Under the "all events" test, as embodied in Treasury
Regulations, an accrual-basis taxpayer is entitled to deduct a
business expense for the taxable year in which all events have
occurred which determine the fact of the taxpayer's liability, and
in which the amount of that liability can be determined with
reasonable accuracy. In the year at issue, a consolidated federal
income tax return was filed by General Dynamics Corporation and
several of its wholly owned subsidiaries (hereafter respondent).
Respondent is an accrual-basis taxpayer whose fiscal year is the
calendar year. Beginning in 1972, it became a self-insurer with
regard to its employee medical care plan. To receive medical
payment reimbursements, employees must submit claims forms to
employee benefits personnel, who verify eligibility and forward
worthy claims to the plan's administrators, whose claims processors
review the claims and approve covered expenses for payment. To
account for the delay between the provision of medical services and
the payment of claims, respondent established reserve accounts
reflecting its liability for medical care received, but still not
paid for, as of December 31, 1972. On its amended 1972 tax return,
respondent sought a refund based on its claimed deduction of its
reserve as an accrued expense. The Internal Revenue Service
disallowed the deduction, but the Claims Court sustained it,
holding that "all events" which determined the fact of respondent's
liability had taken place when its employees received covered
services, and that the amount of liability could be determined with
reasonable accuracy. The Court of Appeals affirmed.
Held: Where the filing of claims is a condition
precedent to liability, an accrual-basis taxpayer providing medical
benefits to its employees cannot deduct at the close of the taxable
year an estimate of its obligation to pay for medical care obtained
by employees or their qualified dependents during the final quarter
of the year, claims for which have not been reported to the
employer. Pp.
481 U. S.
242-247.
(a) The proposed deduction fails the "all events" test, because
it depends on a mere estimate of respondent's liability based on
events that had not occurred before the close of the 1972 taxable
year. The last event necessary to fix respondent's liability was
not the receipt of medical
Page 481 U. S. 240
care by covered individuals, but the filing of properly
documented claims forms. Such filing is not a mere technicality,
nor is the possibility that some employees might not file claims
after receiving services "extremely remote and speculative." Pp.
481 U. S.
242-245.
(b) Respondent has not demonstrated that its liability as to any
medical care claims was firmly established as of the close of the
1972 taxable year. Although the parties stipulated that respondent
had not received claims for all services rendered during the year
by the year's end, and that some claims received had not been
processed at that time, respondent failed to show what portion of
the claims had been filed by the end of the year, or even that it
knew of specific claims that had been filed, but not yet processed.
The fact that respondent may have been able to make a reasonably
accurate actuarial estimate of how many claims would be filed for
the last quarter of 1972 cannot justify a deduction. If the "all
events" test permitted such a deduction, Congress would not have
retained 26 U.S.C. § 832(b)(5), which allows insurance
companies to deduct additions to reserves for "incurred but not
reported" claims. Pp.
481 U. S.
245-247.
773 F.2d 1224, reversed.
MARSHALL, J., delivered the opinion of the Court, in which
REHNQUIST, C.J., and BRENNAN, WHITE, POWELL, and SCALIA, JJ.,
joined. O'CONNOR, J., filed a dissenting opinion, in which BLACKMUN
and STEVENS, JJ., joined,
post, p.
481 U. S.
247.
JUSTICE MARSHALL delivered the opinion of the Court.
The issue in this case is whether an accrual-basis taxpayer
providing medical benefits to its employees may deduct at the close
of the taxable year an estimate of its obligation to pay for
medical care obtained by employees or their qualified dependents
during the final quarter of the year, claims for which have not
been reported to the employer.
Page 481 U. S. 241
I
Taxpayers, respondents herein, are the General Dynamics
Corporation and several of its wholly owned subsidiaries (General
Dynamics). [
Footnote 1] General
Dynamics uses the accrual method of accounting for federal tax
purposes; its fiscal year is the same as the calendar year. From
1962 until October 1, 1972, General Dynamics purchased group
medical insurance for its employees and their qualified dependents
from two private insurance carriers. Beginning in October, 1972,
General Dynamics became a self-insurer with regard to its medical
care plans. Instead of continuing to purchase insurance from
outside carriers, it undertook to pay medical claims out of its own
funds, while continuing to employ private carriers to administer
the medical care plans.
