Kunzig, Judge,
delivered the opinion of the court.
This income tax refund case comes before the court on appeal from the Trial Division where findings and an opinion were filed April 1, 1975 by Trial Judge George Willi, pursuant to Buie 134(h). His decision has been reviewed on the briefs, exceptions, and oral argument of counsel. Upon consideration thereof, the court finds itself in agreement with portions of that recommended decision and reaches essentially the same result on major sections of the case, although we base our opinion on somewhat different legal reasoning. Most of the Trial Judge's findings of fact are adopted, but with some modifications we deem proper upon consideration of exceptions by the parties.
Plaintiff and defendant contest the proper timing for plaintiff's deduction of payroll tax expenses. Plaintiff is an accrual basis taxpayer using calendar year reporting periods. The tax expenses arose in connection with three different types of compensation payments made to plaintiff's employees in 1965: (1) "year-end" wages, (2) bonuses, and (3) vacation pay. Plaintiff attempts to deduct such tax expenses in 1964, the year that the underlying compensation obligations accrued. Defendant asks us to conclude that plaintiff could not deduct the tax expenses until this underlying compensation was actually paid in 1965. The classic "all events" test must be 'applied in the instant case to determine the proper timing for plaintiff's tax expense deductions. Applying this test, we hold that plaintiff may deduct in its 1964 return those taxes corresponding to the "year-end" wages accrued in 1964, but plaintiff may not deduct payroll taxes on accrued bonuses and vacation pay until its 1965 return.
The payroll tax expenses at issue here involve Kodak's payments under the Federal Insurance Contributions Act (FICA), the Federal Unemployment Tax Act (FUTA), and various state unemployment taxes.
The compensation paid by plaintiff which gave rise to the taxes and, thus, the tax expense deductions involved in the instant action, takes three forms. The first type is "year-end" wages. Wages earned during the last week of 1964 "accrued" as of the end of 1964, but were not paid until the first week of 1965. Kodak wants to deduct the payroll taxes on such "year-end" accrued wages in 1964.
Second, at the end of each year, plaintiff declared cash bonuses in favor of its employees. The right to receive this special compensation vested in employees at the end of 1964, but the bonuses were not payable until March 1965. Again, plaintiff desires a 1964 tax expense deduction. Since liability accrued in 1964, reasons plaintiff, the liability for tax should similarly accrue and yield a 1964 payroll tax expense deduction.
Third, as of the end of 1984, various of plaintiff's employees had earned the right to paid vacations to be taken in 1965. An employee's right to vacation pay vested in 1964 despite the fact that payment would not take place until the following year. Again, since plaintiff's liability for the vacation pay accrued in 1964, it would like to deduct the corresponding payroll tax expense on its 1964 return.
Both parties agree that plaintiff properly 'accrued and deducted the three types of compensation at the time its liability for the payments became fixed in 1964. They disagree on the proper year for deducting the payroll tace payments made to Government agencies as a result of the compensation payments. Plaintiff argues that its liability for all three types of compensation accrued in 1964, and the tax payments should be deducted in the same return.
The Internal Revenue Service (IRS) concluded that plaintiff was not entitled to deduct the payroll tax expense on the 1964 tax return and assessed a deficiency. Plaintiff paid the deficiency, filed a refund claim and by timely petition in this court, brought the present action after the IRS disallowed the claim.
Kodak makes a "five prong" assault on defendant's denial of the 1964 payroll tax expense deductions. First, since it consistently matched wage expense and payroll tax expense without challenge by the IRS during prior years, plaintiff claims that defendant cannot now complain of its tax accounting treatment of the payroll tax expenses. Second, Kodak contends the generally accepted principles of accounting should be adopted in this case. The payroll tax expenses which arise from the wages should be "matched" with the wages for tax accounting purposes. Third, the matching and allocation principles enumerated in J.I. Case Co. v. United States, 106 Ct. Cl. 267, 65 F. Supp. 464 (1946) are, according to plaintiff, applicable in the present case to grant it a 1964 deduction. Fourth, Kodak relies upon the "all events" test to claim 1964 deductions for the payroll taxes at issue here. Finally, plaintiff claims that it will be the victim of a double denial of the payroll tax expenses at issue here if defendant's position is upheld.
