WEEK 3 RESEARCH PROJECT
(Set #1)
ACCT 429
DeVry University
IMPORTANT NOTE TO STUDENTS
This assignment is being distributed solely for your use in completing the Week 3 project in
DeVry University’s online Accounting 429 class. This assignment is an individual assignment,
and you are to complete it without any outside assistance by any other student, individual, or
outside materials, other than those specifically permitted by the problem. Any violations of
these requirements will be addressed as an academic integrity violation. Similarly, this
assignment may not be shared with any other student at any time, even after your completion
of the course. Students to do so may be subject to sanctions pursuant to DeVry’s academic
integrity policy, even though they may no longer be enrolled in Accounting 429.
Week 3 Research Project (Set #1)
DeVry University Acct 429
Performing tax research is an important part of tax practice. As outlined in Chapter 2 of your
textbook, tax law is developed through a number of different governmental entities. Congress
enacts the tax Code as statutory law. The Treasury Department is tasked with the
implementation of the tax Code and, in the course of doing so, develops a number of
documents and materials to aid taxpayers in understanding the Treasury Department's
interpretation of the code, including the Regulations. In turn, the Internal Revenue Service
("IRS”) has the direct responsibility for implementing the tax Code and in assessing and
collecting the applicable tax from taxpayers. In the course of its duties, it also develops a
number of materials, including Revenue Rulings, Revenue Procedures, and Private Letter
Rulings, in which it sets forth its understanding of the tax laws. Finally, the federal courts
decide tax cases in which taxpayers contest the government's interpretation of the tax laws. In
deciding these cases, the federal courts set forth binding interpretation of what the tax laws
provide. All of these materials (often called primary resources) are important resources in
performing tax research. On top of these primary sources of tax law, there are a number of
secondary materials provided by various organizations and publishers. These secondary
materials offer editorial analysis of the tax laws (somewhat akin to a Cliffs’ Notes® on tax laws)
to help tax practitioners understand the tax laws and apply them in given situations.
The following assignment has three (3) different graded elements. Two of them require you to
prepare tax file memoranda, while the remaining element requires you to compose an essay
answering the question asked. AS SUCH, YOU WILL BE SUBMITTING THREE SEPARATE
DOCUMENTS FOR THIS ASSIGNMENT.
1. The first two assignments require you to compose tax file memoranda. In each of these
problems, you will be given a fact pattern or issue that requires you to decide or analyze
a particular issu.
1. WEEK 3 RESEARCH PROJECT
(Set #1)
ACCT 429
DeVry University
IMPORTANT NOTE TO STUDENTS
This assignment is being distributed solely for your use in
completing the Week 3 project in
DeVry University’s online Accounting 429 class. This
assignment is an individual assignment,
and you are to complete it without any outside assistance by any
other student, individual, or
outside materials, other than those specifically permitted by the
problem. Any violations of
these requirements will be addressed as an academic integrity
violation. Similarly, this
2. assignment may not be shared with any other student at any
time, even after your completion
of the course. Students to do so may be subject to sanctions
pursuant to DeVry’s academic
integrity policy, even though they may no longer be enrolled in
Accounting 429.
Week 3 Research Project (Set #1)
DeVry University Acct 429
Performing tax research is an important part of tax practice. As
outlined in Chapter 2 of your
textbook, tax law is developed through a number of different
governmental entities. Congress
enacts the tax Code as statutory law. The Treasury Department
is tasked with the
implementation of the tax Code and, in the course of doing so,
develops a number of
documents and materials to aid taxpayers in understanding the
Treasury Department's
interpretation of the code, including the Regulations. In turn,
the Internal Revenue Service
("IRS”) has the direct responsibility for implementing the tax
Code and in assessing and
collecting the applicable tax from taxpayers. In the course of
its duties, it also develops a
3. number of materials, including Revenue Rulings, Revenue
Procedures, and Private Letter
Rulings, in which it sets forth its understanding of the tax laws.
Finally, the federal courts
decide tax cases in which taxpayers contest the government's
interpretation of the tax laws. In
deciding these cases, the federal courts set forth binding
interpretation of what the tax laws
provide. All of these materials (often called primary resources)
are important resources in
performing tax research. On top of these primary sources of tax
law, there are a number of
secondary materials provided by various organizations and
publishers. These secondary
materials offer editorial analysis of the tax laws (somewhat akin
to a Cliffs’ Notes® on tax laws)
to help tax practitioners understand the tax laws and apply them
in given situations.
The following assignment has three (3) different graded
elements. Two of them require you to
prepare tax file memoranda, while the remaining element
requires you to compose an essay
answering the question asked. AS SUCH, YOU WILL BE
SUBMITTING THREE SEPARATE
4. DOCUMENTS FOR THIS ASSIGNMENT.
1. The first two assignments require you to compose tax file
memoranda. In each of these
problems, you will be given a fact pattern or issue that requires
you to decide or analyze
a particular issue of tax law. You will also be provided with a
number of the primary
sources discussed above (e.g., Revenue Rulings, cases) on that
issue of tax law. You will
then compose a tax file memoranda concerning that taxpayer.
You can find details as to
how to compose such a memorandum in Chapter 2 of your text,
including a sample text
file memorandum in Figure 2.6 on page 2-26 of your text. Use
the materials provided to
determine the proper solution to the taxpayer’s issues. In
particular, discuss the
materials in some detail in the “Analysis” section of the tax file
memorandum. THIS IS
IMPORTANT! The most important part of any tax file
memorandum is the thoroughness
of the analysis defending the conclusion reached in the
memorandum. Accordingly,
5. most of the points awarded on the assignment are allocated to
the “Analysis” section of
the memorandum. In assessing these assignments, consideration
will be given to,
among other factors, (1) your accuracy in summarizing the
relevant facts; (2) the
accuracy of your identification and statement of the “Issue”
presented by the problem;
(3) the accuracy of your “Conclusion;” (4) the thoroughness and
quality of your analysis
Week 3 Research Project (Set #1)
DeVry University Acct 429
offered in the “Analysis” section of your memorandum; and (5)
the overall
professionalism of your memorandum (e.g., presentation, use of
proper grammar,
proper spelling, and quality of communication). EACH OF THE
TAX MEMORANDA IS
WORTH 30 POINTS, FOR A TOTAL OF 60 POINTS.
2. The remaining assignment requires you to perform some
research on the Internet to
6. find relevant materials and to analyze these materials. As
previously noted, in
performing this research, you may not take advantage of any
resources other than those
specifically permitted by the assignment, including assignments
previously completed by
other students or other similar materials. You will then
complete an essay answering
the question or questions presented by this assignment. Your
submission will be graded
on a number of factors, including (1) your ability to locate
relevant research and
materials on the Internet; (2) your ability to analyze these
resources; (3) your ability to
draw conclusions from these resources and to defend these
conclusions with analysis of
the research and materials located; and (4) the overall
professionalism and content of
your essay (e.g., presentation, use of proper grammar, proper
spelling, and quality of
communication). THIS ESSAY IS WORTH 20 POINTS.
Please note that these assignments are worth a significant
portion of your grade. As such, you
should take them seriously, and leave yourself enough time to
7. complete them. Do not wait
until the last weekend to begin these assignments. If you do, it
will be very difficult for you to
submit quality responses to each of the four questions or
problems posed. Please also note
that preparing these answers conscientiously will help you in
preparing for the final
examination, given that you may be required to perform similar
analyses on the exam. Should
you have a question, please ask your instructor. Good luck!
Week 3 Research Project (Set #1)
DeVry University Acct 429
TAX RESEARCH MEMORANDUM ASSIGNMENT 1
One of your clients is an incorporated funeral home, Peaceful
Pastures Funeral Home, Inc.
(“Peaceful”). Peaceful, an accrual basis taxpayer, provides a
full line of funeral services and sells
goods related to those services. Over the last few years,
however, the cost of these goods and
services have risen dramatically. As a result, more of
Peaceful’s customers have had difficulties
8. paying their bills or have selected goods and services that cost
less, sharply impacting Peaceful's
bottom line.
As a result, Peaceful has attempted to design an approach that
allows customers to prepay for
their funeral goods and services. Under this program, the
customer pays in advance for the
goods and services that will be provided at the time of their
death, often at a significant
discount. Under the terms of the contract, the payments are
refundable at the contract
purchaser's request any time until the goods and services are
provided to them. Given that it is
an accrual basis taxpayer, Peaceful has included these payments
and income for the year the
funeral service is provided.
This year, the IRS sent Peaceful an audit notice. It contends
that the amount prepaid under
Peaceful’s program constitutes prepaid income that must be
included in Peaceful’s income (and
therefore subject to tax) in the year in which it is received.
Peaceful has come to you for
advice. Is the IRS correct?
9. COMPOSE A TAX FILE MEMORANDUM CONCERNING
THIS ISSUE USING THESE FACTS AND THE
RESEARCH MATERIALS PROVIDED TO YOU IN THE NEXT
FEW PAGES (30 POINTS).
Checkpoint Contents
Federal Library
Federal Source Materials
Federal Tax Decisions
American Federal Tax Reports
American Federal Tax Reports (Prior Years)
1990
AFTR 2d Vol. 65
65 AFTR 2d 90-407 (888 F.2d 208) - 65 AFTR 2d
90-301 (19 Cl Ct 1)
COMM. v. INDIANAPOLIS POWER & LIGHT
CO., 65 AFTR 2d 90-394 (110 S.Ct.589), Code Sec(s) 451;
61, (S Ct), 01/09/1990
American Federal Tax Reports
COMM. v. INDIANAPOLIS POWER & LIGHT CO., Cite as 65
AFTR 2d 90-394
(110 S.Ct.589), 01/09/1990 , Code Sec(s) 61
10. COMMISSIONER of Internal Revenue, PETITIONER v.
INDIANAPOLIS POWER & LIGHT COMPANY,
RESPONDENT
Case Information:
HEADNOTE
1. TIME FOR REPORTING INCOME—Prepaid income—receipt
for future services or sale of personal property.
Customer deposits required by public utility to insure customer
creditworthiness and bill payment weren't advance
payments for electricity and weren't taxable income to utility on
receipt. Utility didn't have requisite "complete
dominion" over payments at time they were made, the crucial
point for determining taxable income. 11th Circuit's
holding in City Gas Co. of Fla. v. Comm., 50 AFTR 2d 82-5959
( 689 F2d 943), not followed. Utility's right to
keep deposits depended on events outside its control—
customer's purchase of electricity, decision to have deposit
applied to future bills, or default. Utility's dominion over fund
was far less complete than is ordinarily case in
advance-payment situation. Closest analogy is lease deposits.
Reference(s): PH Fed 2d ¶4515.191(90); ¶615.003(10). Code
Sec. 61 ; Code Sec. 451 .
OPINION
On Writ of Certiorari to the United States Court of Appeals for
the Seventh Circuit.
