United States v. General Dynamics Corp.
95 L. Ed. 2d 226, 1987 U.S. LEXIS 1818, 481 U.S. 239 (1987)
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Rule of Law:
Under the 'all events' test for accrual-basis taxpayers, an expense is deductible for federal tax purposes only when all events have occurred that determine the fact of liability, and the amount of the liability can be determined with reasonable accuracy. For self-insured employee medical benefits, the fact of liability is not established until a properly documented claim form is filed by the employee.
Facts:
- General Dynamics Corporation, an accrual-basis taxpayer, purchased group medical insurance for its employees from private carriers from 1962 until October 1, 1972.
- Beginning October 1, 1972, General Dynamics became a self-insurer for its medical care plans, undertaking to pay medical claims directly from its own funds while employing private carriers to administer the plans.
- To receive reimbursement for covered medical services, General Dynamics’ employees submit claims forms to personnel who verify eligibility.
- Eligible claims are then forwarded to plan administrators who review and approve covered expenses for payment.
- Due to processing time and delays in employees filing claims, there is a lag between the provision of medical services and payment by General Dynamics.
- As of December 31, 1972, General Dynamics established reserve accounts to reflect its estimated liability for medical care received by employees but not yet paid for.
Procedural Posture:
- General Dynamics initially did not deduct its medical care reserve in computing its 1972 tax.
- In 1977, after the Internal Revenue Service (IRS) began an audit of its 1972 tax return, General Dynamics filed an amended return claiming the reserve as an accrued expense and seeking a refund.
- The IRS disallowed the deduction.
- General Dynamics sought relief in the Claims Court.
- The Claims Court sustained the deduction, holding it satisfied the 'all events' test.
- The Court of Appeals for the Federal Circuit affirmed the Claims Court's decision, largely on the basis of its opinion.
- The United States sought review of whether all the events necessary to fix liability had occurred.
- The Supreme Court granted certiorari.
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Issue:
Does the 'all events' test permit an accrual-basis taxpayer to deduct an estimated liability for employee medical services already rendered, but for which claims have not yet been filed with the employer by the close of the taxable year?
Opinions:
Majority - Justice Marshall
No, the 'all events' test does not permit an accrual-basis taxpayer to deduct an estimate of liability for employee medical services already rendered if claims for those services have not yet been filed with the employer by the close of the taxable year. The Court referenced the 'all events' test from United States v. Anderson and Treas. Reg. § 1.461-1(a)(2), which requires that liability must first be firmly established, not contingent or merely an estimate of an anticipated expense. The Court disagreed with the lower courts’ conclusion that the last event necessary to fix liability was the receipt of medical care. Instead, it determined that General Dynamics’ liability arose 'only if properly documented claims forms were filed.' The failure to file a claim is not a 'mere technicality' nor an 'extremely remote and speculative possibility' like those deemed insufficient to prevent accrual in United States v. Hughes Properties, Inc. The taxpayer carries the burden of proving entitlement to a deduction, and General Dynamics failed to show that any part of its reserve represented claims for which liability was firmly established as of December 31, 1972. The Court further noted that the Internal Revenue Code specifically allows insurance companies to deduct 'incurred but not reported' (IBNR) claims under a separate provision (§ 832(b)(5)), implying that the 'all events' test does not generally permit such deductions for other entities.
Dissenting - Justice O’Connor
Yes, the 'all events' test should permit an accrual-basis taxpayer to deduct an estimate of liability for employee medical services already rendered, even if claims for those services have not yet been filed, because the obligation to pay became fixed once the medical services were provided. Justice O’Connor argued that the majority applied a rigid version of the 'all events' test, which retreats from the Court's more pragmatic application in United States v. Hughes Properties, Inc., where the speculative possibility of nonpayment did not prevent accrual. She contended that General Dynamics’ medical benefits plans created a contractual obligation to pay for covered services once they were rendered, and General Dynamics could not avoid liability by terminating the plan or firing an employee after services were received. The potential that some employees might not file claims was, in her view, merely a 'formal contingency' or 'highly improbable,' similar to the situations in United States v. Anderson (deducting a tax before assessment) and Continental Tie & Lumber Co. v. United States (including statutory income before claim or award). The dissent criticized the majority for unnecessarily widening the gap between tax and financial accounting methods.
Analysis:
This case significantly clarifies the 'fact of liability' prong of the 'all events' test, particularly for self-funded employee benefit plans. It establishes that an estimated future payout, even if actuarially probable, is not deductible for tax purposes until a specific triggering event (like filing a claim) occurs, making the liability definite. The decision highlights a divergence between prudent business accounting, which might accrue such expenses, and tax accounting, which prioritizes a more stringent definition of 'fixed' liability. This ruling limits the ability of non-insurance companies to deduct reserves for 'incurred but not reported' expenses, reinforcing the principle that a taxpayer cannot deduct an estimate of an anticipated expense based on future events, no matter how statistically certain.