Of all five arguments, only number four, Kodak's advocacy of the "all events" test, is applicable here.
First, despite the fact that plaintiff has consistently matched compensation and the related payroll taxes in its tax accounting, it cannot assert any right to continue such treatment from the mere failure of the IKS to challenge such practice in past years. At best, plaintiff's consistency is inconclusive. Electric & Neon, Inc. v. Commissioner, 56 T.C. 1324, 1333 (1971); Miffin v. Commissioner, 24 T.C. 973, 979 (1955). Plaintiff must show not only that its treatment of the payroll tax expenses has been consistent, but also that it is correct.
Plaintiff's second argument, that generally accepted principles of accounting favor matching the compensation and the payroll tax may be sound from a business accounting standpoint. However, tax accounting differs in many material respects from business accounting. One such area of divergence is the "matching" principle which plaintiff urges upon us in this case. Cf. American Automobile Association v. United States, 367 U.S. 687, 694-97 (1961). To obtain a deduction, plaintiff must show that tax accounting principles, not business practice, require such treatment.
We also cannot give credence to plaintiff's third argument, that the principles of J.I. Case Co., supra, create a 1964 payroll tax deduction in this instance. In Case we held that the taxpayer could deduct property taxes allocable to a short fiscal year since the taxpayer's income could not otherwise be accurately reflected. However, Case stemmed primarily from the nature of the taxpayer's short and nonrecurring fiscal year. We do not have such a situation in the facts at bar, and hold J.I. Case Co. inapposite.
Plaintiff's fourth 'argument, that the "all events" test applies to the instant facts to give a 1964 deduction, while not technically correct in all respects, is more true to the mark. Here Kodak has hit upon the proper test, but would have us apply that test in a legally erroneous manner.
A tax wliicli accrues in an earlier year but is not paid until the following year may be deducted in the prior year if it meets the "all events" test established by the Supreme Court in United States v. Anderson, 269 U.S. 422 (1926). If all events which determine liability and fix the amount of the tax occur before the end of the prior year, a deduction is available to an accrual basis taxpayer.
In a technical sense it may be argued that a tax does not accrue u/ntil it has been assessed and becomes due; but it is also true that in advance of the assessment of a tax, all the events may occur which fix the amownt of the tax and determine the liability of the taxpayer to pay.it. In this respect for purposes of accounting and ascertaining true income for a given accounting period, the munitions tax in question here did not stand on any different footing than other accrued expenses appearing on ap-pellee's books. Id. at 441. (Emphasis added).
The "all events" test has been applied frequently and regularly in this court and other jurisdictions to determine proper timing for tax expense deductions. See, e.g., United States v. Consolidated Edison Co., 366 U.S. 380, 385 n. 5 (1961); Clevite Corp. v. United States, 181 Ct. Cl. 652, 658, 386 F. 2d 841, 843 (1967); Turtle Wax, Inc. v. Commissioner, 43 T.C. 460, 466-67 (1965); Denver & Rio Grande Western Railroad Co. v. Commissioner, 38 T.C. 557, 572 (1962). Most recently, we applied the "all events" test in Union Pacific Railroad Co. v. United States, 208 Ct. Cl. 1, 524 F. 2d 1343 (1975). We held that the test applied to determine de-ductibility of payroll taxes, similar to those in the instant case, which stemmed from accrued vacation pay. In Union Pacific we concluded that plaintiff was not entitled to deduct payroll taxes in the earlier year because "all events" fixing liability for the tax had not occurred in this prior year. It must be reemphasized that we used the "dll events" test to reach this result.
The "all events" test has become so accepted that it is now embodied in the Income Tax Regulations.
Under an accrual method of accounting, an expense is deductible for the taxable year in which all events have occurred which determine the fact of liability and the amount thereof can be determined with reasonable accuracy. Treas. Keg. § 1.461-1 (a) (2) (1970). (Originally promulgated in 1957, 1958-1 Cum. Bull. 215 (1957)).