To receive reimbursement of expenses for covered medical
services, respondent's employees submit claims forms to employee
benefits personnel, who verify that the treated persons were
eligible under the applicable plan as of the time of treatment.
Eligible claims are then forwarded to the plan's administrators.
Claims processors review the claims and approve for payment those
expenses that are covered under the plan.
Because the processing of claims takes time, and because
employees do not always file their claims immediately, there is a
delay between the provision of medical services and payment by
General Dynamics. To account for this time lag, General Dynamics
established reserve accounts to reflect its liability for medical
care received, but still not paid for, as of December 31, 1972. It
estimated the amount of those reserves with the assistance of its
former insurance carriers.
Originally, General Dynamics did not deduct any portion of this
reserve in computing its tax for 1972. In 1977, however,
Page 481 U. S. 242
after the Internal Revenue Service (IRS) began an audit of its
1972 tax return, General Dynamics filed an amended return, claiming
it was entitled to deduct its reserve as an accrued expense, and
seeking a refund. The IRS disallowed the deduction, and General
Dynamics sought relief in the Claims Court.
The Claims Court sustained the deduction, holding that it
satisfied the "all events" test embodied in Treas.Reg. §
1.4611(a)(2), 26 CFR § 1.461-1(a)(2) (1986), since "all
events" which determined the fact of liability had taken place when
the employees received covered services, and the amount of
liability could be determined with reasonable accuracy. Thus, the
court held that General Dynamics was entitled to a refund. 6 Cl.Ct.
250 (1984). The Court of Appeals for the Federal Circuit affirmed,
largely on the basis of the Claims Court opinion. 773 F.2d 1224,
1226 (1985).
The United States sought review of the question whether all the
events necessary to fix liability had occurred. [
Footnote 2] We granted certiorari, 476 U.S.
1181 (1986). We reverse.
II
As we noted in
United States v. Hughes Properties,
Inc., 476 U. S. 593,
476 U. S. 600
(1986), whether a business expense has been "incurred" so as to
entitle an accrual-basis taxpayer to deduct it under § 162(a)
of the Internal Revenue Code, 26 U.S.C. § 162(a), is governed
by the "all events" test that originated in
United States v.
Anderson, 269 U. S. 422,
269 U. S. 441
(1926). In
Anderson, the Court held that a taxpayer was
obliged to deduct from its 1916 income a tax on profits from
munitions sales that took place in 1916. Although the tax would not
be assessed, and therefore would not formally be due until 1917,
all the events which fixed the amount of the tax and determined the
taxpayer's liability to pay it
Page 481 U. S. 243
had occurred in 1916. The test is now embodied in Treas.Reg.
§ 1.461-1(a)(2), 26 CFR § 1.461-1(a)(2) (1986), which
provides that
"[u]nder an accrual method of accounting, an expense is
deductible for the taxable year in which all the events have
occurred which determine the fact of the liability and the amount
thereof can be determined with reasonable accuracy. [
Footnote 3]"
It is fundamental to the "all events" test that, although
expenses may be deductible before they have become due and payable,
liability must first be firmly established. This is consistent with
our prior holdings that a taxpayer may not deduct a liability that
is contingent,
see Lucas v. American Code Co.,
280 U. S. 445,
280 U. S. 452
(1930), or contested,
see Security Flour Mills Co. v.
Commissioner of Internal Revenue, 321 U.
S. 281,
321 U. S. 284
(1944). Nor may a taxpayer deduct an estimate of an anticipated
expense, no matter how statistically certain, if it is based on
events that have not occurred by the
Page 481 U. S. 244
close of the taxable year.
Brown v. Helvering,
291 U. S. 193,
291 U. S. 201
(1934);
cf. American Automobile Assn. v. United States,
367 U. S. 687,
367 U. S. 693
(1961).
