United States v. General Dynamics Corp, 85-1385

• Decision Date: 22 April 1987
• Docket Number: No. 85-1385,85-1385
• Citation: 95 L.Ed.2d 226,481 U.S. 239,107 S.Ct. 1732
• Parties: UNITED STATES, Petitioner v. GENERAL DYNAMICS CORP., et al
• Court: U.S. Supreme Court

481 U.S. 239

107 S.Ct. 1732

95 L.Ed.2d 226

UNITED STATES, Petitioner

v GENERAL DYNAMICS CORP., et al.

No. 85-1385.

Argued Jan. 13, 1987.

Decided April 22, 1987.

Syllabus

Under the "all events" test, as embodied in Treasury Regulations, an accrual-basis taxpayer is entitled to deduct a business expense for the taxable year in which all events have occurred which determine the fact of the taxpayer's liability, and in which the amount of that liability can be determined with reasonable accuracy. In the year at issue, a consolidated federal income tax return was filed by General Dynamics Corporation and several of its wholly owned subsidiaries (hereafter respondent). Respondent is an accrual basis taxpayer whose fiscal year is the calendar year. Beginning in 1972, it became a self-insurer with regard to its employee medical care plan. To receive medical payment reimbursements, employees must submit claims forms to employee benefits personnel, who verify eligibility and forward worthy claims to the plan's administrators, whose claims processors review the claims and approve covered expenses for payment. To account for the delay between the provision of medical services and the payment of claims, respondent established reserve accounts reflecting its liability for medical care received, but still not paid for, as of December 31, 1972. On its amended 1972 tax return, respondent sought a refund based on its claimed deduction of its reserve as an accrued expense. The Internal Revenue Service disallowed the deduction, but the Claims Court sustained it, holding that "all events" which determined the fact of respondent's liability had taken place when its employees received covered services, and that the amount of liability could be determined with reasonable accuracy. The Court of Appeals affirmed.

Held: Where the filing of claims is a condition precedent to liability, an accrual basis taxpayer providing medical benefits to its employees cannot deduct at the close of the taxable year an estimate of its obligation to pay for medical care obtained by employees or their qualified dependents during the final quarter of the year, claims for which have not been reported to the employer. Pp. 242-247.

(a) The proposed deduction fails the "all events" test because it depends on a mere estimate of respondent's liability based on events that had not occurred before the close of the 1972 taxable year. The last event necessary to fix respondent's liability was not the receipt of medi- cal care by covered individuals, but the filing of properly documented claims forms. Such filing is not a mere technicality, nor is the possibility that some employees might not file claims after receiving services "extremely remote and speculative." Pp. 242-245.

(b) Respondent has not demonstrated that its liability as to any medical care claims was firmly established as of the close of the 1972 taxable year. Although the parties stipulated that respondent had not received claims for all services rendered during the year by the year's end, and that some claims received had not been processed at that time, respondent failed to show what portion of the claims had been filed by the end of the year, or even that it knew of specific claims that had been filed but not yet processed. The fact that respondent may have been able to make a reasonably accurate actuarial estimate of how many claims would be filed for the last quarter of 1972 cannot justify a deduction. If the "all events" test permitted such a deduction, Congress would not have retained 26 U.S.C. § 832(b)(5), which allows insurance companies to deduct additions to reserves for "incurred but not reported" claims. Pp. 245-247.

773 F.2d 1224 (CA Fed.1985) reversed.

MARSHALL, J., delivered the opinion of the Court, in which REHNQUIST, C.J., and BRENNAN, WHITE, POWELL, and SCALIA, JJ., joined. O'CONNOR, J., filed a dissenting opinion, in which BLACKMUN and STEVENS, JJ., joined, post, p. 247.

Alan I. Horowitz, Washington, D.C., for petitioner.

Lynne E. McNown, Chicago, Ill., for the respondent.

Justice MARSHALL delivered the opinion of the Court.

The issue in this case is whether an accrual-basis taxpayer providing medical benefits to its employees may deduct at the close of the taxable year an estimate of its obligation to pay for medical care obtained by employees or their qualified dependents during the final quarter of the year, claims for which have not been reported to the employer.

I

Taxpayers, respondents herein, are the General Dynamics Corporation and several of its wholly owned subsidiaries (General Dynamics).¹ General Dynamics uses the accrual method of accounting for federal tax purposes; its fiscal year is the same as the calendar year. From 1962 until October 1, 1972, General Dynamics purchased group medical insurance for its employees and their qualified dependents from two private insurance carriers. Beginning in October 1972, General Dynamics became a self-insurer with regard to its medical care plans. Instead of continuing to purchase insurance from outside carriers, it undertook to pay medical claims out of its own funds, while continuing to employ private carriers to administer the medical care plans.