Normally we would proceed directly to apply the "all events" test to the facts of the instant situation in order to determine the proper deduction time for the tax expense at issue here. However, defendant argues that the recent Supreme Court decision in Otte v. United States, 419 U.S. 43 (1974) requires us to hold that payroll taxes are not deductible until the underlying compensation is paid. Therefore, we must first ascertain the impact of Otte on the "all events" test.
The Otte decision relied upon by defendant is a bankruptcy case. The specific portion of the case which defendant would have us use instead of the "all events" test concerned the filing of proofs of the bankruptcy claim. The general rule in the bankruptcy setting is that in order to obtain a share of the bankrupt's estate, proof of claim against the bankrupt must be filed within six months of the initial bankruptcy court order. In Otte, neither the United States nor New York City had filed proof of payroll tax liability on the part of the bankrupt. The bankruptcy trustee argued that the taxes could not be recovered from the estate because of this failure to file notice of the tax claim. The government instru-mentalities contended otherwise. The Supreme Court held in favor of the governments. Reasoning that "[liability for the tax accrues only when the wage is paid," the Court excused both the United States and New York City from the filing requirement.
In the instant case, defendant argues that Otte either overrules the "all events" test in the payroll tax area, or it presents an "ultimate application" of the test. For several reasons we reject such arguments.
First on a fundamental level, the Otte decision rests on bankruptcy law, the "all events" test on tax accounting principles. Otte never addressed the timing of "accrual" in the tax setting. We simply cannot presume that a bankruptcy decision overrules, sub silentio, tax accounting principles established by the Supreme Court some fifty years ago and consistently applied by courts, tax regulations and taxpayers in all intervening years.
Second, the rationale of Otte does not conflict with the "all events" test. To say, as defendant argues, that Otte alters the "all events" test, confuses two very different concepts. The Otte decision hinges upon the accrual of legal liability. The "all events" test measures the proper timing for expense deductions. The technical term "accrual" as used in Otte refers to the time that a liability comes into existence as a legally enforceable claim. The "all events" test on the other hand looks to a liability that is so fixed that the fact of liability is certain and the amount thereof reasonably ascertainable, although not necessarily legally enforceable. The "all events" test thus allows deductions when the taxpayer has a special kind of knowledge which gives him enough facts to demonstrate the absolute necessity of paying an expense at some future date without regard to such matters as actual payment taking place, existence of legal liability, or accrual. Therefore, we cannot construe the Otte language as affecting the "all events" test since Otte is based on a concept of "accrual" which has no relation to the problem of deduction timing.
Third, we should not drive a further wedge into existing differences between tax and business accounting methods without a compelling reason to do so. Tax accounting treatment of income and expense often differs from the generally accepted principles of business accounting. Of. American Automobile Association, supra. However, there is usually some good explanation for the divergence. For example, the question of deduction of expense from income is an area where business accounting and tax accounting provide different treatment of expense items. In Union Pacific, supra, we determined that the taxpayer could not deduct payroll taxes on accrued vacation pay in an earlier year because the fact of tax liability could not be determined with certainty as of the end of the prior year. But, from a business standpoint, the tax expense was so readily calculable that the taxpayer rightfully would have been warranted to take the expense deduction on its income statement in the earlier year. Why this difference between business and tax accounting? The primary reason here is certainty. For business purposes, the expense can be deducted if a reasonable estimate can be made. For tax purposes, the expense cannot be taken unless (1) the fact of liability is certain and (2) a reasonably ascertainable computation of the amount can be made.
If we follow Otte and conclude that no payroll tax deduction can be taken until the -underlying wage is paid, we would create a further split between tax and business accounting without a reasonable explanation for requiring different treatment. Absent a compelling 'basis providing otherwise, our goal should be to reconcile business and tax treatment of an item, rather than to drive them farther apart.