Syllabus
11. Respondent Indianapolis Power and Light Co. (IPL), a regulated
Indiana utility and an accrual-basis taxpayer,
requires customers having suspect credit to make deposits with
it to assure prompt payment of future electric bills.
Prior to termination of service, customers who satisfy a credit
test can obtain a refund of their deposits or can
choose to have the amount applied against future bills.
Although the deposits are at all times subject to the
company's unfettered use and control, IPL does not treat them
as income at the time of receipt but carries them on
its books as current liabilities. Upon audit of IPL's returns for
the tax years at issue, petitioner Commissioner of
Internal Revenue asserted deficiencies, claiming that the
deposits are advance payments for electricity and
Code Sec(s): 61
Court Name: U.S. Supreme Court,
Docket No.: No. 88-1319,
Date
Decided:
01/09/1990
Prior History: Court of Appeals, 62 AFTR 2d 88-5708 ( 857
F.2d 1162), aff'g 88 TC 964
(No.52), affirmed.
Tax Year(s): Years 1974, 1975, 1976, 1977.
Disposition: Decision for Taxpayer.
Cites: 65 AFTR 2d 90-394, 493 US 203, 110 S Ct 589, 107 L Ed
2d 591, 90-1 USTC P 50007.
12. therefore are taxable to IPL in the year of receipt. The Tax
Court ruled in favor of IPL on its petition for
redetermination, holding that the deposits' principal purpose is
to serve as security rather than a prepayment of
income. The Court of Appeals affirmed.
Held: The customer deposits are not advance payments for
electricity and therefore do not constitute taxable
income to IPL upon receipt. Although IPL derives some
economic benefit from the deposits, it does not have the
requisite "complete dominion" over them at the time they are
made, the crucial point for determining taxable
income. IPL has an obligation to repay the deposits upon
termination of service or satisfaction of the credit test.
Moreover, a customer submitting a deposit makes no
commitment to purchase any electricity at all. Thus, while
deposits eventually may be used to pay for electricity by virtue
of customer default or choice, IPL's right to retain
them at the time they are made is contingent upon events
outside its control. This construction is consistent with
the Tax Court's longstanding treatment of sums deposited to
secure a tenant's performance of a lease agreement,
perhaps the closet analogy to the present situation.
857 F.2d 1162 [ 62 AFTR2d 88-5708], affirmed.
BLACKMUN, J., delivered the opinion for a unanimous Court.
Opinion
Justice BLACKMUN delivered the opinion of the Court.
Respondent Indianapolis Power & Light Company (IPL)
13. requires certain customers to make deposits with it to assure
payment of future bills for electric service. Petitioner
Commissioner of Internal Revenue contends that these deposits
are advance payments for electricity and therefore constitute
taxable income to IPL upon receipt. IPL contends
otherwise.
I
IPL is a regulated Indiana corporation that generates and sells
electricity in Indianapolis and its environs. It keeps its
books on the accrual and calendar year basis. [pg. 90-395]
During the years 1974 through 1977, approximately 5%
of IPL's residential and commercial customers were required to
make deposits "to insure prompt payment," as the
customers' receipts stated, of future utility bills. These
customers were selected because their credit was suspect.
Prior to March 10, 1976, the deposit requirement was imposed
on a case-by-case basis. IPL relied on a credit test
but employed no fixed formula. The amount of the required
deposit ordinarily was twice the customer's estimated
monthly bill. IPL paid 3% interest on a deposit held for six
months or more. A customer could obtain a refund of the
deposit prior to termination of service by requesting a review
and demonstrating acceptable credit. The refund
usually was made in cash or by check, but the customer could
choose to have the amount applied against future
bills.
In March 1976, IPL amended its rules governing the deposit
program. See Title 170, Ind. Admin. Code 4-1-15 (1988).
Under the amended rules, the residential customers from whom
deposits were required were selected on the basis of
a fixed formula. The interest rate was raised to 6% but was
payable only on deposits held for 12 months or more. A
deposit was refunded when the customer made timely payments
14. for either nine consecutive months, or for 10 out of
12 consecutive months so long as the two delinquent months
were not themselves consecutive. A customer could
obtain a refund prior to that time by satisfying the credit test.
As under the previous rules, the refund would be
made in cash or by check, or, at the customer's option, applied
against future bills. Any deposit unclaimed after
seven years was to escheat to the State. See Ind. Code §32-9-1-
6(a) (1988) 1
IPL did not treat these deposits as income at the time of receipt.
Rather, as required by state administrative
regulations, the deposits were carried on its books as current
liabilities. Under its accounting system, IPL recognized
income when it mailed a monthly bill. If the deposit was used to
offset a customer's bill, the utility made the
necessary accounting adjustments. Customer deposits were not
physically segregated in any way from the
company's general funds. They were commingled with other
receipts and at all times were subject to IPL's
unfettered use and control. It is undisputed that IPL's treatment
of the deposits was consistent with accepted
accounting practice and applicable state regulations.
Upon audit of respondent's returns for the calendar years 1974
through 1977, the Commissioner asserted
deficiencies. Although other items initially were in dispute, the
parties were able to reach agreement on every issue
except that of the proper treatment of customer deposits for the
years 1975, 1976, and 1977. The Commissioner
took the position that the deposits were advance payments for
electricity and therefore were taxable to IPL in the
year of receipt. He contended that the increase or decrease in
customer deposits outstanding at the end of each
year represented an increase or decrease in IPL's income for the
year. 2 IPL disagreed and filed a petition in the
15. United States Tax Court for redetermination of the asserted
deficiencies.
In a reviewed decision, with one judge not participating, a
unanimous Tax Court ruled in favor of IPL. 88 T.C. 964
(1987). The court followed the approach it had adopted in City
Gas Co. of Florida v. Commissioner of Internal
Revenue, 74 T.C. 386 (1980), rev'd, 689 F.2d 943 [ 50
AFTR2d 82-5959] (CA 11 1982). It found it
necessary to "continue to examine all of the circumstances," 88
T.C., at 976, and relied on several factors in
concluding that the deposits in question were properly excluded
from gross income. It noted, among other things,
that only 5% of IPL's customers were required to make deposits;
that the customer rather than the utility controlled
the ultimate disposition of a deposit; and that IPL consistently
treated the deposits as belonging to the customers,
both by listing them as current liabilities for accounting
purposes and by paying interest. Id., at 976-978.
The United States Court of Appeals for the Seventh Circuit
affirmed the Tax Court's decision. 857 F.2d 1162 [
62 AFTR2d 88-5708] (1988). The court stated that "the proper
approach to determining the appropriate tax
treatment of a customer deposit is to look at the primary
purpose of the deposit based on all the facts and
circumstances...." Id., at 1167. [pg. 90-396] The court appeared
to place primary reliance, however, on IPL's
obligation to pay interest on the deposits. It asserted that " as
the interest rate paid on a deposit to secure income
begins to approximate the return that the recipient would be
expected to make from 'the use' of the deposit amount,
16. the deposit begins to serve purposes that comport more squarely
with a security deposit." Id., at 1169. Noting that
IPL had paid interest on the customer deposits throughout the
period in question, the court upheld, as not clearly
erroneous, the Tax Court's determination that the principal
purpose of these deposits was to serve as security
rather than as prepayment of income. Id., at 1170.
Because the Seventh Circuit was in specific disagreement with
the Eleventh Circuit's ruling in City Gas Co. of Florida,
supra, we granted certiorari to resolve the conflict. —U.S. —
(1989).
II
We begin with the common ground. IPL acknowledges that
these customer deposits are taxable as income upon
receipt if they constituteadvance payments for electricity to be
supplied. 3 The Commissioner, on his part, concedes
that customer deposits that secure the performance of
nonincome-producing covenants—such as a utility
customer's obligation to ensure that meters will not be
damaged—are not taxable income. And it is settled that
receipt of a loan is not income to the borrower. See
Commissioner v. Tufts, 461 U.S. 300, 307 [ 51 AFTR2d
83-1132] (1983) ("Because of [the repayment] obligation, the
loan proceeds do not qualify as income to the
taxpayer"); James v. United States, 366 U.S. 213, 219 [ 7
AFTR2d 1361] (1961) (accepted definition of
gross income "excludes loans"); Commissioner v. Wilcox, 327
U.S. 404, 408 [ 34 AFTR 811] (1946). IPL,
stressing its obligation to refund the deposits with interest,
asserts that the payments are similar to loans. The
17. Commissioner, however, contends that a deposit which serves to
secure the payment of future income is properly
analogized to an advance payment for goods or services. See
Rev. Rul. 72-519, 1972-2 Cum. Bull. 32, 33 ("[W]
hen the purpose of the deposit is to guarantee the customer's
payment of amounts owed to the creditor, such a
deposit is treated as an advance payment, but when the purpose
of the deposit is to secure a property interest of
the taxpayer the deposit is regarded as a true security deposit").
In economic terms, to be sure, the distinction between a loan
and an advance payment is one of degree rather than
of kind. A commercial loan, like an advance payment, confers
an economic benefit on the recipient: a business
presumably does not borrow money unless it believes that the
income it can earn from its use of the borrowed funds
will be greater than its interest obligation. See Illinois Power
Co. v. Commissioner of Internal Revenue, 792 F.2d
683, 690 [ 58 AFTR2d 86-5122] (CA7 1986). Even though
receipt of the money is subject to a duty to repay,
the borrower must regard itself as better off after the loan than
it was before. The economic benefit of a loan,
however, consists entirely of the opportunity to earn income on
the use of the money prior to the time the loan
must be repaid. And in that context our system is content to tax
these earnings as they are realized. The recipient
of an advance payment, in contrast, gains both immediate use of
the money (with the chance to realize earnings
thereon) and the opportunity to make a profit by providing
goods or services at a cost lower than the amount of the
payment.
The question, therefore, cannot be resolved simply by noting
18. that respondent derives some economic benefit from
receipt of these deposits. 4 Rather, the issue turns upon the
nature of the rights and obligations that IPL assumed
when the deposits were made. In determining what sort of
economic benefits qualify as income, this Court has
invoked various formulations. It has referred, for example, to
"undeniable accessions to wealth, clearly realized, and
over which the taxpayers have complete dominion."
Commissioner v. Glenshaw Glass Co., [pg. 90-397] 348 U.S.
426, 431 [ 47 AFTR 162] (1955). It also has stated: "When a
taxpayer acquires earnings, lawfully or unlawfully,
without the consensual recognition, express or implied, of an
obligation to repay and without restriction as to their
disposition, 'he has received income....' " James v. United
States, 366 U.S., at 219, quoting North American Oil
Consolidated v. Burnet, 286 U.S. 417, 424 [ 11 AFTR 16]
(1932). IPL hardly enjoyed "complete dominion" over
the customer deposits entrusted to it. Rather, these deposits
were acquired subject to an express "obligation to
repay," either at the time service was terminated or at the time a
customer established good credit. So long as the
customer fulfills his legal obligation to make timely payments,
his deposit ultimately is to be refunded, and both the
timing and method of that refund are largely within the control
of the customer.