We think that this case, like
Brown, involves a mere
estimate of liability based on events that had not occurred before
the close of the taxable year, and therefore the proposed deduction
does not pass the "all events" test. We disagree with the legal
conclusion of the courts below that the last event necessary to fix
the taxpayer's liability was the receipt of medical care by covered
individuals. [
Footnote 4] A
person covered by a plan could only obtain payment for medical
services by filling out and submitting a health expense benefits
claim form. App. 23. Employees were informed that submission of
satisfactory proof of the charges claimed would be necessary to
obtain payment under the plans.
Id. at 58. General
Dynamics was thus liable to pay for covered medical services only
if properly documented claims forms were filed. [
Footnote 5] Some covered individuals, through
oversight, procrastination, confusion over the coverage provided,
or fear of disclosure to the employer of the extent or nature of
the services received, might not file claims for reimbursement to
which they are plainly entitled. Such filing is not a mere
technicality. It is crucial to the establishment of liability on
the part of the taxpayer. Nor does the failure to file a claim
represent the type of "extremely remote and speculative
possibility" that we
Page 481 U. S. 245
held in
Hughes, 476 U.S. at
476 U. S. 601,
did not render an otherwise fixed liability contingent.
Cf.
Lucas v. North Texas Lumber Co., 281 U. S.
11,
281 U. S. 13
(1930) (where executory contract of sale was created in 1916 but
papers necessary to effect transfer were not prepared until 1917,
unconditional liability for the purchase price was not created in
1916, and the gain from the sale was therefore not realized until
1917). Mere receipt of services for which, in some instances,
claims will not be submitted does not, in our judgment, constitute
the last link in the chain of events creating liability for
purposes of the "all events" test.
The parties stipulated in this case that, as of December 31,
1972, the taxpayer had not received all claims for medical
treatment services rendered in 1972, and that some claims had been
filed for services rendered in 1972 that had not been processed.
App. 26. The record does not reflect which portion of the claims
against General Dynamics for medical care had been filed but not
yet processed and which portion had not even been filed at the
close of the 1972 tax year. The taxpayer has the burden of proving
its entitlement to a deduction.
Helvering v. Taylor,
293 U. S. 507,
293 U. S. 514
(1935). Here, respondent made no showing that, as of December 31,
1972, it knew of specific claims which had been filed but which it
had not yet processed. Because the taxpayer failed to demonstrate
that any of the deducted reserve represented claims for which its
liability was firmly established as of the close of 1972, all the
events necessary to establish liability were not shown to have
occurred, and therefore no deduction was permissible.
This is not to say that the taxpayer was unable to forecast how
many claims would be filed for medical care received during this
period, and estimate the liability that would arise from those
claims. Based on actuarial data, General Dynamics may have been
able to make a reasonable estimate of how many claims would be
filed for the last quarter of 1972. But that alone does not justify
a deduction. In
Brown, supra,
Page 481 U. S. 246
the taxpayer, a general agent for insurance companies, sought to
take a deduction for a reserve representing estimated liability for
premiums to be returned on the percentage of insurance policies it
anticipated would be cancelled in future years. The agent may well
have been capable of estimating with a reasonable degree of
accuracy the ratio of cancellation refunds to premiums already
paid, and establishing its reserve accordingly. Despite the "strong
probability that many of the policies written during the taxable
year" would be cancelled, 291 U.S. at
291 U. S. 201,
the Court held that
"no liability accrues during the taxable year on account of
cancellations which it is expected may occur in future years, since
the events necessary to create the liability do not occur during
the taxable year."
Id. at
291 U. S. 200.
A reserve based on the proposition that a particular set of events
is likely to occur in the future may be an appropriate conservative
accounting measure, but does not warrant a tax deduction.
See
American Automobile Assn. v. United States, supra, at
367 U. S. 692;
Lucas v. American Code Co., 280 U.S. at
280 U. S.
452.