Finally, defendant argues that application of Otte does not overrule or even alter the "a 11 events" test, but merely presents its "ultimate application" in the payroll tax area. However, defendant ignores the fact that if the underlying wage payment is the necessary last hurdle needed for the test, there is no test remaining. Such an interpretation would sound the death knell of the long-followed "all events" test in the payroll tax area. The "payment" requirement effectively puts taxpayers on a cash basis for purposes of payroll tax deductions. We see no reason for construing Otte in this manner.
In short, we do not interpret Otte as overruling or changing the application of the "all events" test. As the Supreme Court declared some fifty years ago, the "all events" test is the valid indicator for timing expense deductions.
Having determined that we must apply the "all events" test, we turn to the three types of compensation in the present action: (1) "year-end" wages, (2) bonuses, and (3) vacation pay.
We shall evaluate each of these types of compensation to find if the test is met for 1964. Before we begin this undertaking, an understanding both of the nature of the payroll taxes and of the "all events" test is called for.
The "all events" test presents two hurdles for taxpayers who desire expense deductions. First, the taxpayer must show that the fact of liability is certain as of the end of the year in question. Second, the taxpayer must demonstrate that the amount of the liability can be reasonably ascertained. The central consideration here is that the fact of liability is measured on an item by item basis, rather than as an overall estimate. More specifically, in the payroll tax area, the fact of liability is measured by considering each individual employee rather than the totality of all employees. Union Pacific, supra, 208 Ct. Cl. at 20, 524 F. 2d at 1350; Clevite Corp. v. United States, 181 Ct. Cl. 652, 658, 386 F. 2d 841, 843 (1967). Rev. Bull. 54-608, 1954-2 Cum. Bull. 8, 9-10. In the case at bar, Kodak must show that the fact of payroll tax expense for the given employee was certain for each, employee as of the end of 1964 and that the amount of such liability was reasonably ascertainable with regard to each employee.
The payroll taxes at issue in this case are all of the same nature. Each represents a tax levied as a percentage of compensation paid by an employer to his employees. If the taxes held no more complications than this, application of the "all events" test to them would be easy. When the employer became liable for the wages, we could simply apply the tax rate and find precisely how much tax would arise in conjunction with the compensation. For example, if plaintiff owed $100,000 in accrued vacation pay to its employees at the end of 1964, plaintiff would, absent further complications, have been liable for $3100 in FUTA tax and for $3625 in FICA tax in 1965. All events fixing this liability would have occurred at the time the vacation pay accrued at the end of 1964, and plaintiff would have been entitled to a 1964 deduction for FICA and FUTA tax.
However, one added factor complicates application of the "all events" test. This is the yearly "ceiling" on the payroll taxes at issue here. Each of the taxes contains such a ceiling. For example, the FICA ceiling on wages paid during the years at issue here was $4800. Until an employee earned this amount in a given year, the employer paid FICA tax on his wages. After the employee earned $4800 in a given year, no FICA tax was imposed on subsequent wages paid by the employer. The effect of the ceiling is to create a degree of uncertainty in determining, as of the end of a given year, at what time or for how many months an employer will have to pay tax during the next year for each individual employee.
Let us use another example. This time we refer to the Union Pacific case mentioned above. There, various employees earned vacation pay in 1942. The plaintiff became liable to pay this compensation as of the end of 1942 despite the fact that its employees were not to be paid until 1943. The payroll tax on these accrued wages was subject to an individual monthly ceiling of $300. If an employee earning $600 per month took his vacation during the first week of a given month in 1943, payroll tax would be imposed on the employer. If he took the vacation during the last week, no tax would be imposed. The employees could elect the time they would take their 1943 vacations, and there was no way that plaintiff could tell at the end of 1942 whether or not it would, in fact, have to pay tax on a given employee's vacation pay in 1943. Thus all events were not met because of the ceilings, and the taxpayer could not deduct the payroll taxes in its 1942 return. Union Pacific, supra.
Having discussed the nature of the "all events" test and the payroll taxes, we now apply the "all events" test to the tax expenses in question.