The Commissioner stresses the fact that these deposits were not
placed in escrow or segregated from IPL's other
funds, and that IPL therefore enjoyed unrestricted use of the
money. That circumstance, however, cannot be
19. dispositive. After all, the same might be said of a commercial
loan; yet the Commissioner does not suggest that a
loan is taxable upon receipt simply because the borrower is free
to use the funds in whatever fashion he chooses
until the time of repayment. In determining whether a taxpayer
enjoys "complete dominion" over a given sum, the
crucial point is not whether his use of the funds is
unconstrained during some interim period. The key is whether
the
taxpayer has some guarantee that he will be allowed to keep the
money. IPL's receipt of these deposits was
accompanied by no such guarantee.
Nor is it especially significant that these deposits could be
expected to generate income greater than the modest
interest IPL was required to pay. Again, the same could be said
of a commercial loan, since, as has been noted, a
business is unlikely to borrow unless it believes that it can
realize benefits that exceed the cost of servicing the
debt. A bank could hardly operate profitably if its earnings on
deposits did not surpass its interest obligations; but
the deposits themselves are not treated as income. 5 Any income
that the utility may earn through use of the
deposit money of course is taxable, but the prospect that income
will be generated provides no ground for taxing
the principal.
The Commissioner's advance payment analogy seems to us to
rest upon a misconception of the value of an advance
payment to its recipient. An advance payment, like the deposits
at issue here, concededly protects the seller
against the risk that it would be unable to collect money owed it
after it has furnished goods or services. But an
advance payment does much more: it protects against the risk
that the purchaser will back out of the deal before
the seller performs. From the moment an advance payment is
20. made, the seller is assured that, so long as it fulfills its
contractual obligation, the money is its to keep. Here, in
contrast, a customer submitting a deposit made no
commitment to purchase a specified quantity of electricity, or
indeed to purchase any electricity at all. 6 IPL's right
to keep the money depends upon the customer's purchase of
electricity, and upon his later decision to have the
deposit applied to future bills, not merely upon the utility's
adherence to its contractual duties. Under these
circumstances, IPL's dominion over the fund is far less
complete than is ordinarily the case in an advance-payment
situation.
The Commissioner emphasizes that these deposits frequently
will be used to pay for electricity, either because the
customer defaults on his obligation or because the customer,
having established credit, chooses to apply the deposit
to future bills rather than to accept a refund. When this occurs,
the Commissioner argues, the transaction, from a
cash-flow standpoint, is equivalent to an advance payment. In
his view this economic equivalence mandates
identical tax treatment.
Whether these payments constitute income when received,
however, depends upon the parties' rights and obligations at the
time the
payments are made. The problem with petitioner's argument
perhaps can best be understood if we imagine a loan between
parties
involved in an ongoing commercial relationship. At the time the
loan falls due, the lender may decide to apply the money owed
him to
the purchase of goods or services rather than to accept
repayment in cash. But this decision does not mean that the
loan, when made,
was an advance payment after all. The lender in effect has taken
21. repayment of his money (as was his contractual right) and has
chosen
to use the proceeds for the purchase of goods or services from
the borrower. Although, for the sake of convenience, the parties
may
combine the two steps, that decision does not blind us to the
fact that in substance two transactions are involved. 8 It is this
element of
choice that distinguishes an advance payment from a loan.
Whether these customer deposits are the economic equivalents
of advance
payments, and therefore taxable upon receipt, must be
determined by examining the relationship between the parties at
the time of the
deposit. The individual who makes an advance payment retains
no right to insist upon the return of the funds; so long as the
recipient
fulfills the terms of the bargain, the money is its to keep. The
customer who submits a deposit to the utility, like the lender in
the
previous hypothetical, retains the right to insist upon repayment
in cash; he may choose to apply the money to the purchase of
electricity, but he assumes no obligation to do so, and the utility
therefore acquires no unfettered "dominion" over the money at
the
time of receipt.
When the Commissioner examines privately structured
transactions, the true understanding of the parties, of course,
may not be
apparent. It may be that a transfer of funds, though nominally a
loan, may conceal an unstated agreement that the money is to be
applied to the purchase of goods or services. We need not, and
do not, attempt to devise a test for addressing those situations
where
22. the nature of the parties' bargain is legitimately in dispute. This
particular respondent, however, conducts its business in a
heavily
regulated environment; its rights and obligations vis-a-vis its
customers are largely determined by law and regulation rather
than by
private negotiation. That the utility's customers, when they
qualify for refunds of deposits, frequently choose to apply those
refunds to
future bills rather than taking repayment in cash does not mean
that any customer has made an unspoken commitment to do so.
Our decision is also consistent with the Tax Court's
longstanding treatment of lease deposits—perhaps the closest
analogy to the
present situation. The Tax Court traditionally has distinguished
between a sum designated as a prepayment of rent—which is
taxable
upon receipt—and a sum deposited to secure the tenant's
performance of a lease agreement. See, e.g., J. & E. Enterprises,
Inc. v.
Commissioner, 26 TCM 944 [ ¶67,191 PH Memo TC](1967). 9
In fact, the customer deposits at issue here are less plausibly
regarded as income than lease deposits would be. The [pg. 90-
399] typical lease deposit secures the tenant's fulfillment of a
contractual
obligation to pay a specified rent throughout the term of the
lease. The utility customer, however, makes no commitment to
purchase
any services at all at the time he tenders the deposit.
We recognize that IPL derives an economic benefit from these
23. deposits. But a taxpayer does not realize taxable income from
every
event that improves his economic condition. A customer who
makes this deposit reflects no commitment to purchase services,
and IPL's
right to retain the money is contingent upon events outside its
control. We hold that such dominion as IPL has over these
customer
deposits is insufficient for the deposits to qualify as taxable
income at the time they are made.
The judgment of the Court of Appeals is affirmed.
It is so ordered.
1
During the years 1974 through 1977, the total amount that
escheated to the State was less than $9,325. Stipulation of Facts
¶25.
2
The parties' stipulation sets forth the balance in IPL's
customer-deposit account on December 31 of each of the years
1954, 1974,
1975, 1976, and 1977. In his notice of deficiency, the
Commissioner concluded that IPL was required to include in
income for 1975 the
increase in the account between December 31, 1954, and
December 31, 1975. For 1976 and 1977, IPL was allowed to
24. reflect in income
the respective decreases in the account during those years.
3
This Court has held that an accrual-basis taxpayer is required
to treat advance payments as income in the year of receipt. See
Schlude v. Commissioner, 372 U.S. 128 [ 11 AFTR2d 751]
(1963); American Automobile Assn. v. United States, 367 U.S.
687 [ 7 AFTR2d 1618] (1961); Automobile Club of Michigan v.
Commissioner, 353 U.S. 180 [ 50 AFTR 1967] (1957). These
cases concerned payments—nonrefundable fees for services—
that indisputably constituted income; the issue waswhen that
income was
taxable. Here, in contrast, the issue is whether these deposits, as
such, are income at all.
4
See Illinois Power Co., 792 F.2d, at 690. See also Burke &
Friel, Recent Developments in the Income Taxation of
Individuals, Tax-Free
Security: Reflections on Indianapolis Power & Light, 12 Rev. of
Taxation of Individuals 157, 174 (1988) (arguing that
economic-benefit
approach is superior in theory, but acknowledging that "an
economic-benefit test has not been adopted, and it is unlikely
that such an
25. approach will be pursued by the Service or the courts").
5
Cf. Rev. Rul. 71-189, 1971-1 Cum. Bull. 32 (inactive deposits
are not income until bank asserts dominion over the accounts).
See
also Fidelity-Philadelphia Trust Co. v. Commissioner, 23 T.C.
527 (1954).
6
A customer, for example, might terminate service the day after
making the deposit. Also, IPL's dominion over a deposit
remains
incomplete even after the customer begins buying electricity. As
has been noted, the deposit typically is set at twice the
customer's
estimated monthly bill. So long as the customer pays his bills in
a timely fashion, the money he owes the utility (for electricity
used but
not yet paid for) almost always will be less than the amount of
the deposit. If this were not the case, the deposit would provide
inadequate protection. Thus, throughout the period the deposit
is held, at least a portion is likely to be money that IPL has no
real
assurance of ever retaining.
7
26. The Commissioner is unwilling, however, to pursue this line of
reasoning to the limit of its logic. He concedes that these
deposits would
not be taxable if they were placed in escrow, Tr. of Oral Arg. 4;
but from a cash-flow standpoint it does not make much
difference
whether the money is placed in escrow or commingled with the
utility's other funds. In either case, the utility receives the
money and
allocates it to subsequent purchases of electricity if the
customer defaults or chooses to apply his refund to a future bill.
8
The Commissioner contends that a customer's decision to take
his refund while making a separate payment for services, rather
than
applying the deposit to his bill, would amount to nothing more
than an economically meaningless "exchange of checks." But in
our view
the "exchange of checks," while less convenient, more
accurately reflects the economic substance of the transactions.
9
In J. & E. Enterprises the Tax Court stated: "If a sum is
received by a lessor at the beginning of a lease, is subject to his
unfettered
27. control, and is to be applied as rent for a subsequent period
during the term of the lease, such sum is income in the year of
receipt
even though in certain circumstances a refund thereof may be
required.... If, on the other hand, a sum is deposited to secure
the
lessee's performance under a lease, and is to be returned at the
expiration thereof, it is not taxable income even though the fund
is
deposited with the lessor instead of in escrow and the lessor has
temporary use of the money.... In this situation the
acknowledged
liability of the lessor to account for the deposited sum on the
lessee's performance of the lease covenants prevents the sum
from being
taxable in the year of receipt." 26 TCM, at 945-946.
In Rev. Rul. 72-519, 1972-2 Cum. Bull. 32, the Commissioner
relied in part on J. & E. Enterprises as authority for the
proposition
that deposits intended to secure income-producing covenants are
advance payments taxable as income upon receipt, while
deposits
intended to secure nonincome-producing covenants are not. Id.,
at 33. In our view, neither J. & E. Enterprises nor the other
cases cited
in the Revenue Ruling support that distinction. See Hirsch
29. Case Information:
HEADNOTE
1. Time for reporting income—accrual method—refundable
deposit vs. advance payments—pre-need
funeral contracts. Accrual-method funeral home corp. properly
reported monies received for Massachusetts-
regulated pre-need funeral service contracts in year services
were actually rendered, rather than in payment year
as IRS contended: following Supreme Court precedent,
payments were refundable deposits, not advance payments,
where contracts contained open-ended cancellation and refund
rights that left taxpayer without complete dominion
and control over funds. Notably, under contracts' plain language
and pursuant to Massachusetts regs], customers
controlled whether or when refund would be made; and fact that
cancellation/refund rights were rarely exercised
was irrelevant.