That these estimated claims were not intended to fall within the
"all events" test is further demonstrated by the fact that the
Internal Revenue Code specifically permits insurance companies to
deduct additions to reserves for such "incurred but not reported"
(IBNR) claims.
See 26 U.S.C. § 832(b)(5) (providing
that an insurance company may treat as losses incurred "all unpaid
losses outstanding at the end of the taxable year"); §
832(c)(4) (permitting deduction of losses incurred as defined in
§ 832(b)(5)). [
Footnote 6]
If the "all events" test permitted the deduction of an estimated
reserve representing claims that were actuarially likely but not
yet reported, Congress would not have needed to maintain an
Page 481 U. S. 247
explicit provision that insurance companies could deduct such
reserves. [
Footnote 7]
General Dynamics did not show that its liability as to any
medical care claims was firmly established as of the close of the
1972 tax year, and is therefore entitled to no deduction. The
judgment of the Court of Appeals is
Reversed.
[
Footnote 1]
Respondents filed a consolidated federal income tax return for
1972, the year at issue here. We therefore treat them as a single
entity.
[
Footnote 2]
The United States did not seek review of whether the amount of
liability in this case could be determined with reasonable
accuracy.
See Pet. for Cert. 13, n. 2.
[
Footnote 3]
The regulation in force in 1972 was identical to the present
version.
See 26 CFR § 1.461-1(a)(2) (1972).
The "all events" test has been incorporated into the Internal
Revenue Code by the Deficit Reduction Act of 1984, Pub.L. 98-369,
98 Stat 598, 607, 26 U.S.C. § 461(h)(4) (1982 ed., Supp. III).
Section 461(h) imposed limits on the application of the test,
providing that,
"in determining whether an amount has been incurred with respect
to any item during any taxable year, the all events test shall not
be treated as met any earlier than when economic performance with
respect to such item occurs."
§ 461(h)(1). The pertinent portions of the 1984 amendments
were retained in the Tax Reform Act of 1986.
Section 461(h) does not apply in this case. It became effective
as of July 18, 1984, the date of the enactment of the Deficit
Reduction Act.
See § 91(g)(1)(A), 26 U.S.C. §
461 note (1982 ed., Supp. III). While that statute permits a
taxpayer to elect the application of § 461(h) to amounts
incurred on or before July 18, 1984,
see § 91(g)(2),
there is no indication that the taxpayer here has done so. We do
not address how this case would be decided under § 461(h), but
note that the legislative history of the Act indicates that,
"[i]n the case of . . . employee benefit liabilities, which
require a payment by the taxpayer to another person, economic
performance occurs as the payments to such person are made."
H.R.Rep. No. 98-432, pt. 2, p. 1255 (1984);
see also
H.Conf.Rep. No. 98-861, p. 872 (1984).
[
Footnote 4]
We do not challenge the Claims Court's factual conclusion that
the processing of the claims was "routine," "clerical," and
"ministerial in nature," 6 Cl.Ct. 250, 254 (1984). The Claims Court
did not, however, make any factual findings with respect to the
filing of claims. We conclude that, as a matter of law,
the filing of a claim was necessary to create liability.
[
Footnote 5]
General Dynamics could not avoid its obligation to pay for
services after they were received by, for example, discharging the
employee. If an employee were terminated after receiving covered
services but before filing a claim, the taxpayer would still be
obliged to reimburse that employee, App. 22 -- but
only in the
event that the employee filed a claim form. The filing of the
claim is thus a true condition precedent to liability on the part
of the taxpayer.
[
Footnote 6]
During the time that private insurance carriers provided
insurance coverage for General Dynamics employees, the insurers
maintained reserves for IBNR claims and deducted those reserves in
the tax year in which the services were received. 6 Cl.Ct. at
262.
[
Footnote 7]
Respondent has never sought to be treated as an insurance
company entitled to take IBNR deductions under the provisions of
Subchapter L.
JUSTICE O'CONNOR, with whom JUSTICE BLACKMUN and JUSTICE STEVENS
join, dissenting.
