Ford Motor Co. v. Comm'r of Internal Revenue, 14949–91.

CourtUnited States Tax Court
Writing for the CourtWELLS
Citation102 T.C. No. 6,102 T.C. 87
PartiesFORD MOTOR COMPANY and Affiliated Companies, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent.
Docket NumberNo. 14949–91.,14949–91.
Decision Date31 January 1994

102 T.C. 87
102 T.C. No. 6

FORD MOTOR COMPANY and Affiliated Companies, Petitioners
v.
COMMISSIONER OF INTERNAL REVENUE, Respondent.

No. 14949–91.

United States Tax Court.

Jan. 31, 1994.


[102 T.C. 88]

John S. Nolan, Washington, DC, Loren M. Opper and Monika D. Hajek, Dearborn, MI, for petitioners.

Reid M. Huey, Indianapolis, IN, and Nancy B. Herbert, Washington, DC, for respondent.

OPINION
WELLS, Judge:

Respondent determined a deficiency in petitioners' Federal income tax for the 1970 taxable year in the amount of $3,300,151. Petitioners are hereinafter collectively referred to as petitioner. The deficiency is based on respondent's disallowance of a portion of the deductions claimed by petitioner with respect to obligations it incurred under “structured settlements” it reached in 1980 1 with tort claimants.2 Petitioner claims deductions for the accrual of the total future payments to the tort claimants under the structured settlements. Respondent determined that petitioner's accrual of such payments does not clearly reflect income. The issue we must decide is whether respondent's determination is an abuse of discretion. The parties also presented extensive arguments on the issue of whether the obligations for which petitioner claims deductions have met the all events test required by the regulations for the accrual of deductions. We do not address those arguments because of our holding below that respondent's determination was not an abuse of discretion, even if it is assumed that the all events test is met.

The parties submitted the instant case fully stipulated. At the time it filed the petition in the instant case, petitioner's

[102 T.C. 89]

principal place of business was Dearborn, Michigan. Petitioner is engaged in a number of businesses, including the manufacturing of automobiles. Petitioner maintains its books and records and files its income tax returns using the accrual method of accounting.

During 1980, petitioner entered into approximately 20 “structured settlement” agreements resolving various personal injury or accidental death claims. The claimants were persons and survivors of deceased persons (tort claimants) whose injuries or deaths were allegedly the result of motor vehicle accidents caused by defective vehicles manufactured by petitioner. The settlement agreements provide for payments totaling $24,477,699 to be paid out over various periods, the longest of which is 58 years. Petitioner purchased single premium annuity contracts from various insurance companies with respect to all structured settlements it executed with the tort claimants during 1980. The total cost of the premiums for the annuity contracts was $4,424,587.3 The annuity contracts were structured so that yearly annuity payments to be received under the annuity contracts would equal the yearly amount of the deferred payments owed to the tort claimants under the structured settlement agreements. Some of the settlement agreements required petitioner to purchase annuities. None of the settlement agreements, however, released petitioner from liability with respect to the deferred payments. Petitioner remained the owner of all the annuity contracts, and, in the event the issuer defaulted, petitioner would be required to pay the remaining balance of the deferred payments owed to the tort claimants.

A stipulated summary of the structured settlements is attached to this opinion as appendix A. The summary shows that petitioner's obligations to the tort victims were of three general types under the structured settlements. “Type I Settlements” provided for periodic payments to be made for a period certain. “Type II Settlements” provided for periodic payments to be made for the duration of the claimant's life.

[102 T.C. 90]

“Type III Settlements” contain elements of both Type I and II Settlements by providing for periodic payments to be made for a period certain, and thereafter, for the duration of the claimant's life.

On its 1980 return, petitioner claimed deductions for the various types of settlements as follows: 4 Type I Settlements—the total amount of the periodic payments; Type II Settlements—the amounts it actually paid during 1980; Type III Settlements—the total amount of payments for the period certain portion. In its amended petition, petitioner claims a deduction in 1980 for the total amounts paid or to be paid to the tort claimants under Type I, Type II, and Type III settlement agreements. As a result, petitioner claims that the proper amount of the deduction taken in 1980 should be increased to $24,477,699 from $10,636,994. In the notice of deficiency, respondent allowed total deductions of $4,259,464.

The parties stipulated that the present value of petitioner's total future obligations to the tort claimants does not exceed the amounts petitioner paid for the annuity contracts. A stipulated summary is attached as appendix B, which outlines: (1) The amount of the deduction allowed in the notice of deficiency; (2) the amount of the deduction claimed by petitioner on its 1980 return; (3) the amount of petitioner's increased claim; and (4) the amount that remains in dispute.

