Metro Leasing & Development Corp. v. Comm'r of Internal Revenue

• Decision Date: 17 July 2002
• Docket Number: No. 8054–99.,8054–99.
• Citation: 119 T.C. No. 2,119 T.C. 8
• Parties: METRO LEASING AND DEVELOPMENT CORPORATION, East Bay Chevrolet Company, A Corporation, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent *
• Court: U.S. Tax Court

119 T.C. 8

119 T.C. No. 2

METRO LEASING AND DEVELOPMENT CORPORATION, East Bay Chevrolet Company, A Corporation, Petitioner

v.COMMISSIONER OF INTERNAL REVENUE, Respondent *

No. 8054–99.

United States Tax Court.

July 17, 2002.

Corporate taxpayer petitioned for redetermination of accumulated earnings tax liability. The Tax Court, 2001 WL 530694, Gerber, J., held that corporation was liable for accumulated earnings tax. In supplemental opinion, the Tax Court, Gerber, J., further held that: (1) as a matter of first impression, tax liability on installment sale income had not accrued; (2) no part of paid, but contested, tax liability reduced taxpayer's accumulated taxable income; and (3) as a matter of first impression, capital gains were reduced by income tax imposed on the gains before reducing accumulated taxable income.

Decision for IRS.

Halpern, J., filed concurring opinion.

William L. Raby, for petitioner.

Kathryn K. Vetter, for respondent.

GERBER, J.

In an earlier opinion, we decided that P permitted its 1995 earnings to accumulate beyond the reasonable needs of its business. Secs. 531–537, I.R.C. There remains, however, a dispute concerning the computation of the accumulated earnings tax. P contends, alternatively, that R failed to reduce P's accumulated earnings tax base by the following amounts: (1) “ Deferred” tax attributable to installment sale proceeds to be received by P in tax years after 1995; (2) the amount of the income tax deficiency determined by respondent which remains contested by P and for which P has made payment after filing its petition; and (3) the difference between the amount of tax liability reported on P's return and the amount of tax that would have been due on P's net capital gain.

All three reductions proposed by P require our interpretation of sec. 535(b), I.R.C. Proposed reductions (1) and (2) involve the interpretation of sec. 535(b)(1), I.R.C., and sec. 1.535–2(a)(1), Income Tax Regs. Reduction (3) involves sec. 535(b)(6), I.R.C. Reductions (1) and (3) present questions of first impression. With respect to reduction (2), this Court's decision on the issue was reversed by the Court of Appeals for the Fifth Circuit in J.H. Rutter Rex Manufacturing Co. v. Commissioner, 853 F.2d 1275 (5th Cir.1987), revg. on this point T.C. Memo.1987–296. If we follow the holding of the Court of Appeals, P would be entitled to a reduction for the paid, but still contested, income tax deficiency. R urges this Court not to follow the holding of the Court of Appeals.

Held: This Court will not follow the holding of Court of Appeals on this point in Rutter Rex. Held, further, sec. 535(b), I.R.C., and underlying regulations are interpreted, and R's computation of P's accumulated earnings tax liability is correct.

SUPPLEMENTAL OPINION ¹

In an earlier opinion, we decided that petitioner permitted its 1995 earnings to accumulate beyond the reasonable needs of its business. See secs. 531–537; ² Metro Leasing & Dev. Corp. v. Commissioner, T.C. Memo.2001–119. We also decided the amount of reasonable compensation for petitioner's officers. To reflect our holding and to adjust for agreed items, the parties were required to compute the amount of resulting income tax and accumulated earnings tax liabilities pursuant to Rule 155 computation procedures.

The parties, in docket No. 8054–99, disagree about the computation of the accumulated earnings tax liability. That tax liability is computed by applying the accumulated earnings tax rate to a corporation's accumulated taxable income. Accumulated taxable income is computed by making certain adjustments to taxable income. Respondent computed a proposed accumulated earnings tax liability of $56,248, and petitioner disagreed, contending that three additional adjustments should be made to respondent's computation. If any of petitioner's proposed adjustments are sustained, the resulting accumulated earnings tax liability would be within a range of amounts from zero to $51,074.

Petitioner argues that, in computing accumulated taxable income, respondent failed to reduce taxable income by the following items: (1) Income tax attributable to unrealized and unrecognized installment sale proceeds (if correct, this adjustment would result in no accumulated earnings tax liability); (2) the amount of the income tax deficiency either determined by respondent or decided by this Court (resulting in no liability or $13,666 in accumulated earnings tax, respectively); and (3) an increased reduction under section 535(b)(6), if any accumulated earnings tax liability results after our consideration of proposed adjustments (1) and (2).

