commissioner of Internal Revenue, 24 T.C. 973, 979 (1955). Plaintiff must show not only that its treatment of the payroll tax expenses has been consistent, but also that it is correct.

Plaintiff's second argument, that generally accepted principles of accounting favor matching the compensation and the payroll tax may be sound from a business accounting standpoint. However, tax accounting differs in many material respects from business accounting. One such area of divergence is the "matching" principle which plaintiff urges upon us in this case. Cf. American Automobile Association v. United States, 367 U.S. 687, 694-97, 81 S.Ct. 1727, 1730-32, 6 L.Ed.2d 1109, 1113-15 (1961). To obtain a deduction, plaintiff must show that tax accounting principles, not business practice, require such treatment.

We also cannot give credence to plaintiff's third argument, that the principles of J. I. Case Co., supra, create a 1964 payroll tax deduction in this instance. In Case we held that the taxpayer could deduct property taxes allocable to a short fiscal year since the taxpayer's income could not otherwise be accurately reflected. However, Case stemmed primarily from the nature of the taxpayer's short and nonrecurring fiscal year. We do not have such a situation in the facts at bar, and hold J. I. Case Co. inapposite.

Plaintiff's fourth argument, that the "all events" test applies to the instant facts to give a 1964 deduction, while not technically correct in all respects, is more true to the mark. Here Kodak has hit upon the proper test, but would have us apply that test in a legally erroneous manner.⁶

A tax which accrues in an earlier year but is not paid until the following year may be deducted in the prior year if it meets the "all events" test established by the Supreme Court in United States v. Anderson, 269 U.S. 422, 46 S.Ct. 131, 70 L.Ed. 347 (1926). If all events which determine liability and fix the amount of the tax occur before the end of the prior year, a deduction is available to an accrual basis taxpayer.

In a technical legal sense it may be argued that a tax does not accrue until it has been assessed and becomes due; but it is also true that in advance of the assessment of a tax, all the events may occur which fix the amount of the tax and determine the liability of the taxpayer to pay it. In this respect, for purposes of accounting and ascertaining true income for a given accounting period, the munitions tax in question here did not stand on any different footing than other accrued expenses appearing on appellee's books. Id. at 441, 46 S.Ct. at 134, 70 L.Ed. at 351. (Emphasis added).

The "all events" test has been applied frequently and regularly in this court and other jurisdictions to determine proper timing for tax expense deductions. See, e. g., United States v. Consolidated Edison Co., 366 U.S. 380, 385 n. 5, 81 S.Ct. 1326, 1329, 1330, 6 L.Ed.2d 356, 360 (1961); Clevite Corp. v. United States, 386 F.2d 841, 843, 181 Ct.Cl. 652, 658 (1967); Turtle Wax, Inc. v. Commissioner of Internal Revenue, 43 T.C. 460, 466-67 (1965); Denver & Rio Grande Western Railroad Co. v. Commissioner of Internal Revenue, 38 T.C. 557, 572 (1962). Most recently, we applied the "all events" test in Union Pacific Railroad Co. v. United States, 208 Ct.Cl. ___, 524 F.2d 1343 (1975).⁷ We held that the test applied to determine deductibility of payroll taxes, similar to those in the instant case, which stemmed from accrued vacation pay. In Union Pacific we concluded that plaintiff was not entitled to deduct payroll taxes in the earlier year because "all events" fixing liability for the tax had not occurred in this prior year. It must be reemphasized that we used the "all events" test to reach this result.

The "all events" test has become so accepted that it is now embodied in the Income Tax Regulations.

Under an accrual method of accounting, an expense is deductible for the taxable year in which all events have occurred

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