Lutz v. CIR

• Decision Date: 03 June 1968
• Docket Number: No. 21439-21441.,21439-21441.
• Citation: 396 F.2d 412
• Parties: Eleanor M. LUTZ, Petitioner, v. COMMISSIONER OF INTERNAL REVENUE, Respondent. E. W. LUTZ and Helen E. B. Lutz, Petitioners, v. COMMISSIONER OF INTERNAL REVENUE, Respondent. Philip B. LUTZ and Shirley H. Lutz, Petitioners, v. COMMISSIONER OF INTERNAL REVENUE, Respondent.
• Court: U.S. Court of Appeals — Ninth Circuit

396 F.2d 412 (1968)

Eleanor M. LUTZ, Petitioner, v. COMMISSIONER OF INTERNAL REVENUE, Respondent.

E. W. LUTZ and Helen E. B. Lutz, Petitioners, v. COMMISSIONER OF INTERNAL REVENUE, Respondent.

Philip B. LUTZ and Shirley H. Lutz, Petitioners, v. COMMISSIONER OF INTERNAL REVENUE, Respondent.

Nos. 21439-21441.

United States Court of Appeals Ninth Circuit.

June 3, 1968.

Donald C. Dahlgren (argued), of Skeel, McKelvy, Henke, Evenson & Uhlmann, Seattle, Wash., for appellants.

Howard M. Koff (argued), Lee A. Jackson, Harry Baum, Attys., Dept. of Justice, Washington, D. C., Mitchell Rogovin, Asst. Atty. Gen., Tax Div., Dept. of Justice, Lester Uretz, Chief Counsel, Internal Revenue Service, Washington, D. C., for appellee.

Before JOHNSEN,^* BARNES and ELY, Circuit Judges.

BARNES, Circuit Judge:

Petitioners are members of a family partnership which engaged in the construction of military and residential housing in the State of Washington during its taxable years 1960 and 1962. The State of Washington has had at all times relevant hereto a retail sales tax. The amount of the tax on the partnership sales in its taxable year 1960 was $113,943.46, and in 1962 $215,465.96. Petitioners, reporting on the completed contract basis for federal income tax purposes, claimed their proportionate shares of the Washington tax as a deduction. The Commissioner disallowed the deduction, and the Tax Court upheld the Commissioner.¹ Petitioners have sought review here under 26 U.S.C. § 7482.

The partnership construction projects which gave rise to the application of the Washington tax were both awarded under the Capehart Act of 1955 (42 U. S.C. § 1594). Due to the fact that under the Capehart Act the housing facilities are owned by a corporation, the stock of which is ultimately owned by the Secretary of Defense, there was some question as to whether the Washington tax on the sale of such structures was lawful. Several other Capehart contractors, but not petitioners' partnership, challenged the tax by suit in a state court. The State of Washington notified the partnership that collection of the tax was being held in abeyance pending determination of the litigation, although returns were still required. This procedure was later made applicable to all Capehart contractors by a general administrative ruling. The partnership filed Washington State tax returns showing its sales as being to the federal government, and indicating that no sales tax was due. The Washington Tax Commission assessed the sales tax against the partnership, but payment was deferred pending the outcome of the litigation. Interest and penalties on the deferred payments were waived by the State. Later the partnership filed a bond for payment of these taxes with the Washington authorities. The tax was upheld by the trial court, and the Washington Supreme Court affirmed in August of 1963. Murray v. State, 62 Wash.2d 619, 384 P.2d 337 (1963). A writ of certiorari was denied by the Supreme Court of the United States. Inland Empire Builders, Inc. v. Washington, 378 U.S. 580, 84 S.Ct. 1910, 12 L.Ed.2d 1035 (1964). Shortly thereafter the partnership paid all of the assessed Washington taxes in full.

In accounting for federal income taxes, the partnership accrued the Washington sales tax as an expense and showed the assessed amounts as a liability. It deducted the expense in the taxable year of the completion of the project to which the tax applied. The Commissioner denied the deduction for the years claimed by the petitioners, insisting that the expense was deductible only in the year in which it was paid. The year of the deduction is the sole issue on appeal.

As noted above, the Tax Court upheld the Commissioner's position. The basis for the Tax Court's decision was that the "all events" test had not been satisfied for the taxable years 1960 and 1962 since the litigation had not finally ended until 1964. This "all events" test was announced by the Supreme Court in United States v. Anderson, 269 U.S. 422, 441, 46 S.Ct. 131, 70 L.Ed. 347 (1926). The rule is basically that before an expense becomes deductible, all events which fix the amount and liability of the taxpayer must have occurred. As the Supreme Court explained in Dixie Pine Products Co. v. Commissioner of Internal Revenue, 320 U.S. 516, 519, 64 S.Ct. 364, 365, 88 L.Ed. 270 (1944):

"It has long been held that, in order truly to reflect the income of a given year, all the events must occur in that year which fix the amount and the fact of the taxpayer\'s liability for items of indebtedness deducted though not paid; and this cannot be the case where the liability is contingent and is contested by the taxpayer." (Footnotes omitted.)