For financial purposes, petitioner reported the structured settlements as follows: (a) Settlements for a period certain or for the remainder of the claimant's life, when funded by an annuity 5—the cost of the annuity was expensed in the year of settlement; (b) settlements for the remainder of the claimant's life, when not funded by an annuity—the present value of the total payments for the projected life was expensed in the year of settlement; (c) settlements for a period certain, when not funded by an annuity—the present value of the total of the payments would be expensed in the year of settlement; (d) settlements not funded by annuities—the yearly

[102 T.C. 91]

incremental change in the present value of the outstanding liability would be expensed each year as interest. For financial reporting purposes, petitioner did not create a reserve for amounts paid or projected to be paid to claimants under the 1980 structured settlement agreements.

We must decide whether respondent's determination is an abuse of discretion. Respondent's position is that petitioner's accrual does not clearly reflect income and that its deduction should be limited to the cost of the annuity contracts, an amount which does not exceed the present value of such future payments. Petitioner claims that it is entitled to accrue for tax purposes the total future payments under its obligations to the tort claimants. Essentially, respondent would limit petitioner's deduction to the amounts petitioner expensed on its books for financial purposes for the year in issue.

Section 446(b) 6 vests the Commissioner with broad discretion in determining whether a particular method of accounting clearly reflects income. RLC Industries Co. v. Commissioner, 98 T.C. 457, 491 (1992); Capitol Federal Savings & Loan Association v. Commissioner, 96 T.C. 204, 209 (1991); Prabel v. Commissioner, 91 T.C. 1101, 1112 (1988), affd. 882 F.2d 820 (3d Cir.1989). The Commissioner's determination is entitled to more than the usual presumption of correctness. RLC Industries Co. v. Commissioner, supra at 491; RECO Industries, Inc. v. Commissioner, 83 T.C. 912, 920 (1984); Peninsula Steel Products & Equip. Co. v. Commissioner, 78 T.C. 1029, 1044 (1982). Accordingly, respondent's interpretation of the “clear reflection standard [of section 446(b) ] ‘should not be interfered with unless clearly unlawful.’ ” Thor Power Tool Co. v. Commissioner, 439 U.S. 522, 532 (1979) (quoting Lucas v. American Code Co., 280 U.S. 445, 449 (1930)). The taxpayer bears “a heavy burden of [proof],” and the Commissioner's determination “is not to be set aside unless shown to be ‘plainly arbitrary.’ ” Thor Power Tool Co. v. Commissioner, supra at 532–533 (quoting Lucas v. Structural Steel Co., 281 U.S. 264, 271 (1930)).

The issue of whether the taxpayer's method of accounting clearly reflects income is a question of fact to be determined

[102 T.C. 92]

on a case-by-case basis. See Pacific Enterprises & Subs. v. Commissioner, 101 T.C. ––––, –––– (1993) (slip op. at 19); RLC Indus. Co. v. Commissioner, supra at 489; Hamilton Indus., Inc. v. Commissioner, 97 T.C. 120, 128–129 (1991); RECO Indus., Inc. v. Commissioner, supra at 920; Peninsula Steel Products & Equip. Co. v. Commissioner, supra at 1045; Sam W. Emerson Co. v. Commissioner, 37 T.C. 1063, 1067 (1962). In Capitol Federal Savings & Loan Association v. Commissioner, supra at 213, we stated:

In reviewing the Commissioner's actions, however, we do not substitute our judgment for the Commissioner's, nor do we permit taxpayers to carry their burden of proof by a mere preponderance of the evidence. Taxpayers are required to clearly show that the Commissioner's action was arbitrary, capricious, or without sound basis in fact. [Citations omitted].

In reviewing the Commissioner's determination that the taxpayer's method of accounting does not clearly reflect income, the function of a court is to determine whether there is any adequate basis in law for the Commissioner's conclusion. RCA Corp. v. United States, 664 F.2d 881, 886 (2d Cir.1981); Louisville & N. R.R. Co. v. Commissioner, 641 F.2d 435, 439 (6th Cir.1981) affg. in part, revg. in part and remanding 66 T.C. 962 (1976). Consequently, for petitioner to prevail, it must prove that respondent's disallowance of petitioner's deductions beyond the amounts petitioner paid to purchase the annuity contracts is arbitrary and capricious and without sound basis in fact or law.

Before we turn to the parties' arguments, a simple illustration will help frame the issue and highlight the distortion about which respondent complains. For our illustration, we take the numbers from Settlement Agreement A, set forth in appendix A, which provides for the claimant to be paid $504,000 in 42 equal, annual installments of $12,000. The payments are to be made from...

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