First Chicago Corp. v. C.I.R.

Decision Date16 March 1988
Docket NumberNo. 87-2028,87-2028
Citation842 F.2d 180
Parties-902, 88-1 USTC P 9244 FIRST CHICAGO CORPORATION, Petitioner-Appellee, v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellant.
CourtU.S. Court of Appeals — Seventh Circuit

Teresa E. McLaughlin, Dept. of Justice, Washington, D.C., for respondent-appellant.

John L. Snyder, Hopkins & Sutter, Chicago, Ill., for petitioner-appellee.

Before BAUER, Chief Judge, POSNER, Circuit Judge, and WILL, Senior District Judge. *

POSNER, Circuit Judge.

The government appeals from a decision by the Tax Court, 88 T.C. 663, holding that there is no minimum tax on tax-preference items until the items confer an actual benefit on the taxpayer. The facts are simple, their legal significance elusive.

In 1980 and 1981, First Chicago Corporation, the parent of the First National Bank of Chicago, had taxable income of $21 million and $39 million (we are rounding to the nearest million), on which income tax of $6 and $12 million would have been due had not First Chicago accumulated immense foreign tax credits. After applying these credits to the tax, First Chicago not only owed no tax in either year but had millions of dollars in credits left over to apply to income tax due in subsequent years. It also had large investment tax credits that it could have used in 1980 and 1981 but did not, instead carrying them forward along with the foreign tax credits for possible use in future years.

In figuring First Chicago's taxable income in 1980 and 1981, the Internal Revenue Service allowed certain deductions for what are called "tax preference items"--specifically, accelerated depreciation on real property, percentage depletion in excess of basis, and long-term capital gains. These deductions reduced First Chicago's taxable income by several million dollars in each year but did not save it any actual income tax in those years; its foreign and investment tax credits were so huge that even if it hadn't had the benefit of the tax-preference items it would have owed no tax. The only effect of the items was, by reducing the tax owed by First Chicago prior to use of the credits, to reduce the amount of those credits that it had to use up in 1980 and 1981 in order to eliminate all tax liability, and thus to increase--by a total of almost $11 million--the amount of those credits that it could use in future years. Whether or not First Chicago would ever use the extra credits to reduce its income tax was uncertain; that would depend on its taxable income in the years before the credits expired. Foreign tax credits, however, are usable for five years, see 26 U.S.C. Sec. 904(c), and investment tax credits for fifteen, see 26 U.S.C. Sec. 39(a)(1); and the parties stipulated that it was likely although not certain that First Chicago would eventually derive a tax benefit from the extra credits and thus indirectly from the 1980 and 1981 tax-preference items, though when and in what amount is uncertain; that would depend on its income in future years, on its deductions in those years, and on when the credits expire, and even on the last question the record is silent.

A section of the Internal Revenue Code passed in 1969, 26 U.S.C. Sec. 56(a), imposes a 15 percent tax on the taxpayer's tax-preference items (after certain deductions). This is the minimum tax. For taxable years after 1986 the Tax Reform Act of 1986 has replaced the minimum tax with the alternative minimum tax (a creature that first appeared in the Code in 1978, that existed concurrently with the minimum tax until 1986, and that now survives alone). The 1986 Act is not directly in issue in this case, although it may, as we shall see, have an indirect bearing.

The purpose of minimum tax (original or alternative) is to make sure that the aggregating of tax-preference items does not result in the taxpayer's paying a shockingly low percentage of his income as tax. Although one might think that the minimum tax fails in this purpose because First Chicago paid no income tax in 1980 or 1981 even though it had substantial income in both years, it paid no income tax only by virtue of having paid income tax to foreign countries, so it did not escape income taxation altogether. The Internal Revenue Service, however, decided that First Chicago should pay the minimum tax on the tax-preference items listed on its tax returns for 1980 and 1981 even though it had derived no tax benefit from those items in those years (thanks to its abundant tax credits) and may never do so, though probably it will do so some day. But the Tax Court, relying on a statute passed in 1976 which provides that the Treasury "shall prescribe regulations under which items of tax preference shall be properly adjusted where tax treatment giving rise to such items will not result in the reduction of the taxpayer's [federal income tax] for any taxable years," 26 U.S.C. Sec. 58(h), disagreed.

Standing alone--that is, without section 58(h)--section 56(a) would impose minimum tax on tax-preference items even though the items never conferred a tax benefit on the taxpayer. This would be a harsh and arbitrary result. The reason for minimum tax is to prevent the taxpayer from using tax-preference items to escape income taxation; and if the taxpayer saves not a penny in income tax, the imposition of minimum tax would be punitive and bear no relation to the objective of the minimum-tax program. The sparse legislative history as well as the text of section 58(h) indicates that this section was added in order to prevent these anomalous consequences. The committee reports give the example of an individual who has no taxable income because of deductions for accelerated depreciation on real property (a tax-preference item) but, since he has other deductions as well, actually derives less (or it could be no) tax benefit from the accelerated depreciation, yet may still be subject to minimum tax on it. S.Rep. No. 938, 94th Cong., 2d Sess. 113 (1976), U.S.Code Cong. & Admin.News 1976, pp. 2897, 3439. (The other committee reports are identical.) The example is puzzling; why doesn't the taxpayer take a smaller deduction for accelerated depreciation, to make sure he isn't claiming a tax preference (subject to the minimum tax) that is not generating any tax benefit for him? Who would claim a deduction that would increase his tax liability?

These and other questions might have been answered if the Treasury Department had ever gotten around to promulgating regulations under section 58(h), as ordered to do by Congress, but it never did, blaming its default on a staggering workload caused by the number of tax bills that Congress has enacted in recent years. See Occidental Petroleum Corp. v. Commissioner, 82 T.C. 819, 829 n. 6 (1984). The government might have been expected to, but does not, take the exceptionally hard line that since the Treasury never issued regulations under which items of tax preference "shall be properly adjusted" where the items yield no tax benefit to the taxpayer, section 58(h) is not in play at all, and First Chicago is exposed to the tender mercies of section 56(a), which imposes minimum tax on tax-preference items without regard to whether the taxpayer has ever benefited from the items or ever will. Instead the government concedes that section 58(h) is effective ex proprio vigore --that is, even without implementing regulations--but says that all it does is remove a tax-preference item from the minimum tax if the item never produces any reduction in the taxpayer's federal income tax, a condition negated here by the parties' stipulation.

The obvious objection to the government's position is that the determination whether the condition (no benefit, ever) has been satisfied cannot be made until the end of the period during which the tax-preference items might confer a tax benefit (here as long as fifteen years); and by that time the statute of limitations for seeking a tax refund, which is only two or three years, see 26 U.S.C. Sec. 6511(a), will have expired. To this the government replies, first, that it will be happy to stipulate to an extension of the statute of limitations in such cases. See 26 U.S.C. Secs. 6501(c)(4), 6511(c), (d)(3). And if it doesn't stipulate, there is some chance that the taxpayer might obtain relief under the mitigation provisions of the Code or the doctrine of equitable recoupment. See, e.g., Kolom v. United States, 791 F.2d 762 (9th Cir.1986). Alternatively, the taxpayer could bring a suit for refund before the statute of limitations expired but ask the court to stay its proceedings until the period in which the taxpayer might benefit from the tax-preference items had expired, although...

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