Reference(s): ¶ 4515.191(22) Code Sec. 451
2. Accuracy-related penalties—burden of proof and
production—substantial authority—reliance on return
preparer. Accuracy-related penalties for negligence and/or
substantial understatement were upheld to extent
applicable after Rule 155 computations against funeral home
corp. with respect to conceded items: IRS met its
burden of production as to subject items through presumptively
correct deficiency notice and taxpayer's
concessions; taxpayer showed no substantial authority for or
adequate disclosure of those items; and alleged
reliance on return preparer wasn't excuse absent proof that
preparer was given all necessary information as to
subject items.
30. Reference(s): ¶ 66,625.01(20) ; ¶ 74,915.03(3) Code Sec. 6662 ;
Code Sec. 7491
Syllabus
Official Tax Court Syllabus
P is a funeral home organized and operating in Massachusetts.
During the years in issue, P entered into
preneed funeral contracts and received payments in advance of
death for goods and services to be
provided later at the contract beneficiary's death. These
payments were refundable at the contract
purchaser's request, pursuant to State law, at any time until the
goods and services were furnished. P,
an accrual basis taxpayer, included these payments in income
not in the year of receipt but in the year
in which the goods and services were provided.
Code Sec(s): 451
Docket: Dkt. No. 14722-02.
Date Issued: 12/16/2003.
Judge: Opinion by Wherry, J.
Tax Year(s): Years 1996, 1997.
Disposition: Decision for Taxpayer in part and for
Commissioner in part.
Held: Payments received by P under its preneed funeral
31. contracts are includable in gross income only
upon the provision of the subject goods and services.
Held, further, P is liable for the sec. 6662, I.R.C., accuracy-
related penalty with respect to items
conceded by P, apart from the preneed accounting issue.
Counsel
Edward DeFranceschi, David Klemm, and Jason Bell, for
petitioner.
Louise R. Forbes, for respondent.
WHERRY, Judge
MEMORANDUM FINDINGS OF FACT AND OPINION
Respondent determined the following deficiencies and penalty
with respect to petitioner's Federal income taxes for
the calendar years 1996 and 1997:
Penalty
Year Deficiency I.R.C. Sec. 6662
---- ---------- ----------------
1996 $1,044,037 $106,877.80
1997 1,817 —
After concessions by the parties, the principal issues for
decision are: [pg. 1968]
(1) Whether payments received by petitioner under preneed
funeral contracts are includable in gross income during
the year of receipt or during the year in which the goods and
32. services are provided by petitioner; and
(2) whether petitioner is liable for the section 6662 accuracy-
related penalty. 1
FINDINGS OF FACT
Some of the facts have been stipulated and are so found. The
stipulations of the parties, with accompanying
exhibits, are incorporated herein by this reference.
Petitioner is a funeral home located at all relevant times in New
Bedford, Massachusetts. Petitioner began operations
in 1963 as a partnership and was incorporated under the laws of
the Commonwealth of Massachusetts on September
19, 1967. Brothers Thomas Perry and William Perry each own a
50-percent interest in petitioner and are funeral
directors licensed by the Commonwealth of Massachusetts.
Petitioner's Operations
Prior to and during the years in issue, petitioner entered into
preneed funeral contracts. Under these arrangements,
the contract purchaser selected, on a prospective basis, the
goods and services to be provided by petitioner at the
contract beneficiary's death. Petitioner would designate the
selected items and applicable charges on a written
form.
If the resultant balance was then paid in advance of death,
either in a lump sum or in installments, petitioner agreed
to honor the contract at death as written, without additional cost
to the purchaser or family. If the resultant
balance was to be paid through the proceeds of an insurance
policy or was left unfunded, the amount due would be
33. recalculated in accordance with the prices in effect at the time
of death.
The written form used by petitioner for these purposes was not
specific to prearranged funerals and contained no
express provisions regarding the use or refundability of amounts
received thereunder. A handwritten notation that
the contract was irrevocable was added to certain of the forms,
allegedly for reasons related to Medicaid eligibility.
Regardless of such language, however, it was petitioner's
practice to indicate to purchasers that they had the right
to cancel at any time and would receive their money back. 2
The experience of petitioner has been that only a very small
percentage of preneed contracts are in fact canceled.
The record indicates that during the period from approximately
1997 through the time of trial in 2003, six contracts
were canceled. 3 The amounts paid thereon were refunded, and
on certain occasions the refunds also included an
interest component based on “kind of a guess” about prevailing
rates.
During the years in issue, petitioner maintained a business
checking account and the following investments: A
Putnam Investments mutual fund account, a Merrill Lynch ready
asset account, Fleet Financial shares,
Massachusetts Savings Investments certificates of deposit, a
BayBank money market account, a BayBrokerage
account (for 1996 only), and a BayBank escrow account.
Moneys received pursuant to preneed contracts were
placed by petitioner in one of the investment vehicles. Upon
petitioner's provision of goods and services at the
death of a preneed contract beneficiary, an amount equal to the
purchase price of the contract was transferred
34. from the investment accounts to petitioner's checking account.
The BayBank escrow account is a compilation of accounts,
opened before 1996, each in the name of an individual
contract beneficiary. Petitioner's accountant advised
establishment of the escrow account in the early 1990s. This
account was used for the deposit of preneed receipts for a
period prior to the years in issue, until the resultant
administrative burden caused petitioner to discontinue the
practice. The balance of the BayBank escrow account as
of January [pg. 1969] 1, 1996, was $106,579.16, and those
funds are not at issue in this proceeding. The
investments other than the Baybank escrow account are held
solely in petitioner's name and list petitioner's tax
identification number.
Petitioner's Accounting and Tax Reporting
Petitioner is an accrual basis taxpayer. For accounting purposes,
petitioner records payments received pursuant to
preneed contracts as liabilities under the designation
prearranged funerals. Petitioner does not recognize as income
payments recorded on its books and records as prearranged
funerals until the tax year in which the goods and
services are provided. Petitioner does recognize interest and
dividend income earned on the investments, exclusive
of the BayBank escrow account, into which the preneed funds
are deposited.
Petitioner filed Forms 1120, U.S. Corporation Income Tax
Return, for 1996, 1997, and 1998 consistent with the
foregoing approach. Attached to each return is a Schedule L,
Balance Sheets per Books. These Schedules L reflect
as “Other investments” the following balances in petitioner's
investment vehicles, including the BayBank escrow
account:
35. Year As of Jan. 1 As of Dec. 31
---- ------------ -------------
1996 $2,270,655 $2,431,946
1997 2,431,946 2,515,217
1998 2,515,217 2,503,934
Also on the Schedules L, petitioner included in “Other current
liabilities” the following amounts for prearranged
funerals:
Year As of Jan. 1 As of Dec. 31
---- ------------ -------------
1996 $1,587,416 $1,612,272
1997 1,612,272 1,614,929
1998 1,614,929 1,543,284
Respondent on June 26, 2002, issued to petitioner the statutory
notice of deficiency underlying the present
litigation. Therein, respondent determined, inter alia, that
moneys received under preneed contracts are to be
characterized as income to petitioner in the year of receipt.
OPINION
I. Preliminary Matters
A. Burden of Proof
In general, the Commissioner's determinations are presumed
correct, and the taxpayer bears the burden of proving
otherwise. Rule 142(a). Section 7491, effective for court
proceedings that arise in connection with examinations
36. commencing after July 22, 1998, may operate, however, in
specified circumstances to place the burden on the
Commissioner. Internal Revenue Restructuring & Reform Act of
1998, Pub. L. 105-206, sec. 3001(c), 112 Stat.
727. With respect to factual issues and subject to enumerated
limitations, section 7491(a) may shift the burden
of proof to the Commissioner in instances where the taxpayer
has introduced credible evidence. Concerning penalties
and additions to tax, section 7491(c) places the burden of
production on the Commissioner.
The record in this case is not explicit as to when the underlying
examination began. 4 As regards the substantive
accounting issues, however, the Court finds it unnecessary to
decide whether the burden should be shifted under
section 7491(a). Few facts concerning how petitioner
conducted the preneed transactions are in dispute. Given
this circumstance, the record is not evenly weighted and is more
than sufficient to render a decision on the merits
based upon a preponderance of the evidence. With respect to the
penalty, because respondent on brief assumes
that section 7491(c) is applicable, the Court will do likewise.
B. Evidentiary Motion
After the trial in this case, petitioner filed a motion for the
Court to take judicial notice of the consent judgment
rendered in Commonwealth v. Deschene-Costa, C.A. [pg. 1970]
No. C03-0647 (Mass. Super. Ct. June 4, 2003). The
37. motion is made pursuant to rule 201 of the Federal Rules of
Evidence, which provides in relevant part as follows:
Rule 201. Judicial Notice of Adjudicative Facts
(a) Scope of rule.—This rule governs only judicial notice of
adjudicative facts.
(b) Kinds of facts.—A judicially noticed fact must be one not
subject to reasonable dispute in that it is
either (1) generally known within the territorial jurisdiction of
the trial court or (2) capable of accurate
and ready determination by resort to sources whose accuracy
cannot reasonably be questioned.
This Court has previously noted that “under rule 201, records of
a particular court in one proceeding commonly are
the subject of judicial notice by the same and other courts in
other proceedings”, and “Also generally subject to
judicial notice under rule 201 is the fact that a decision or
judgment was entered in a case, that an opinion was
filed, as well as the language of a particular opinion.” Estate of
Reis v. Commissioner, 87 T.C. 1016, 1027 (1986).
In the judgment that is the subject of petitioner's motion, the
defendant funeral home operator, when confronted by
the Commonwealth of Massachusetts, consented to a permanent
injunction and to payment of restitution for misuse
of funeral trust funds. Commonwealth v. Deschene-Costa,
supra. Respondent agrees that the Court may take
judicial notice of the judgment under the above-quoted
standards of rule 201 but questions the relevance of the
material. Accordingly, the Court will take judicial notice of the
existence and content of the judgment pursuant to
rule 201 but will give it only such consideration as is warranted
38. by its pertinence to the Court's analysis of
petitioner's case.
II. General Rules
A. Federal Taxation Principles
The Internal Revenue Code imposes a Federal tax on the taxable
income of every corporation. Sec. 11(a).
Section 61(a) specifies that gross income for purposes of
calculating such taxable income means “all income from
whatever source derived”. Encompassed within this broad
pronouncement are all “undeniable accessions to wealth,
clearly realized, and over which the taxpayers have complete
dominion.” Commissioner v. Glenshaw Glass Co.,
348 U.S. 426, 431 [47 AFTR 162] (1955). Stated otherwise,
gross income includes earnings unaccompanied by an
obligation to repay and without restriction as to their
disposition. James v. United States, 366 U.S. 213, 219 [7
AFTR 2d 1361] (1961).