The Tax Court found it unnecessary to decide whether the partnership was "contesting" its liability because, in its view, irrespective of whether the partnership was contesting its liability the "all events" test had not been satisfied. Inherent in this conclusion is the major premise that if anyone is contesting a liability similar in nature to a liability of the taxpayer, the taxpayer's liability remains contingent for federal income tax purposes until the contest is ended. We reject the premise as it applies to the facts of this case.

We can find no authority (and we have been cited to none) for the proposition that a third party's contest of liability makes a taxpayer's similar liability contingent. We recognize the fact that if the contestant is successful in voiding a tax the taxpayer might later be able to recoup his payment or avoid that liability. Such a possibility, we feel, is too remotely connected with the taxpayer to describe the liability as contingent.

We prefer the reasoning of Dravo Corp. v. United States, 348 F.2d 542, 172 Ct.Cl. 200 (1965). In 1953 Dravo filed a capital stock tax return with Pennsylvania authorities, which return was accepted. In 1956, however, the 1953 tax was reviewed and increased. Dravo paid the increase without protest. Dravo, however, filed an amended return of federal income taxes for the year 1953 and sought to deduct the 1956 additional payment. The Commissioner disallowed the additional deduction and Dravo sued for the refund. The Court of Claims upheld Dravo and ordered the refund.

"We do not think it proper to extend the concept of `contest\' to the instant situation where the only basis for such an extension is taxpayer\'s subjective motive as to what was intended when a return was filed. If a departure from the traditional concepts of proper accrual tax accounting is required by the fact of contest, it should be evidenced by taxpayer\'s objective acts; i. e., lodging a formal protest with the tax authorities or instituting a suit in a court of law. To conclude otherwise would ignore the principle of an uncontested tax, and equate actual contest with acquiescence without contest. But more important, in order that income may be clearly reflected for any taxable year, it is necessary to reflect the state tax liabilities for that year. When the liability is not disputed and the precise amount is later determined, it is in accordance with sound principles of accounting that the tax accrue in the year in which the liability occurred. The government\'s position would result in completely distorting taxpayer\'s income for the years 1956 and 1953." (Footnote omitted.)

It is noteworthy that in the case at bar the government also seeks to effect a distortion of income figures.² There is no dispute that the Washington tax was on the Capehart contract sales. Those sales resulted in revenue which was properly returned in 1960 and 1962. To most accurately determine income requires that all expenses attributable to each contract be deducted in the year when the contract proceeds were reported as revenues. See American Institute of Certified Public Accounts, Accounting Research & Terminology Bulletins 28 (Final ed. 1961). It is apparent that, as the Court of Claims indicated in Dravo, adoption of a narrow interpretation of "contest" within the meaning of Dixie Pine Products will lead to a more accurate and equitable determination of net income for the purposes of taxation.³ We therefore conclude that a "contest" requires a formal, direct challenge to the substance of the asserted liability, and that a taxpayer does not engage in a contest where he merely abides the outcome of litigation or protests prosecuted by others.⁴

As to the Tax Court's application of the "all events" test of Anderson, we are unable to see how the litigation attacking the Washington tax could be said to have made petitioners' obligation to the State for the taxes during the period involved in any way contingent. The pendency of the suit did not affect the State's right to assess and collect the taxes. And petitioners would have had to make payment of them through this time, if the State had so insisted, since petitioners were not engaged in a contest as to the statute's validity.

Thus the outcome of the pending suit could not be said to have any "all events" relationship to the question of petitioners' liability for the taxes as they were assessed. The suit could, of course, upon a subsequent favorable result, give rise to a defeasance of the liability created by the statute for each of such years, but this would not make the liability so existing a contingent one while the statute was operative.

In the reflection of petitioners' income as to this period of actually existing liability, the requirement of Dixie Pine Products would be satisfied, that "all the events must occur in that year which fixed the amount and the fact of the taxpayer's liability for items of indebtedness deducted though not paid". The desire of the State here for purposes of its own not to have the petitioners pay the assessed taxes immediately was a mere postponement of payment and not a change as to the existing obligation and liability. Petitioners no less owed the taxes from and as of the time...