In the Arthur Conan Doyle short story, Silver Blaze, fictional detective Sherlock Holmes solved the case by inferring intent from silence—the significance of a dog who didn’t bark.
In a tax court case this week (149 T.C. No. 2, Gregory), internal revenue code section 468, which deals with reclamation and closing costs for mines and landfills, is silent as to the definition of the term “taxpayer.”
The question is whether the deduction allowed in code section 468 applies to cash basis taxpayers, who generally deduct expenses (including noncash expenses) in the tax year in which the expense is paid, or only to taxpayers who use the accrual method and deduct expenses in the year in which they are incurred.
The taxpayer used the cash basis when preparing federal income tax returns, and claimed the deduction. The IRS says the deduction is only available to taxpayers who use the accrual method.
One argument presented by the IRS is based on the use of a single word in code section 468.
Here’s the wording the IRS points to:
From code section 468(d)(2)(A): Mining reclamation and closing costs are defined as “[a]ny expenses incurred for any land reclamation or closing activity which is conducted in accordance with a reclamation plan.”
From code section 468(d)(2)(B): Solid-waste disposal and closing costs are defined as “[a]ny expense incurred for any land reclamation or closing activity in connection with any solid-waste disposal site.”
The court pointed out a problem with the IRS’s argument by highlighting the code’s use of a different word.
Here’s the wording the court says doesn’t help the IRS:
From code section 468(a)(2)(C): Reserve to be charged for amounts paid.—Any amount paid by the taxpayer during any taxable year for qualified reclamation or closing costs allocable to portions of the reserve property for which the election under paragraph (1) was in effect shall be charged to the appropriate reserve as of the close of the taxable year.
From code section 468(a)(3): Allowance of deduction for excess amounts paid.—There shall be allowed as a deduction for any taxable year the excess of– (A) the amounts described in paragraph (2)(C) paid during such taxable year, over (B) the closing balance of the reserve for such taxable year.
Based on the above definition of cash and accrual,
what are the two specific words that point
to either a cash basis or an accrual basis taxpayer?
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The words are “incurred” and “paid.”
The IRS argues that the term “incurred” in section 468–which the IRS says is usually used in the context of the accrual method–shows that section 468 was meant to apply only to accrual-method taxpayers.
Section 468 uses the term “incurred” twice.
We agree with the IRS that “incurred” often refers to an expense that is deductible under the accrual method while the word “paid” often refers to an expense that is deductible under the cash method. The supreme court itself has said “incurred” in this context refers to the accrual method. The court also noted that the term “paid” (specifically in section 162) refers to the cash method.
There’s a problem, though, with the IRS’s argument that “incurred” is a subtle signal that “taxpayer” in section 468 must mean “accrual method taxpayer”—section 468 also uses the term “paid” four times.
Section 468 uses terms that signal its application to both accrual- and cash-accounting. Reading “taxpayer” in section 468 to mean “all taxpayers”–even if this creates a current deduction for a future expense–just means that this section creates another exception to a general rule for cash-method taxpayers.
The code and regulations are filled with general rules and exceptions to them. So this argument doesn’t help the IRS.
Editorial Note: The court decided the case for the taxpayer, stating that the term “taxpayer” in section 468 includes cash-method taxpayers, and adding that “since section 468 itself doesn’t define the term, we hold that the general definition under section 7701(a)(14) applies. The taxpayer is eligible to currently deduct its estimated clean-up costs under section 468, and the taxpayer may claim those deductions on their returns.”