Section 451(a) provides the following general rule regarding
the year in which items of gross income should be
included in taxable income:
The amount of any item of gross income shall be included in the
gross income for the taxable year in
which received by the taxpayer, unless, under the method of
accounting used in computing taxable
income, such amount is to be properly accounted for as of a
different period.
39. Consistent with the principle of section 451, section 446(a)
and (b) directs that taxpayers are to
compute taxable income using the method of accounting
regularly employed for keeping their books, with the
exception that “if the method used does not clearly reflect
income, the computation of taxable income shall be made
under such method as, in the opinion of the Secretary, does
clearly reflect income.” In general, the accrual method
is designated a permissible method of accounting for purposes
of section 446. Sec. 446(c)(2).
Under the accrual method, income is to be included for the
taxable year when all events have occurred that fix the
right to receive the income and the amount of the income can be
determined with reasonable accuracy. Secs.
1.446-1(c)(1)(ii), 1.451- 1(a), Income Tax Regs. Typically, all
events that fix the right to receive income have
occurred upon the earliest of the following to take place: The
income is (1) actually or constructively received; (2)
due; or (3) earned by performance. Schlude v. Commissioner,
372 U.S. 128, 133 [11 AFTR 2d 751] (1963);
Johnson v. Commissioner, 108 T.C. 448, 459 (1997), affd. in
part, revd. in part and remanded on another ground
184 F.3d 786 [84 AFTR 2d 99-5306] (8th Cir. 1999). [pg.
1971]
As caselaw applying the above standards has evolved, it has
become well established that amounts constituting
advance payments for goods or services are includable in gross
income in the year received. Schlude v.
40. Commissioner, supra; AAA v. United States, 367 U.S. 687 [7
AFTR 2d 1618] (1961); Auto. Club of Mich. v.
Commissioner, 353 U.S. 180 [50 AFTR 1967] (1957); RCA
Corp. v. United States, 664 F.2d 881 [48 AFTR 2d
81-6164] (2d Cir. 1981); see also Commissioner v. Indianapolis
Power & Light Co., 493 U.S. 203, 207 & n.3 [65
AFTR 2d 90-394] (1990).
In contrast, amounts properly characterized as loans, deposits,
or trust funds are not includable upon receipt.
Commissioner v. Indianapolis Power & Light Co., supra at 207-
208; Johnson v. Commissioner, supra at 467-475; Oak
Indus., Inc. v. Commissioner, 96 T.C. 559, 563-564 (1991);
Angelus Funeral Home v. Commissioner, 47 T.C.
391, 397 (1967), affd. 407 F.2d 210 [23 AFTR 2d 69-673] (9th
Cir. 1969). The rationale underlying this
distinction is that money received in the capacity solely of a
borrower, depository, agent, or fiduciary, because it is
accompanied by an obligation to repay or restriction as to
disposition, is not income at all. See Commissioner v.
Indianapolis Power & Light Co., supra at 208 n.3; Johnson v.
Commissioner, supra at 474-475. Hence, no question of
the timing of income accrual is presented. See Commissioner v.
Indianapolis Power & Light Co., supra at 208 n.3;
Johnson v. Commissioner, supra at 474-475.
B. State Funeral Services Regulation
Preneed contracts and arrangements in the Commonwealth of
Massachusetts are governed by the regulations of the
Board of Registration in Embalming and Funeral Directing.
41. Mass. Regs. Code tit. 239, secs. 4.01-4.10 (2003); see
also Mass. Gen. Laws Ann. ch. 112, sec. 85 (West 2003)
(authorizing the board to adopt, promulgate, and
enforce regulations). For purposes of these regulations, a “pre-
need funeral contract” is defined as “any pre- need
funeral services contract or pre-need funeral arrangements
contract, entered into in advance of death”. Mass. Regs.
Code tit. 239, sec. 4.01 (2003). A “pre-need funeral services
contract”, in turn, is:
any written agreement whereby a licensed funeral establishment
agrees, prior to the death of a named
person, to provide specifically-identified funeral goods and/or
services to that named person upon
his/her death, and which is signed by both the buyer and a duly
authorized representative of the
licensed funeral establishment. [Id.]
Similarly, “pre-need funeral arrangements contract” means:
any written arrangement between a licensed funeral
establishment and another person which establishes
a source of funds to be used solely for the purpose of paying for
funeral goods and/or services for a
named person, but which does not identify the specific funeral
goods and/or services to be furnished to
that person. [Id.]
The regulations set forth the required contents of “pre-need
funeral contracts”. Mass. Regs. Code tit. 239, sec.
4.03 (2003). As pertains to funding, contracts are to contain the
following:
A written acknowledgement, signed by the buyer, which
indicates that:
42. 1. The buyer has established a funeral trust fund pursuant to 239
CMR 4.00 and has received all
disclosures required by 239 CMR 4.06(3); or
2. The buyer has elected to purchase a pre-need insurance
policy or annuity and has received all
disclosures required by 239 CMR 4.07(2); or
3. The buyer has tendered payment in full for all funeral goods
and services specified in the contract and
has received satisfactory written evidence that those goods or
services will be furnished at time of
death; or
4. The buyer has declined to select a funding method and has
paid no money to the funeral
establishment; [Mass. Regs. Code tit. 239, sec. 4.03(1)(d)
(2003).]
A “funeral trust” within the meaning of the foregoing provision
is “a written [pg. 1972] agreement of trust whereby
funds are transferred to a named trustee with the intention that
the trustee will manage and administer those funds
for the benefit of a named beneficiary and use those funds to
pay for funeral goods and/or services to be furnished
to that named beneficiary.” Mass. Regs. Code tit. 239, sec. 4.01
(2003).
Cancellation rights likewise are specified in the regulations, as
follows:
Any buyer of a pre-need funeral contract may cancel that
contract and receive a full refund of all
43. monies paid, without penalty, at any time within ten days after
signing said contract. After the
expiration of this ten-day “cooling off period” a pre-need
funeral contract may be canceled in
accordance with 239 CMR 4.06(8). [Mass. Regs. Code tit. 239,
sec. 4.05(1) (2003).]
The referenced Mass. Regs. Code tit. 239, sec. 4.06(8) (2003)
reads, in pertinent part:
The buyer who signed a pre-need funeral contract, or his/her
legal representative, may cancel a pre-
need funeral contract with a licensed funeral establishment at
any time by sending written notice of
such cancellation, via certified mail, return receipt requested, to
said funeral establishment. If a funeral
trust has been established to fund said pre-need funeral
contract, and the licensed funeral
establishment is not the trustee, the buyer shall forward a copy
of said notice of cancellation to the
named trustee of said funeral trust.
III. Contentions of the Parties
We turn now to the parties' contentions regarding application of
the foregoing rules to petitioner's situation.
Petitioner contends that the payments received pursuant to
preneed contracts are not includable in gross income
until the underlying funeral goods and services are provided. In
support of this assertion, petitioner references three
alternative theories for exclusion. Petitioner's primary argument
is that the payments constitute nontaxable deposits
under the reasoning of Commissioner v. Indianapolis Power &
Light Co., supra. Additionally, petitioner maintains that
the amounts at issue should be characterized as trust funds akin
to those excluded from income in cases such as
44. Angelus Funeral Home v. Commissioner, supra. Petitioner's
third basis for its treatment of the payments is that even
if the amounts are found to be advance payments of income,
rather than deposits or trust funds, their deferral is
appropriate under the exception established in Artnell Co. v.
Commissioner, 400 F.2d 981 [22 AFTR 2d 5590] (7th
Cir. 1968), revg. and remanding 48 T.C. 411 (1967), to the
general rule requiring immediate inclusion of
advances.
With respect to the section 6662 penalty, petitioner argues that
the lines of cases cited above provide
substantial authority and reasonable cause for taking the
position that the funds received for preneed contracts
were not income or property of petitioner.
In contrast, respondent contends that petitioner obtained
dominion and control over the preneed funds at the time
of receipt such that the amounts are properly included in income
as advance payments under the all events test.
Respondent further argues that each of the exceptions relied
upon by petitioner is inapplicable on these facts.
Specifically, it is respondent's position that advance payments
for services to be rendered by the taxpayer are not
the equivalent of a refundable security deposit or loan and,
hence, are not controlled by the standards set forth in
Commissioner v. Indianapolis Power & Light Co., supra.
Second, respondent emphasizes that petitioner's control over
the funds and the absence of any contractual or legal
restrictions preclude treating the moneys as in trust. 5 Finally,
respondent alleges that petitioner cannot qualify for the limited
Artnell Co. v. Commissioner, supra, exception to the
all events test where there exists no certainty as to when or
45. whether petitioner will perform under the contracts.
In connection with the section 6662 penalty, respondent
disputes petitioner's assertions of substantial authority
and reasonable cause. Respondent points particularly [pg. 1973]
to the reporting by petitioner of interest on the
preneed payments, the choice to invest the funds in petitioner's
name rather than in regulated trust accounts, and
the advice petitioner received from its accountant pertaining to
the BayBank escrow account.
IV. Preneed Accounting
We first consider whether the preneed payments at issue should
be treated as deposits governed by Commissioner
v. Indianapolis Power & Light Co., 493 U.S. 203 [65 AFTR 2d
90-394] (1990). The Supreme Court in Commissioner
v. Indianapolis Power & Light Co., supra at 210, established
what is referred to as the “complete dominion” test for
identifying those payments over which the taxpayer has such
control as to render them income:
In determining whether a taxpayer enjoys “complete dominion”
over a given sum, the crucial point is not
whether his use of the funds is unconstrained during some
interim period. The key is whether the
taxpayer has some guarantee that he will be allowed to keep the
money. ***
Further, the answer to this inquiry “depends upon the parties'
rights and obligations at the time the payments are
made .” Id. at 211.
46. With respect to distinguishing between taxable advance
payments and nontaxable deposits, the Supreme Court
further explained:
An advance payment, like the deposits at issue here, concededly
protects the seller against the risk
that it would be unable to collect money owed it after it has
furnished goods or services. But an
advance payment does much more: it protects against the risk
that the purchaser will back out of the
deal before the seller performs. From the moment an advance
payment is made, the seller is assured
that, so long as it fulfills its contractual obligation, the money
is its to keep. Here, in contrast, a
customer submitting a deposit made no commitment to purchase
a specified quantity of electricity, or
indeed to purchase any electricity at all. IPL's right to keep the
money depends upon the customer's
purchase of electricity, and upon his later decision to have the
deposit applied to future bills, not merely
upon the utility's adherence to its contractual duties. ***
***
It is this element of choice that distinguishes an advance
payment * * * The individual who makes an
advance payment retains no right to insist upon the return of the
funds; so long as the recipient fulfills
the terms of the bargain, the money is its to keep. The customer
who submits a deposit to the utility
*** retains the right to insist upon repayment in cash; he may
choose to apply the money to the
purchase of electricity, but he assumes no obligation to do so,
and the utility therefore acquires no
unfettered “dominion” over the money at the time of receipt.