Section 446(a) of the Internal Revenue Code of 1954 provides
that taxable income
"shall be computed under the method of accounting on the basis
of which the taxpayer regularly computes his income in keeping his
books."
The Code specifically recognizes the use of "an accrual method,"
26 U.S.C. § 446(c)(2), under which a taxpayer is permitted to
deduct an expense in the year in which it is "incurred," regardless
of when it is actually paid. § 162(a). Under the "all events"
test, long applied by this Court and the Internal Revenue Service,
an expense may be accrued and deducted when all the events that
determine the fact of liability have occurred, and the amount of
the liability can be determined with reasonable accuracy.
Treas.Reg. § 1.461-1, 26 CFR § 1.461-1(a)(2) (1986).
Because the Court today applies a rigid version of the "all events"
test that retreats from our most recent application of that test,
and unnecessarily drives a greater wedge between tax and financial
accounting methods, I respectfully dissent.
This case calls for the Court to revisit the issue addressed
only last Term in
United States v. Hughes Properties,
Inc., 476 U. S. 593
(1986). At issue in
Hughes Properties was whether a casino
operator utilizing the accrual method of accounting could deduct
amounts guaranteed for payment on "progressive" slot machines, but
not yet won by a playing
Page 481 U. S. 248
patron. A progressive slot machine has a jackpot whose size
increases as money is gambled on the machine. Under Nevada law, a
casino operator is prohibited from reducing the amount of the
progressive jackpot. We concluded, therefore, that all the events
had occurred that determine the fact of the casino operator's
liability, despite the fact that the jackpot might not be won for
as long as four years. We rejected the argument made by the United
States that the casino operator's obligation to pay the jackpot
arose only upon a winning patron's pull of the handle, even though
it was conceivable that the jackpot might never be won:
"There is always a possibility, of course, that a casino may go
out of business, or surrender or lose its license, or go into
bankruptcy, with the result that the amounts shown on the jackpot
indicators would never be won by playing patrons. But this
potential nonpayment of an incurred liability exists for every
business that uses an accrual method, and it does not prevent
accrual.
See, e.g., Wien Consolidated Airlines, Inc. v.
Commissioner, 528 F.2d 735 (CA9 1976). 'The existence of an
absolute liability is necessary; absolute certainty that it will be
discharged by payment is not.'
Helvering v. Russian Finance
& Constr. Corp., 77 F.2d 324, 327 (CA2 1935)."
United States v. Hughes Properties, Inc., supra, at
476 U. S.
605-606.
In my view, the circumstances of this case differ little from
those in
Hughes Properties. The taxpayer here is seeking
to deduct the amounts reserved to pay for medical services that are
determined to have been provided to employees in the taxable year,
whether or not the employees' claims for benefits have been
received. The taxpayer's various medical benefits plans provided
schedules for the medical and hospital benefits, and created a
contractual obligation by the taxpayer to pay for the covered
services upon presentation of a claim. The courts below found that
the obligation to pay became fixed once the covered medical
services were received
Page 481 U. S. 249
by the employee.
See App. 25. Once the medical services
were rendered to an employee while the relevant benefit plan was in
effect, General Dynamics could not avoid liability by terminating
the plan prior to the filing of a claim.
Id. at 133-134.
Neither could General Dynamics extinguish its liability by firing
an employee before the employee filed a claim for benefits.
Id. at 87.
It is true, of course, that it was theoretically possible that
some employees might not file claim forms. In my view, however,
this speculative possibility of nonpayment differs not at all from
the speculation in
Hughes Properties that a jackpot might
never be paid by a casino. As we observed in
Hughes
Properties, the potential of nonpayment of a liability always
exists, and it alone does not prevent accrual. The beneficiary of a
liability always has the option of waiving payment, but a taxpayer
is still unquestionably entitled to deduct the liability. An
injured employee entitled absolutely to reimbursement for medical
services under a workers' compensation statute, for example, may
fail to utilize the medical services. The employer, however, has
been held to be entitled to deduct the expected medical expenses,
because the workers' compensation law creates liability.