The first compensation payment we consider is the "year-end" wages which were earned in 1964, but paid the first week of 1965. No one disputes the fact that plaintiff was totally and unequivocally obligated to pay the wages as of the end of 1964. Plaintiff has demonstrated that its legal obligation to pay the "year-end" wages was fixed, certain, and exactly ascertained upon the termination of that tax year. It properly deducted the "year-end" wage expense from its 1964 income. Concurrently, plaintiff's obligation for payroll tax on the "year-end" wages also became -fixed and certain as an automatic consequence of the definite and legal obligation to pay the "year-end" wages. All that was required of plaintiff to determine its tax was a simple, precise, mathematical calculation. Nothing depended on the taxpayer's discretion or on outside events which might or might not occur. The payroll taxes on "year-end" wages meet the "all events" test, and plaintiff is entitled to deduct them on its 1964 return.
The second type of accrued compensation, bonuses, presents a more complex problem. The bonuses accrued on December 31, 1964. They were payable in March 1965. Since plaintiff knew the yearly salary of each employee, it could, but for one event, determine as of the end of 1964, the fact of tax liability on the bonuses. The one event which clouds this picture stems from the possibility that the employee might receive a pay raise during the interval between December 31 and the time of the March bonus payment.
We turn to another example. An employee earning $2000 per month was to receive his dividend of $800 on March 1, 1965. 'On December 31, 1964, plaintiff could readily see the fact of liability in that it would be responsible for FICA tax on the bonus when it made the March payment. But, if the employee received a raise to $3000 per month in January, effective February 1, 1965, plaintiff would no longer be liable for the tax when the March payment was made, since the employee would have reached the $4800 ceiling in February.
Because of the uncertainty raised by possible early 1965 salary increases, we cannot say that plaintiff knew in December 1964 the fact of its 1965 tax liability on each individual employee for bonuses. Since the fact of tax liability must be certain, the "all events" test fails of application at this point. We find it unnecessary to reach the second hurdle, whether the amount itself was reasonably ascertainable. The "all events" test is not met for plaintiff's taxes on accrued bonuses and Kodak may not deduct the payroll taxes imposed on such bonuses in its 1964 return.
The final type of compensation at issue here, accrued vacation pay, presents a situation quite similar to the Union Pacific case. Although this case differs from Union Pacific in that the tax ceilings are yearly rather than monthly, the principle remains the same. Plaintiff cannot demonstrate that it knew in December 1964 when a given employee would take his 1965 vacation. Thus Kodak could not know in 1964 whether the employee would take the vacation before or after said individual employee's salary reached the 1965 ceiling. Plaintiff could not determine precisely as of the end of 1964, the fact of tax liability on vacation pay earned by each individual employee. Since the fact of tax liability must be certain, the "all events" test fails of application at this point. We again find it unnecessary to reach the second hurdle, whether the amount itself was reasonably ascertainable.
In summary, in this income tax refund suit, plaintiff attempts to obtain a 1964 deduction for payroll taxes imposed on compensation which plaintiff properly accrued and deducted in its 1964 tax return. The principles of "matching," of consistency in past accounting practice without chai- lenge, and of allocation as in J. I. Case Co., do not grant plaintiff the right to such 1964 deduction. The "all events" test is the proper method for determining the deductibility of payroll taxes in 1964. Otte does not operate to extinguish the "all events" test in the tax arena. The test must be applied to each employee on an individual basis. Plaintiff must show that the fact of tax liability is certain and that the amount of tax is reasonably ascertainable for each individual employee. For the tax on "year-end" wages, plaintiff has been able to demonstrate both, but has failed to show that the fact of tax liability was certain with respect to the tax on bonuses and vacation pay.
Accordingly, plaintiff is not entitled to a 1964 income tax deduction for payroll taxes pertaining to accrued bonuses and accrued vacation pay. Plaintiff is entitled to deduct from its 1964 income, payroll taxes imposed on "year-end" accrued wages.
"If all events have occurred which fix the amount of the tax and determine the liability of the taxpayer to pay it," a deduction is available. United States v. Anderson, 269 U.S. 422 (1926).