47. [Id. at 210- 212; fn. ref. omitted.]
This Court, in applying the reasoning of Commissioner v.
Indianapolis Power & Light Co., supra, has similarly
emphasized the importance of which party controls the
conditions under which repayment or refund of the disputed
amounts will be made. See, e.g., Herbel v. Commissioner, 106
T.C. 392, 413-414 (1996), affd. 129 F.3d 788
[80 AFTR 2d 97-8172] (5th Cir. 1997); Highland Farms, Inc. v.
Commissioner, 106 T.C. 237, 251-252 (1996);
Kansas City S. Indus., Inc. v. Commissioner, 98 T.C. 242, 262
(1992); Michaelis Nursery, Inc. v. Commissioner,
T.C. Memo. 1995-143 [1995 RIA TC Memo ¶95,143]. We have
summarized that “if the payor controls the
conditions under which the money will be repaid or refunded,
generally, the payment is not income to the recipient.”
Herbel v. Commissioner, supra at 413. “On the other hand, if
the recipient of the payment controls the conditions
under which the payment will be repaid or refunded, we have
held that the recipient has some guaranty that it will
be allowed to keep the money, and hence, the recipient enjoys
complete dominion over the payment.” Id. at 414.
[pg. 1974]
Thus, while refundability per se is insufficient for identifying
nontaxable deposits, Johnson v. Commissioner, 108
T.C. 448, 470-471 (1997), refundability within the buyer's
control and outside that of the seller is a significant
indicator under the current jurisprudence. Additionally, to the
extent that any further factual refinement is
warranted to distinguish “the Indianapolis Power & Light line
of cases” from earlier opinions discounting the
48. importance of the refundability criterion, the law classifying
amounts as nontaxable deposits is clear at least insofar
as “the taxpayer's right to retain them was contingent upon the
customer's future decisions to purchase services
and have the deposits applied to the bill.” Johnson v.
Commissioner, supra at 471.
As to other potential indicia, both the Supreme Court in
Commissioner v. Indianapolis Power & Light Co., supra, and
this Court have held that factors such as control over deposits
(i.e., absence of a trust fund), unrestricted use,
nonpayment of interest, and later application of the moneys to
services are probative but not dispositive in
evaluating the existence of complete dominion. Id. at 209-211;
Highland Farms, Inc. v. Commissioner, supra at 251;
Kansas City S. Indus., Inc. v. Commissioner, supra at 261-262;
Oak Indus., Inc. v. Commissioner, 96 T.C. 559,
569-574 (1991); Michaelis Nursery, Inc. v. Commissioner,
supra.
With respect to the facts before us, here petitioner's customers,
and not petitioner, controlled whether and when
any refund of the preneed funds would be made. The regulatory
scheme governing preneed funeral contracts
expressly affords buyers the right to cancel such contracts at
any time. Mass. Regs. Code tit. 239, secs. 4.05, 4.06
(8) (2003). Further, while Mass. Regs. Code tit. 239, sec.
4.06(8) (2003), contains a more detailed description of
the applicable cancellation procedures in the event that a
funeral trust has been established, the express text
covers preneed funeral contracts and does not limit this
cancellation right to those instances involving a funeral
49. trust. Accordingly, whether or not petitioner placed the preneed
funds in trust is not crucial to our analysis of the
refundability criterion.
In addition, in view of respondent's comments on brief
suggesting that petitioner's historical percentage of
cancellations was so low that the right should be disregarded,
we emphasize that it is the bona fide existence of
such a right, not the exercise or frequency of exercise, which
controls. Because the cancellation right is State
granted, 6 we do not face a situation where the outcome might
implicate questions concerning the nature and
legitimacy of the bargain between particular parties. Also, we
would be hard pressed to say that the right here was
illusory when cancellations did occur, and corresponding
refunds were given, in the course of petitioner's business.
The consequence of this fixed right is that, to the extent
Commissioner v. Indianapolis Power & Light Co., 493 U.S.
at 210, identifies an advance payment as one which protects
against the risk that the buyer will back out before the
seller has a chance to perform, the preneed contracts and
payments fail to serve that function. Moreover, the
practical reality of the funeral services business renders this
situation analogous to the factual scenario noted in
Johnson v. Commissioner, supra at 471, as a hallmark of those
refundable receipts clearly within the reasoning of
Commissioner v. Indianapolis Power & Light Co., supra. On
account of the open-ended, “at any time”, nature of the
cancellation right, petitioner's opportunity to perform the
designated services and in fact earn the preneed funds
(thereby eliminating the cancellation right) was contingent upon
the later choice of the decedent's survivors or
representative actually to call upon petitioner to act under the
contract.
50. The mere execution of a preneed contract did not place
petitioner in a position to fulfill the terms of the bargain. As
a [pg. 1975] practical matter, because the ultimate decision to
purchase frequently rested in the hands of third
parties, there existed in these situations what more closely
resembles a condition precedent to petitioner's right to
perform than a condition subsequent that would eliminate a
current right to so act. See Charles Schwab Corp. &
Subs. v. Commissioner, 107 T.C. 282, 293 (1996)
(distinguishing conditions precedent and subsequent in the
context of income accrual), affd. 161 F.3d 1231 [82 AFTR 2d
98-7364] (9th Cir. 1998).
The Court is satisfied that the totality of the unique
circumstances of petitioner's business brings it within the
rationale of Commissioner v. Indianapolis Power & Light Co.,
supra, and its progeny. We hold that the amounts
received by petitioner under these preneed funeral contracts are
includable in income only upon the provision of the
subject goods and services. Furthermore, given this conclusion
based upon Commissioner v. Indianapolis Power &
Light Co., supra, we need not reach petitioner's alternative
contentions regarding excludable trust funds or deferred
recognition of advance payments.
V. Section 6662 Penalty
Subsection (a) of section 6662 imposes an accuracy-related
penalty in the amount of 20 percent of any
underpayment that is attributable to causes specified in
subsection (b). Subsection (b) of section 6662 then
provides that among the causes justifying imposition of the
penalty are: (1) Negligence or disregard of rules or
51. regulations and (2) any substantial understatement of income
tax.
“Negligence” is defined in section 6662(c) as “any failure to
make a reasonable attempt to comply with the
provisions of this title”, and “disregard” as “any careless,
reckless, or intentional disregard.” Caselaw similarly states
that “`Negligence is a lack of due care or the failure to do what
a reasonable and ordinarily prudent person would do
under the circumstances.'” Freytag v. Commissioner, 89 T.C.
849, 887 (1987) (quoting Marcello v. Commissioner,
380 F.2d 499, 506 [19 AFTR 2d 1700] (5th Cir. 1967), affg. on
this issue 43 T.C. 168 (1964) and T.C.
Memo. 1964-299 [¶64,299 PH Memo TC]), affd. 904 F.2d 1011
[66 AFTR 2d 90-5322] (5th Cir. 1990), affd.
501 U.S. 868 [68 AFTR 2d 91-5025] (1991). Pursuant to
regulations, “`Negligence' also includes any failure by the
taxpayer to keep adequate books and records or to substantiate
items properly.” Sec. 1.6662-3(b)(1), Income
Tax Regs.
A “substantial understatement” is declared by section
6662(d)(1) to exist where the amount of the
understatement exceeds the greater of 10 percent of the tax
required to be shown on the return for the taxable
year or $5,000 ($10,000 in the case of a corporation). For
purposes of this computation, the amount of the
understatement is reduced to the extent attributable to an item:
(1) For which there existed substantial authority
for the taxpayer's treatment thereof, or (2) with respect to which
52. relevant facts were adequately disclosed on the
taxpayer's return or an attached statement and there existed a
reasonable basis for the taxpayer's treatment of the
item. See sec. 6662(d)(2)(B).
An exception to the section 6662(a) penalty is set forth in
section 6664(c)(1) and reads: “No penalty shall
be imposed under this part with respect to any portion of an
underpayment if it is shown that there was a
reasonable cause for such portion and that the taxpayer acted in
good faith with respect to such portion.”
Regulations interpreting section 6664(c) state:
The determination of whether a taxpayer acted with reasonable
cause and in good faith is made on a
case-by-case basis, taking into account all pertinent facts and
circumstances. *** Generally, the most
important factor is the extent of the taxpayer's effort to assess
the taxpayer's proper tax liability. *** [
Sec. 1.6664-4(b)(1), Income Tax. Regs.]
Reliance upon the advice of an expert tax preparer may, but
does not necessarily, demonstrate reasonable cause
and good faith in the context of the section 6662(a) penalty.
Id.; see also United States v. Boyle, 469 U.S.
241, 251 [55 AFTR 2d [pg. 1976] 85-1535] (1985); Freytag v.
Commissioner, supra at 888. Such reliance is not an
absolute defense, but it is a factor to be considered. Freytag v.
Commissioner, supra at 888.
In order for this factor to be given dispositive weight, the
taxpayer claiming reliance on a professional must show, at
53. minimum, that (1) the preparer was supplied with correct
information and (2) the incorrect return was a result of the
preparer's error. See, e.g., Westbrook v. Commissioner, 68 F.3d
868, 881 [76 AFTR 2d 95- 7397] (5th Cir. 1995),
affg. T.C. Memo. 1993-634 [1993 RIA TC Memo ¶93,634];
Cramer v. Commissioner, 101 T.C. 225, 251
(1993), affd. 64 F.3d 1406 [76 AFTR 2d 95-6482] (9th Cir.
1995); Ma-Tran Corp. v. Commissioner, 70 T.C.
158, 173 (1978); Pessin v. Commissioner, 59 T.C. 473, 489
(1972).
As previously indicated, section 7491(c) places the burden of
production on the Commissioner. The Commissioner
satisfies this burden by “com[ing] forward with sufficient
evidence indicating that it is appropriate to impose the
relevant penalty” but “need not introduce evidence regarding
reasonable cause, substantial authority, or similar
provisions.” Higbee v. Commissioner, 116 T.C. 438, 446
(2001). Rather, “it is the taxpayer's responsibility to raise
those issues.” Id.
The notice of deficiency issued to petitioner determined
applicability of the section 6662(a) penalty for 1996 on
account of both negligence and/or substantial understatement. 7
To the extent that we have ruled in petitioner's
favor on the accounting issue presented for decision, there can
be no underpayment or corresponding penalty
attributable thereto.
