In a reviewed opinion (Bob Gregory, et ux., et al. v. Commissioner), the Tax Court has held that, for purposes of Section 468(a), dealing with establishing reserves to cover mining and solid waste reclamation and closing costs, the term "taxpayer" includes cash-method taxpayers. Accordingly, the S corporation taxpayer could currently deduct its estimated reclamation and closing costs for a landfill.

Facts

Texas Disposal Systems Landfill, Inc. (TDSL) is a cash-method taxpayer that is an S corporation and a closely held family business. TDSL operates a solid-waste disposal facility that is a modern, fully integrated-service landfill. TDSL is obligated to comply with federal, state, and local environmental regulations, which include cleaning up and restoring the landfill site when the landfill is closed in the future. The Texas Commission on Environmental Quality requires waste-disposal companies to keep a standby letter of credit for this purpose. TDSL's credit requirement had grown to just over $2 million.

In both 2008 and 2009, TDSL deducted approximately $100,000 for estimated clean-up costs under Section 468(a). The IRS disallowed the deductions, arguing that Section 468 only applies to accrual-method taxpayers, making TDSL ineligible. Neither party disputes the amounts of TDSL's deductions, only if it was entitled to the deductions at all.

Law and analysis

Section 468 allows a "taxpayer" to deduct future qualified reclamation or closing costs for mining or solid-waste disposal properties that are allocable to that tax year, but does not define taxpayer. As Section 468 did not define the term, the Court looked to Section 7701(a), which defines the term "taxpayer" as any person subject to any internal revenue tax. The Court noted that the definition is simple, broad and does not distinguish entities that use the accrual method from those that use the cash method. Further, the Court commented that taxpayer is a term that "Congress itself knows how to modify as context requires … Congress could have - as it has on numerous occasions - said 'accrual method taxpayer,' but it chose in [S]ection 468 to say 'taxpayer' instead." As Congress did not modify the term taxpayer, and nothing in Section 468 is "manifestly incompatible" with the default definition in Section 7701(a), the definition applies.

Although the Court held that the definition is unambiguous, it addressed the IRS's numerous contextual counterarguments. First, the IRS pointed to Section 461, which lists several exceptions to the general pay-before-deduct rule for cash-method taxpayers, and does not list Section 468. The Court determined that Section 461 is not an exhaustive list, as it uses the phrase "such as."

Next, the IRS argued that Section 468 uses the term "incurred" twice, which is usually used in the context of the accrual method. The Court agreed that "incurred" usually refers the accrual method and "paid" usually applies to an expense under the cash method. The Court noted, however, that Section 468 also uses the term "paid" four times, further noting that Section 162 combines the two terms by allowing deductions for ordinary and necessary expenses "paid or incurred" in a trade or business. The Court held that Section 468 uses terms that signal its application to both accrual- and cash-accounting, so "taxpayer" means "all taxpayers."

Finally, the IRS argued that Sections 468 and 468A have similar language, and Section 468A applies only to accrual-method taxpayers, so Section 468 must as well. The Court agreed that Section 468A includes a more specific definition of taxpayer, but limits the application to entities with a qualifying interest in a nuclear power plant, not based on an entity's accounting method.

In conclusion, the Court held that Section 468 apples to taxpayers regardless of accounting method so TDSL could deduct its solid waste reclamation and closing costs.

In a concurring opinion, five Tax Court judges said they view the legislative history as showing "that Congress likely intended that the [Section 468] election to set up reserves for mining and waste site reclamation costs … would be available only to accrual basis taxpayers," but nonetheless failed to "reify this intent into the text of [S]ection 468 as actually enacted."

Implications

Before this holding by the Tax Court, it generally was widely perceived that only accrual-method taxpayers could claim the Section 468 deduction. The IRS response to this case holding presently is uncertain.

———————————————