To receive reimbursement of expenses for covered medical services, respondent's employees submit claims forms to employee benefits personnel, who verify that the treated persons were eligible under the applicable plan as of the time of treatment. Eligible claims are then forwarded to the plan's administrators. Claims processors review the claims and approve for payment those expenses that are covered under the plan.

Because the processing of claims takes time, and because employees do not always file their claims immediately, there is a delay between the provision of medical services and payment by General Dynamics. To account for this time lag, General Dynamics established reserve accounts to reflect its liability for medical care received, but still not paid for, as of December 31, 1972. It estimated the amount of those reserves with the assistance of its former insurance carriers.

Originally, General Dynamics did not deduct any portion of this reserve in computing its tax for 1972. In 1977, how- ever, after the Internal Revenue Service (IRS) began an audit of its 1972 tax return, General Dynamics filed an amended return, claiming it was entitled to deduct its reserve as an accrued expense, and seeking a refund. The IRS disallowed the deduction, and General Dynamics sought relief in the Claims Court.

The Claims Court sustained the deduction, holding that it satisfied the "all events" test embodied in Treas. Reg. § 1.461-1(a)(2), 26 C.F.R. § 1.461-1(a)(2) (1986), since "all events" which determined the fact of liability had taken place when the employees received covered services, and the amount of liability could be determined with reasonable accuracy. Thus, the court held that General Dynamics was entitled to a refund. 6 Cl.Ct. 250 (1984). The Court of Appeals for the Federal Circuit affirmed, largely on the basis of the Claims Court opinion. 773 F.2d 1224, 1226 (1985).

The United States sought review of the question whether all the events necessary to fix liability had occurred.² We granted certiorari, 476 U.S. 1181, 106 S.Ct. 2913, 91 L.Ed.2d 543 (1986). We reverse.

II

As we noted in United States v. Hughes Properties, Inc., 476 U.S. 593, 600, 106 S.Ct. 2092, 2096, 90 L.Ed.2d 569 (1986), whether a business expense has been "incurred" so as to entitle an accrual-basis taxpayer to deduct it under § 162(a) of the Internal Revenue Code, 26 U.S.C. § 162(a), is governed by the "all events" test that originated in United States v. Anderson, 269 U.S. 422, 441, 46 S.Ct. 131, 134, 70 L.Ed. 347 (1926). In Anderson, the Court held that a taxpayer was obliged to deduct from its 1916 income a tax on profits from munitions sales that took place in 1916. Although the tax would not be assessed and therefore would not formally be due until 1917, all the events which fixed the amount of the tax and determined the taxpayer's liability to pay it had occurred in 1916. The test is now embodied in Treas. Reg. § 1.461-1(a)(2), 26 C.F.R. § 1.461-1(a)(2) (1986), which provides that "[u]nder an accrual method of accounting, an expense is deductible for the taxable year in which all the events have occurred which determine the fact of the liability and the amount thereof can be determined with reasonable accuracy."³

It is fundamental to the "all events" test that, although expenses may be deductible before they have become due and payable, liability must first be firmly established. This is consistent with our prior holdings that a taxpayer may not deduct a liability that is contingent, see Lucas v. American Code Co., 280 U.S. 445, 452, 50 S.Ct. 202, 204, 74 L.Ed. 538 (1930), or contested, see Security Flour Mills Co. v. Commissioner of Internal Revenue, 321 U.S. 281, 284, 64 S.Ct. 596, 597, 88 L.Ed. 725 (1944). Nor may a taxpayer deduct an estimate of an anticipated expense, no matter how statistically certain, if it is based on events that have not occurred by the close of the taxable year. Brown v. Helvering, 291 U.S. 193, 201, 54 S.Ct. 356, 360, 78 L.Ed. 725 (1934); cf. American Automobile Assn. v. United States, 367 U.S. 687, 693, 81 S.Ct. 1727, 1730, 6 L.Ed.2d 1109 (1961).

We think that this case, like Brown, involves a mere estimate of liability based on events that had not occurred before the close of the taxable year, and therefore the proposed deduction does not pass the "all events" test. We disagree with the legal conclusion of the courts below that the last event necessary to fix the taxpayer's liability was the receipt of medical care by covered individuals.⁴ A person covered by a plan could only obtain payment for medical services by filling out and submitting a health-expense-benefits claim form. App. 23. Employees were informed that submission of satisfactory proof...