However, petitioner also conceded several other adjustments for
1996. 8 The record is entirely devoid of any
54. information regarding the circumstances surrounding
petitioner's position on these items, which include amounts
claimed for beginning inventory, cost of goods sold, legal and
professional fees, and depreciation. To the extent that
these concessions result in an underpayment, we conclude that
respondent has satisfied his burden under
section 7491(c) of production of sufficient evidence. At
minimum, nothing suggests that these errors were other
than negligent. We also note that the threshold determination of
any remaining substantial understatement is
primarily a computational matter, which we leave to the parties.
Accordingly, the burden rests on petitioner to show mitigating
circumstances such as substantial authority, a
reasonable basis, or reasonable cause. Petitioner on brief claims
to have had substantial authority, a reasonable
basis, reasonable cause, and good faith with respect to its
reporting of the preneed contract payments. In contrast,
petitioner directs no comments to the various conceded
adjustments, nor did petitioner introduce any evidence
pertaining to these items. Furthermore, although petitioner
generally points out that its returns were prepared by a
professional tax adviser, again there has been no showing
whatsoever regarding what information petitioner supplied
on the conceded items. We therefore lack grounds on which to
conclude that the incorrect return resulted from the
preparer's errors. Respondent's determination of the section
6662 penalty is sustained to the extent warranted
by computations made in accordance with our holding for
petitioner on the preneed accounting issue.
55. To reflect the foregoing,
An appropriate order will be issued, and decision will be
entered under Rule 155.
1
Unless otherwise indicated, section references are to the
Internal Revenue Code in effect for the years in issue,
and Rule references are to the Tax Court Rules of Practice and
Procedure.
2
The contractual notations were ineffective given their sham
nature and the explicit directives of Massachusetts
law discussed below. See Comdisco, Inc. v. United States, 756
F.2d 569, 576 [55 AFTR 2d 85-1006] (7th Cir.
1985) (“in general, a contract entered in violation of statutory
or regulatory law is unenforceable”).
3
The parties stipulated: “Of the pre-need funeral arrangements
in existence on January 1, 1996, six have been
cancelled. Attached hereto and marked as Exhibits 19-J through
24-J are copies of petitioner's business records
related to these pre-need arrangements.” However, the
referenced exhibits bear contract dates spanning the years
1991 to 1999 and cancellation dates spanning years 1997 to
2003.
4
Presumably, because the Form 4549-A, Income Tax
Examination Changes, contained in the record covers the 1996,
1997, and 1998 years, the audit would have begun after the
September 15, 1999, date on which petitioner's 1998
Federal income tax return appears to have been signed by the
56. return preparer. The possibility exists, however, that
the 1998 or even the 1997 audit may have been added to an
audit for 1996 already in progress. Nonetheless, as
explained in the text, we need not resolve or rely on such
speculation here.
5
Accordingly, respondent considers Rev. Rul. 87-127, 1987-2
C.B. 156, dealing with the treatment of funeral
trusts as grantor trusts of the purchaser, inapplicable here.
6
Although the early case of Angelus Funeral Home v.
Commissioner, 47 T.C. 391 (1967), affd. 407 F.2d 210
[23 AFTR 2d 69-673] (9th Cir. 1969), expressly dealt only with
whether amounts should be excluded from income as
trust funds and did not consider a deposit rationale, the facts
and result support our analysis here. In that case,
payments made under the mortuary's revised preneed contracts
were deemed taxable upon receipt (for lack of
trust), id. at 398, and would not appear to have been otherwise
excludable as deposits. The Court noted that such
refunds as the mortuary gave were made “voluntarily”, and it
“was not obligated to refund any moneys collected
pursuant to the terms of the contracts”. Id. at 394. Nor, in any
event, does it appear that the mortuary raised
refundability as a defense to accrual of the income from the
revised contracts. Id. at 397-299; see also Angelus
Funeral Home v. Commissioner, 407 F.2d at 213-214.
7
The notice also referenced substantial valuation misstatement
as an additional alternative ground, see sec.
6662(b)(3), but since valuation was not a focus of this case, we
disregard the apparent boilerplate reference.
8
58. that the likelihood that a significant contingent liability would
arise from this obligation was
quite remote (between 0% and 5%).
Unfortunately for MegaCorp, a jury disagreed. After hearing
evidence in the case, the jury
concluded that Little did indeed infringe Ideas’ patent and
awarded Ideas $5 million in
damages. As agreed, MegaCorp paid Ideas the $5 million
judgment and deducted this
payment as an ordinary and necessary business expense under §
162.
Upon audit, the IRS has disagreed with this characterization.
The IRS reclassified the $5 million
payment as a capital expenditure under § 263 and disallow the
deduction. MegaCorp has come
to you for advice. Is the IRS correct, or is MegaCorp entitled to
the deduction?
COMPOSE A TAX FILE MEMORANDUM CONCERNING
THIS ISSUE USING THESE FACTS AND THE
RESEARCH MATERIALS PROVIDED TO YOU IN THE NEXT
FEW PAGES (30 POINTS).
59. Checkpoint Contents
Federal Library
Federal Source Materials
Code, Regulations, Committee Reports & Tax Treaties
Internal Revenue Code
Current Code
Subtitle A Income Taxes §§1-1563
Chapter 1 NORMAL TAXES AND SURTAXES §§1-
1400U-3
Subchapter B Computation of Taxable Income §§61-
291
Part VI ITEMIZED DEDUCTIONS FOR
INDIVIDUALS AND CORPORATIONS §§161-199
§162 Trade or business expenses.
Internal Revenue Code
§ 162 Trade or business expenses.
(a) In general.
There shall be allowed as a deduction all the ordinary and
necessary expenses paid or incurred during the
taxable year in carrying on any trade or business, including—
(1) a reasonable allowance for salaries or other compensation
for personal services actually rendered;
(2) traveling expenses (including amounts expended for meals
and lodging other than amounts which are
lavish or extravagant under the circumstances) while away from
home in the pursuit of a trade or
business; and
(3) rentals or other payments required to be made as a condition
to the continued use or possession,
for purposes of the trade or business, of property to which the
60. taxpayer has not taken or is not taking
title or in which he has no equity.
For purposes of the preceding sentence, the place of residence
of a Member of Congress (including any
Delegate and Resident Commissioner) within the State,
congressional district, or possession which he
represents in Congress shall be considered his home, but
amounts expended by such Members within each
taxable year for living expenses shall not be deductible for
income tax purposes in excess of $3,000. For
purposes of paragraph (2) , the taxpayer shall not be treated as
being temporarily away from home during any
period of employment if such period exceeds 1 year. The
preceding sentence shall not apply to any Federal
employee during any period for which such employee is
certified by the Attorney General (or the designee
thereof) as traveling on behalf of the United States in temporary
duty status to investigate or prosecute, or
provide support services for the investigation or prosecution of,
a Federal crime.
(b) Charitable contributions and gifts excepted.
No deduction shall be allowed under subsection (a) for any
contribution or gift which would be allowable as a
deduction under section 170 were it not for the percentage
limitations, the dollar limitations, or the
requirements as to the time of payment, set forth in such
section.
(c) Illegal bribes, kickbacks, and other payments.
(1) Illegal payments to government officials or employees.
No deduction shall be allowed under subsection (a) for any
payment made, directly or indirectly, to an
official or employee of any government, or of any agency or
61. instrumentality of any government, if the
payment constitutes an illegal bribe or kickback or, if the
payment is to an official or employee of a
foreign government, the payment is unlawful under the Foreign
Corrupt Practices Act of 1977. The
burden of proof in respect of the issue, for the purposes of this
paragraph, as to whether a payment
constitutes an illegal bribe or kickback (or is unlawful under the
Foreign Corrupt Practices Act of 1977)
shall be upon the Secretary to the same extent as he bears the
burden of proof under section 7454
(concerning the burden of proof when the issue relates to fraud).
(2) Other illegal payments.
No deduction shall be allowed under subsection (a) for any
payment (other than a payment described in
paragraph (1) ) made, directly or indirectly, to any person, if the
payment constitutes an illegal bribe,
illegal kickback, or other illegal payment under any law of the
United States, or under any law of a State
(but only if such State law is generally enforced), which
subjects the payor to a criminal penalty or the
loss of license or privilege to engage in a trade or business. For
purposes of this paragraph, a kickback
includes a payment in consideration of the referral of a client,
patient, or customer. The burden of proof
in respect of the issue, for purposes of this paragraph, as to
whether a payment constitutes an illegal
bribe, illegal kickback, or other illegal payment shall be upon
the Secretary to the same extent as he
bears the burden of proof under section 7454 (concerning the
burden of proof when the issue relates to
fraud).
62. (3) Kickbacks, rebates, and bribes under medicare and
medicaid.
No deduction shall be allowed under subsection (a) for any
kickback, rebate, or bribe made by any
provider of services, supplier, physician, or other person who
furnishes items or services for which
payment is or may be made under the Social Security Act, or in
whole or in part out of Federal funds
under a State plan approved under such Act, if such kickback,
rebate, or bribe is made in connection
with the furnishing of such items or services or the making or
receipt of such payments. For purposes of
this paragraph, a kickback includes a payment in consideration
of the referral of a client, patient, or
customer.
(d) Capital contributions to Federal National Mortgage
Association.
For purposes of this subtitle, whenever the amount of capital
contributions evidenced by a share of stock
issued pursuant to section 303(c) of the Federal National
Mortgage Association Charter Act ( 12 U.S.C., Sec.
1718 ) exceeds the fair market value of the stock as of the issue
date of such stock, the initial holder of the
stock shall treat the excess as ordinary and necessary expenses
paid or incurred during the taxable year in
carrying on a trade or business.
(e) Denial of deduction for certain lobbying and political
expenditures.
(1) In general.
No deduction shall be allowed under subsection (a) for any
amount paid or incurred in connection with—
63. (A) influencing legislation,
(B) participation in, or intervention in, any political campaign
on behalf of (or in opposition to) any
candidate for public office,
(C) any attempt to influence the general public, or segments
thereof, with respect to elections,
legislative matters, or referendums, or
(D) any direct communication with a covered executive branch
official in an attempt to influence
the official actions or positions of such official.
(2) Exception for local legislation.
In the case of any legislation of any local council or similar
governing body—
(A) paragraph (1)(A) shall not apply, and
(B) the deduction allowed by subsection (a) shall include all
ordinary and necessary expenses
(including, but not limited to, traveling expenses described in
subsection (a)(2) and the cost of
preparing testimony) paid or incurred during the taxable year in
carrying on any trade or business—
(i) in direct connection with appearances before, submission of
statements to, or sending
communications to the committees, or individual members, of
such council or body with
respect to legislation or proposed legislation of direct interest to
the taxpayer, or
(ii) in direct connection with communication of information
between the taxpayer and an
64. organization of which the taxpayer is a member with respect to
any such legislation or
proposed legislation which is of direct interest to the taxpayer
and to such organization,
and that portion of the dues so paid or incurred with respect to
any organization of which the
taxpayer is a member which is attributable to the expenses of
the activities described in clauses
(i) and (ii) carried on by such organization.
