Appeal from a decision of the United States Tax Court allowing a deduction of $1,100,000 in the year transferred to a trust established for the satisfaction of contested liabilities, but created without the agreement of the persons asserting the liability. Decision reversed and remanded for recomputation of deficiency.
Kaufman, Chief Judge, Mansfield and Meskill, Circuit Judges. Mansfield, Circuit Judge, dissenting.
In 1964, Congress enacted § 461(f) of the Internal Revenue Code to achieve a more equitable and rational matching of liability disbursements and receipts for accrual basis taxpayers. It permitted deduction of a liability, even if contested, provided a transfer was made in that tax year to satisfy the claimed liability. The Internal Revenue Service, to effectuate the statutory intent and avoid potential abuse, promulgated Regulation 1.461-2(c)(1)(ii). It permitted a taxpayer to obtain a deduction by transferring money:
We are called upon the decide whether a transfer of funds to a trustee for payment of an asserted liability sometime in the future was deductible under the Regulation, although the claimants were concededly not parties to the agreement. We must also decide whether the requirement of such assent faithfully interprets the intent of the statute. We believe the Regulation plainly requires the person asserting liability to be a party to the trust agreement. Because we are convinced the Regulation contributes to the fairness of the tax structure by limiting § 461(f) to its intended scope, and is designed to forestall potential abuses, we uphold its validity. Accordingly, we reverse the Tax Court's allowance of a deduction for this payment and remand for a calculation of tax liability.
A concise narration of the facts, which are not disputed, will aid in the consideration of the legal issue. Poirier & McLane Corporation, an accrual basis taxpayer, was a contracting firm specializing in road, bridge and tunnel construction.*fn1 In January, 1956, the company received a contract from the New York City Transit Authority to reconstruct a subway tunnel and enlarge a subway station in Brooklyn. The Corporation undertook to indemnify the Transit Authority for all claims arising out of the work performed. By the time the project had been completed, several owners and tenants of property in the vicinage of the construction site had filed negligence and trespass suits against the company. The claims aggregated $581,150.
In October 1958, Poirier & McLane secured from New York State a contract to act as general contractor for the construction of a parkway in Yonkers. The agreement contained the familiar indemnification provision. Poirier & McLane engaged a subcontractor, Raymond Concrete Pile Co., to install the road support pilings. It was charged that the subcontractor performed this work improperly, and by driving pilings into an apartment building adjacent to this construction permanently damaged its foundation. In 1960, the building's owner, Bronxville-Palmer, Ltd., sued Poirier & McLane, Raymond Pile, and the State of New York for negligence and trespass seeking $14,200,000 in damages.
Although Poirier & McLane was insured for aggregate negligence claims up to $500,000, its policy did not cover liability for trespass. Consequently, the company's counsel advised that a reserve be set aside to enable Poirier & McLane to pay possible judgments on the uninsured tort claims. Poirier & McLane's accountant suggested also, that this segregation of funds could be accomplished and an immediate tax deduction taken by placing the money in a trust for the payment of asserted liabilities arising from the Yonkers and Brooklyn construction contracts. Accordingly, Poirier & McLane entered into a trust agreement with Manufacturers Hanover Trust Company. Manufacturers Hanover, as trustee, received $1,100,000 (in a certificate of deposit and Treasury bills), to be held in trust for the sole purpose of paying taxpayer's obligations on the pending claims and which were allocated in the following manner:
The Yonkers Construction $14,200,000 $900,000
The Brooklyn Construction 581,150 200,000
The agreement provided that Manufacturers Hanover would return the balance of the fund after disposition of the claims:
In its 1964 tax return, Poirier & McLane, an accrual basis taxpayer, deducted $1,100,000, on the ground that its transfer of money to the trust constituted payment of a "contested liability", deductible under 26 U.S.C. § 461(f). On January 20, 1972,*fn2 a statutory notice of deficiency was issued to Poirier & McLane, disallowing the deduction and requesting payment of $624,485.37 in additional tax. On April 14, 1972, Poirier & McLane filed a petition in the United States Tax Court, challenging the disallowance and denying the existence of a deficiency*fn3 and by a divided court it ruled against the Commissioner.*fn4
None of the claimants in any of the pending actions signed this trust agreement, nor were they notified of the existence of the trust. This failure has spawned the legal issue which caused the serious division in the Tax Court.
Judge Featherston, writing for the majority, concluded that Regulation 1.461-2(c)(1)(ii) did not require the persons asserting liability to be parties to the trust agreement. Accordingly, he allowed the deduction of the $1,100,000 placed in trust in 1964. Judge Forrester, in an opinion joined by four other judges, concurred in the result, but added that if the Regulation did contain such a requirement, they would declare that portion of the rule invalid. Judge Hall, in a dissenting opinion joined by three other judges, argued that the ...