See
Wien Consolidated Airlines, Inc. v. Commissioner, 528 F.2d 735
(CA9 1976) (holding that accrual basis taxpayer may deduct expected
workers' compensation payments in year of injury even though
injured workers may not utilize medical benefits). Similarly, any
business liability could ultimately be discharged in bankruptcy, or
a check might never be cashed by its recipient. There can be no
doubt, however, that these remote possibilities alone cannot defeat
an accrual basis taxpayer's right to deduct the liability when
incurred.
The Claims Court found that the processing of the employees'
claims was "routine," and "ministerial in nature," 6 Cl.Ct. 250,
254 (1984), and the majority does not question that finding.
Ante at
481 U. S. 244,
n. 4. Instead, the majority holds that "as a matter of law, the
filing of a claim was necessary
Page 481 U. S. 250
to create liability."
Ibid. Even if, in a technical
sense, the Court is correct that the filing of a claim is a
necessary precondition to liability as a matter of law, the failure
to file a claim is, at most, a "merely formal contingenc[y], or
[one] highly improbable under the known facts," that this Court has
viewed as insufficient to preclude accrual and deductability. 2 J.
Mertens, Law of Federal Income Taxation § 12.62, p. 241 (M.
Weinstein, R. Donovan, P. Gaveras, H. Piech, & R. Neeld
rev.1985). Indeed, in the very case that first announced the "all
events" test,
United States v. Anderson, 269 U.
S. 422 (1926), this Court concluded that a taxpayer
should deduct a federal munitions tax before the year in which the
tax was even assessed -- in effect before the Government had made a
claim for the tax. The Court recognized that, "[i]n a technical
legal sense, it may be argued that a tax does not accrue until it
has been assessed and becomes due," but concluded that otherwise
all the events that determined the liability for the munitions tax
had occurred.
Id. at
269 U. S. 441.
Similarly, in
Continental Tie & Lumber Co. v. United
States, 286 U. S. 290
(1932), the Court held that an accrual basis taxpayer should
immediately include as income a federal payment to railroads
created by statute, but neither claimed by the taxpayer nor awarded
by the Federal Government until years later. The Court explained
that, although no railroad had any vested right to payments under
the statute until a claim was made by the railroad and awarded by
the Interstate Commerce Commission,
"[t]he right to the award was fixed by the passage of the
Transportation Act. What remained was mere administrative procedure
to ascertain the amount to be paid."
Id. at
286 U. S. 295.
Clearly, the right to reimbursement for medical benefits under any
of the medical benefits plans at issue in this case arises once
medical services are rendered; the filing and processing of a claim
is purely routine and ministerial, and in the nature of a formal
contingency, as correctly perceived by the courts below.
Page 481 U. S. 251
The holding of the Court today unnecessarily burdens taxpayers
by further expanding the difference between tax and business
accounting methods without a compelling reason to do so. Obviously,
tax accounting principles must often differ from those of business
accounting. The goal of business accounting "is to provide useful
and pertinent information to management, shareholders, and
creditors," while "the responsibility of the Internal Revenue
Service is to protect the public fisc."
United States v. Hughes
Properties, Inc., 476 U.S. at
476 U. S. 603.
Therefore, while prudent businesses will accrue expenses that are
merely reasonably foreseeable, for tax purposes, the liability must
be fixed. But Congress has expressly permitted taxpayers to use the
accrual method of accounting, and from its inception in
United
States v. Anderson, supra, the "all events" test has been a
practical adjustment of the competing interests in permitting
accrual accounting and protecting the public fisc. Unfortunately,
the Court today ignores the pragmatic roots of the "all events"
test, and instead applies it in an essentially mechanistic and
wholly unrealistic manner. Because the liability in this case was
fixed with no less certainty than the range of expenses both
routinely accrued by accrual method taxpayers and approved as
deductible for tax purposes by this Court and other courts in a
variety of circumstances, I respectfully dissent.