I. Tax Liability on Installment Sale Income To Be Received in Years After 1995

Section 531 imposes a tax on a corporate taxpayer's accumulated taxable income. Accumulated taxable income is computed by making certain adjustments to a corporate taxpayer's taxable income. Sec. 535(a). In particular, section 535(b)(1) permits a deduction for Federal income tax “accrued during the taxable year”. In approaching this deduction, petitioner argues that its tax liability on unrealized and unrecognized installment sale income had accrued. This issue is one of first impression in the context of computing accumulated taxable income.

During its 1995 tax year, petitioner sold improved real property. The gross profit from the sale was $1,569,211. Petitioner reported the sale under the installment method.³ Under that method, a taxpayer reports the taxable portion of each installment in the year received. Petitioner received $28,376 in installments for 1995, of which only $20,303 was included in income by petitioner on its 1995 Federal income tax return. Petitioner “deferred” the inclusion in income of the remainder of the $1,569,211 installment sale gross profit until future installments were paid/received.⁴

In arguing that the tax on future installment income had “accrued”, petitioner relies on section 1.535–2(a)(1), Income Tax Regs. That regulation contains the following elaboration on the deduction as being “for taxes accrued during the taxable year, regardless of whether the corporation uses an accrual method of accounting, the cash receipts and disbursements method, or any other allowable method of accounting.”

According to petitioner, the quoted phrase changes all taxpayers' methods of reporting income for purposes of section 535(b)(1) to the accrual method. Petitioner contends that the phrase “regardless of whether the corporation uses an accrual method of accounting, the cash receipts and disbursements method, or any other allowable method of accounting” modifies the statutory phrase “taxes accrued during the taxable year”. In other words, petitioner argues that the taxes that accrued during the 1995 year should include future years' installment sale income as though petitioner had reported the entire sale under the accrual method for 1995. Computing the accrued tax in the manner proposed by petitioner would result in no accumulated taxable income and, therefore, no accumulated earnings tax liability.

Respondent disagrees with petitioner and points out that the language of section 1.535–2(a)(1), Income Tax Regs., was not intended to change petitioner's method for reporting income from the installment to the accrual method. In that regard, respondent contends that section 535(b)(1) and the underlying regulation concern the amount of tax that “accrued during the taxable year”. Respondent also contends that petitioner's post–1995 installment sale income does not meet the well-established standard for accrual of the income and/or tax during petitioner's 1995 Federal tax year.

We agree with respondent. The regulation permits petitioner to deduct its tax liability which had accrued but had not been paid by the end of 1995. The regulation does not change petitioner's tax accounting method for reporting income. Respondent's interpretation of the regulation would result in equal treatment for corporate taxpayers with respect to the accrual of a tax liability for the year(s) under consideration.⁵ Petitioner's interpretation, for purposes of computing accumulated taxable income, would place all taxpayers on the accrual method for reporting income.⁶

We find petitioner's approach to be inherently inconsistent with and contradictory to the statutory scheme, especially when considered in the factual context of this case. In that regard, petitioner seeks the benefit of a reduction attributable to tax on unrealized installment sale income in computing accumulated taxable income. Petitioner, however, has not included any portion of that same income in its tax base for 1995.⁷

Petitioner's interpretation of the subject regulation does not comport with the section 535 statutory phrase “accrued during the taxable year”. In addition, the modification of a taxpayer's overall tax accounting method does not appear to fit within the regimen of section 535(b). “The adjustments prescribed by section 535(a) and (b) are designed generally to assure that a corporation's ‘accumulated taxable income’ reflects more accurately than ‘taxable income’ the amount actually available to the corporation for business purposes.” Ivan Allen Co. v. United States, 422 U.S. 617, 626, 95 S.Ct. 2501, 45 L.Ed.2d 435 (1975).

The adjustments provided for in section 535(b) increase or decrease taxable income, on an annualized basis, to arrive at a base against which to apply the accumulated earnings tax of section 531. For example, section 535(b)(1) provides for a reduction for taxes accrued during the taxable year and section 535(b)(4) requires that net operating loss deductions from other years must be added back. The purpose of these adjustments is to find the amount by which income has been allowed to accumulate beyond the needs of the business for a particular tax year. Respondent's interpretation of the regulatory phrase accomplishes that end. Petitioner's interpretation, on the other hand,...