Int. Rev. Code of 1954, § 8111, as amended, 75 Stat. 131 (1961).
Int. Rev. Code of 1954, § 3301, as amended, 74 Stat. 924 (1960), 77 Stat. 51 (1963).
Labor Law, McKinney's Consol. Laws of N.T. Ann., § 560, 570 ; Tenn. Code Ann., § 50-1326; N.J. Stat. Ann., § 43.21-7; Smith-Hard III. Ann. Stat. eh. 48, § 550; Unemployment Insurance, West's Arm. Calif. Codes, § 976; Vernon's Tex. Civil Stat. Ann., Art. 5221b-5. At the end of 1964, over 98 percent of plaintiff's employees were located in these states.
The double denial question is not before the court at this time. This point has been severed by the Trial Judge and held for further proceedings pending resolution of the issues currently before the court,
For plaintiff's fifth argument, see Note 5, supra.
Trial Judge Willi did not have the benefit of Union Pacific at the time ho rendered his Kodak opinion. The Kodak recommended decision was submitted in April 1975, while Union Pacific was announced October 22, 1975.
In addition to its reliance on Otte for the proposition that plaintiff may not deduct the payroll taxes until the underlying compensation is paid, the dissent cites a numher of statutes and regulations. These statutes and regulations are inapplicable to the deduction timing problem before the court in the instant case. For example, the FICA and FUTA statutes used by the dissent (§§ 3111, 3301) pertain to "Rate of tax," not to timing of deductions. The Treasury Regulations (§ 31.3111-3, 4) also do not govern deductions for the tax expense. Finally, the dissent relies upon section 162(a) to bolster its "payment requirement." While this section does apply to the instant problem, the dissent's interpretation of the term "incur" is so narrow as to emasculate accrual tax accounting. Such an interpretation of "incur" contravenes tax statutes (see, e.g. § 446(b), taxpayer's accounting method must clearly reflect income) and numerous Supreme Court decisions (see, e.g. Anderson, supra. "It has never boon questioned that a taxpayer who accounts on the accrual basis may and should, deduct from gross income a liability which really accrues in the taxable year." Dixie I'ine Co. v. Comm'r, 320 U.S. 516, 519 (1930) (emphasis added)).
The determination of the fact of liabilitj by evaluating each individual employee obviates plaintiff's "forecasting" argument. (Lumping all employees together and determining tax liability as an overall guestimate). The "all events" test never contemplated creation of a legal weather bureau for tax deductions. The unreliability and uncertainty inherent in "forecasting" tax expenses is obvious.
The pica tax rate for the years in question was three and five-eighths percent ; the KuTA, 3.1%.
The following celling applied to the taxes at issue here: PICA, $4S00 per year; FUTA, $3000 per year; New Yorlc unemployment, $3000 per year; Tennessee unemployment, $3300 per year.
The dissent contends that Kodak's obligation to pay the taxes on "year-end" -wages was not fixed at the end of 1964, but was contingent. It cites many cases, presumably in support of such a proposition. We agree with the dissent that if a liability is contingent, the "all events" test fails of application. Indeed, in each case cited by the dissent, the obligation was so uncertain and contingent that the "all events" test could not be used. However, the essential difference between such cases and the present action is "glossed over" by the dissent. In the cited cases, expenses could not be deducted because the obligation was not fixed. In the instant case, the payroll taxes on "year-end" wages (using the dissent's own tests) were: (1) determined; (2) settled; (3) certain; (4) definite; (6) conclusively fixed; (6) authoritatively fixed; (7) within set bounds or limits, and (8) limited in extent or scope. Clearly plaintiff's payroll tax obligation on the "year-end" wages was not contingent and the dissent's cases are inapposite. Further, we cannot say (as does the dissent) that the remote possibility of plaintiff's bankruptcy injects an element of uncertainty sufficient to deny a deduction. After all, bankruptcy is always a "possibility," and therefore the "all events" test could never apply in any situation. Also, such reasoning would totally destroy accrual tax accounting and would clearly conflict with section 446(b), supra.