(3) Application to dues of tax-exempt organizations.
No deduction shall be allowed under subsection (a) for the
portion of dues or other similar amounts paid
by the taxpayer to an organization which is exempt from tax
under this subtitle which the organization
notifies the taxpayer under section 6033(e)(1)(A)(ii) is allocable
to expenditures to which paragraph (1)
applies.
(4) Influencing legislation.
For purposes of this subsection —
(A) In general. The term “influencing legislation” means any
attempt to influence any legislation
through communication with any member or employee of a
legislative body, or with any
government official or employee who may participate in the
formulation of legislation.
(B) Legislation. The term “legislation” has the meaning given
such term by section 4911(e)(2) .
(5) Other special rules.
65. (A) Exception for certain taxpayers. In the case of any taxpayer
engaged in the trade or business
of conducting activities described in paragraph (1) , paragraph
(1) shall not apply to expenditures
of the taxpayer in conducting such activities directly on behalf
of another person (but shall apply
to payments by such other person to the taxpayer for conducting
such activities).
(B) De minimis exception.
(i) In general. Paragraph (1) shall not apply to any in-house
expenditures for any taxable
year if such expenditures do not exceed $2,000. In determining
whether a taxpayer exceeds
the $2,000 limit under this clause, there shall not be taken into
account overhead costs
otherwise allocable to activities described in paragraphs (1)(A)
and (D) .
(ii) In-house expenditures. For purposes of clause (i) , the term
“in-house expenditures”
means expenditures described in paragraphs (1)(A) and (D)
other than—
(I) payments by the taxpayer to a person engaged in the trade or
business of
conducting activities described in paragraph (1) for the conduct
of such activities on
behalf of the taxpayer, or
(II) dues or other similar amounts paid or incurred by the
taxpayer which are allocable
to activities described in paragraph (1) .
66. (C) Expenses incurred in connection with lobbying and political
activities. Any amount paid or
incurred for research for, or preparation, planning, or
coordination of, any activity described in
paragraph (1) shall be treated as paid or incurred in connection
with such activity.
(6) Covered executive branch official.
For purposes of this subsection , the term “covered executive
branch official” means—
(A) the President,
(B) the Vice President,
(C) any officer or employee of the White House Office of the
Executive Office of the President,
and the 2 most senior level officers of each of the other
agencies in such Executive Office, and
(D) (i) any individual serving in a position in level I of the
Executive Schedule under section 5312
of title 5, United States Code , (ii) any other individual
designated by the President as having
Cabinet level status, and (iii) any immediate deputy of an
individual described in clause (i) or (ii) .
(7) Special rule for Indian tribal governments.
For purposes of this subsection , an Indian tribal government
shall be treated in the same manner as a
local council or similar governing body.
(8) Cross reference.
For reporting requirements and alternative taxes related to this
subsection , see section 6033(e) .
67. (f) Fines and penalties.
No deduction shall be allowed under subsection (a) for any fine
or similar penalty paid to a government for the
violation of any law.
(g) Treble damage payments under the antitrust laws.
If in a criminal proceeding a taxpayer is convicted of a violation
of the antitrust laws, or his plea of guilty or
nolo contendere to an indictment or information charging such a
violation is entered or accepted in such a
proceeding, no deduction shall be allowed under subsection (a)
for two-thirds of any amount paid or incurred—
(1) on any judgment for damages entered against the taxpayer
under section 4 of the Act entitled “An
Act to supplement existing laws against unlawful restraints and
monopolies, and for other purposes”,
approved October 15, 1914 (commonly known as the Clayton
Act), on account of such violation or any
related violation of the antitrust laws which occurred prior to
the date of the final judgment of such
conviction, or
(2) in settlement of any action brought under such section 4 on
account of such violation or related
violation.
The preceding sentence shall not apply with respect to any
conviction or plea before January 1, 1970, or to
any conviction or plea on or after such date in a new trial
following an appeal of a conviction before such
date.
68. (h) State legislators' travel expenses away from home.
(1) In general.
For purposes of subsection (a) , in the case of any individual
who is a State legislator at any time during
the taxable year and who makes an election under this
subsection for the taxable year—
(A) the place of residence of such individual within the
legislative district which he represented
shall be considered his home,
(B) he shall be deemed to have expended for living expenses (in
connection with his trade or
business as a legislator) an amount equal to the sum of the
amounts determined by multiplying
each legislative day of such individual during the taxable year
by the greater of—
(i) the amount generally allowable with respect to such day to
employees of the State of
which he is a legislator for per diem while away from home, to
the extent such amount does
not exceed 110 percent of the amount described in clause (ii)
with respect to such day, or
(ii) the amount generally allowable with respect to such day to
employees of the executive
branch of the Federal Government for per diem while away from
home but serving in the
United States, and
(C) he shall be deemed to be away from home in the pursuit of a
trade or business on each
legislative day.
69. (2) Legislative days.
For purposes of paragraph (1) , a legislative day during any
taxable year for any individual shall be any
day during such year on which—
(A) The legislature was in session (including any day in which
the legislature was not in session for
a period of 4 consecutive days or less), or
(B) The legislature was not in session but the physical presence
of the individual was formally
recorded at a meeting of a committee of such legislature.
(3) Election.
An election under this subsection for any taxable year shall be
made at such time and in such manner as
the Secretary shall by regulations prescribe.
(4) Section not to apply to legislators who reside near capitol.
For taxable years beginning after December 31, 1980, this
subsection shall not apply to any legislator
whose place of residence within the legislative district which he
represents is 50 or fewer miles from the
capitol building of the State.
(i) Repealed.
(j) Certain foreign advertising expenses.
(1) In general.
No deduction shall be allowed under subsection (a) for any
expenses of an advertisement carried by a
foreign broadcast undertaking and directed primarily to a
market in the United States. This paragraph
70. shall apply only to foreign broadcast undertakings located in a
country which denies a similar deduction
for the cost of advertising directed primarily to a market in the
foreign country when placed with a
United States broadcast undertaking.
(2) Broadcast undertaking.
For purposes of paragraph (1) , the term “broadcast
undertaking” includes (but is not limited to) radio
and television stations.
(k) Stock reacquisition expenses.
(1) In general.
Except as provided in paragraph (2) , no deduction otherwise
allowable shall be allowed under this
chapter for any amount paid or incurred by a corporation in
connection with the reacquisition of its
stock or of the stock of any related person (as defined in section
465(b)(3)(C) ).
(2) Exceptions.
Paragraph (1) shall not apply to—
(A) Certain specific deductions. Any—
(i) deduction allowable under section 163 (relating to interest),
(ii) deduction for amounts which are properly allocable to
indebtedness and amortized over
the term of such indebtedness, or
(iii) deduction for dividends paid (within the meaning of section
561 ).
(B) Stock of certain regulated investment companies. Any
71. amount paid or incurred in connection
with the redemption of any stock in a regulated investment
company which issues only stock
which is redeemable upon the demand of the shareholder.
(l) Special rules for health insurance costs of self-employed
individuals.
(1) Allowance of deduction.
(A) In general. In the case of an individual who is an employee
within the meaning of section 401
(c)(1) , there shall be allowed as a deduction under this section
an amount equal to the applicable
percentage of the amount paid during the taxable year for
insurance which constitutes medical
care for the taxpayer, his spouse, and dependents.
(B) Applicable percentage. For purposes of subparagraph (A) ,
the applicable percentage shall be
determined under the following table:
For taxable years beginning The applicable
in calendar year -- percentage is --
1999 through 2001 60
2002 70
2003 and thereafter 100.
(2) Limitations.
(A) Dollar amount. No deduction shall be allowed under
paragraph (1) to the extent that the
amount of such deduction exceeds the taxpayer's earned income
(within the meaning of section
72. 401(c) ) derived by the taxpayer from the trade or business with
respect to which the plan
providing the medical care coverage is established.
(B) Other coverage. Paragraph (1) shall not apply to any
taxpayer for any calendar month for
which the taxpayer is eligible to participate in any subsidized
health plan maintained by any
employer of the taxpayer or of the spouse of the taxpayer. The
preceding sentence shall be
applied separately with respect to—
(i) plans which include coverage for qualified long-term care
services (as defined in section
7702B(c) ) or are qualified long-term care insurance contracts
(as defined in section 7702B
(b) ), and
(ii) plans which do not include such coverage and are not such
contracts.
(C) Long-term care premiums. In the case of a qualified long-
term care insurance contract (as
defined in section 7702B(b) ), only eligible long-term care
premiums (as defined in section 213(d)
(10) ) shall be taken into account under paragraph (1) .
(3) Coordination with medical deduction.
Any amount paid by a taxpayer for insurance to which
paragraph (1) applies shall not be taken into
account in computing the amount allowable to the taxpayer as a
deduction under section 213(a) .
73. (4) Deduction not allowed for self-employment tax purposes.
The deduction allowable by reason of this subsection shall not
be taken into account in determining an
individual's net earnings from self-employment (within the
meaning of section 1402(a) ) for purposes of
chapter 2.
(5) Treatment of certain S corporation shareholders.
This subsection shall apply in the case of any individual treated
as a partner under section 1372(a) ,
except that—
(A) for purposes of this subsection , such individual's wages (as
defined in section 3121 ) from the
S corporation shall be treated as such individual's earned
income (within the meaning of section
401(c)(1) ), and
(B) there shall be such adjustments in the application of this
subsection as the Secretary may by
regulations prescribe.
(m) Certain excessive employee remuneration.
(1) In general.
In the case of any publicly held corporation, no deduction shall
be allowed under this chapter for
applicable employee remuneration with respect to any covered
employee to the extent that the amount
of such remuneration for the taxable year with respect to such
employee exceeds $1,000,000.
(2) Publicly held corporation.
For purposes of this subsection, the term “publicly held
corporation” means any corporation issuing any
class of common equity securities required to be registered
74. under section 12 of the Securities Exchange
Act of 1934.
(3) Covered employee.
For purposes of this subsection, the term “covered employee”
means any employee of the taxpayer if—
(A) as of the close of the taxable year, such employee is the
chief executive officer of the
taxpayer or is an individual acting in such a capacity, or
(B) the total compensation of such employee for the taxable
year is required to be reported to
shareholders under the Securities Exchange Act of 1934 by
reason of such employee being among
the 4 highest compensated officers for the taxable year (other
than the chief executive officer).
(4) Applicable employee remuneration.
For purposes of this subsection —
(A) In general. Except as otherwise provided in this paragraph,
the term “applicable employee
remuneration” means, with respect to any covered employee for
any taxable year, the aggregate
amount allowable as a deduction under this chapter for such
taxable year (determined without
regard to this subsection ) for remuneration for services
performed by such employee (whether or
not during the taxable year).
(B) Exception for remuneration payable on commission basis.
The term “applicable employee