United States Tax Court

United States Tax Court

T.C. Memo. 2023-122

HYATT HOTELS CORPORATION & SUBSIDIARIES,

Petitioner

v.

COMMISSIONER OF INTERNAL REVENUE,

Respondent

—————

Docket No. 13858-17.

Filed October 2, 2023.

—————

Carter Cabell Chinnis, Jr., Maria C. Critelli, John T. Hildy, Tyler M.

Johnson, Thomas Lee Kittle-Kamp, Anthony D. Pastore, William A.

Schmalzl, Joshua M. Schneider, Scott M. Stewart, Gary B. Wilcox, and

Joel V. Williamson, for petitioner.

James M. Cascino, David B. Flassing, Angela B. Reynolds, H. Barton

Thomas, and Thomas D. Yang, for respondent.

MEMORANDUM FINDINGS OF FACT AND OPINION

NEGA, Judge: Since 1987, Hyatt Hotels Corp. and Subsidiaries

(Hyatt) has operated a customer rewards program, known as the Gold

Passport Program (Program). Participating travelers who stayed at

Hyatt-branded hotels received rewards points, which when amassed in

a sufficient number could be redeemed for a free stay at any Hyattbranded hotel. Hyatt owned roughly 25% of all Hyatt-branded hotels;

the rest were owned by a variety of third parties, who contracted with

Hyatt for use of its hotel management services and/or its brand name

and other intellectual property. When a participating traveler received

rewards points for a stay at a Hyatt-branded hotel, Hyatt required the

hotel owner to make a payment into an operating fund, which was held

by a Hyatt subsidiary and known as the Gold Passport Fund (Fund).

When a participating traveler redeemed rewards points for a stay at a

Served 10/02/23

2

[*2] Hyatt-branded hotel, Hyatt would make a compensation payment

to the hotel owner out of the Fund. Portions of the Fund’s unused

balance were invested in marketable securities and resulted in realized

gains and accrued interest. Hyatt also used the Fund to pay

administrative and advertising expenses that it determined were

related to the Program.

For federal income tax purposes, Hyatt essentially ignored the

Fund, including none of its revenue in gross income and claiming no

deductions for expenses paid. The Commissioner audited Hyatt’s

returns and determined that this tax treatment was improper. Going a

step further, the Commissioner determined that Hyatt’s treatment was

a method of accounting and that Hyatt thus must include in income as

a transitional adjustment its net revenue from the Program since 1987.

The Commissioner issued a notice of deficiency memorializing those

determinations, and Hyatt timely filed a Petition with this Court. Hyatt

maintains that its treatment of the Fund was proper, arguing that it

held the Fund as a trustee, agent, or conduit for the hotel owners and

not as the true owner for federal income tax purposes. In the

alternative, Hyatt contends that the Commissioner overreached by

characterizing its treatment as a method of accounting and thus the

transitional adjustment should not be sustained.

Also in the

alternative, Hyatt contends that it should be able to offset its gross

receipts with the estimated cost of future compensation payments to

hotel owners by way of a longstanding regulatory provision known as

the trading stamp method.

Accordingly, the issues for decision are (1) whether Program

payments received, interest accrued, and investment gains realized

were includible in Hyatt’s gross income for tax years 2009, 2010, and

2011 (years at issue); (2) whether a change in Hyatt’s tax treatment of

such receipts constitutes a change in method of accounting subject to

section 481 adjustment; and (3) whether Hyatt may adopt the trading

stamp method with respect to the years at issue. 1

1 Unless otherwise indicated, statutory references are to the Internal Revenue

Code, Title 26 U.S.C., in effect at all relevant times, regulation references are to the

Code of Federal Regulations, Title 26 (Treas. Reg.), in effect at all relevant times, and

Rule references are to the Tax Court Rules of Practice and Procedure.

3

FINDINGS OF FACT

[*3]

I.

Hyatt

Hyatt is a corporation organized under the laws of Delaware. 2 At

all relevant times, including when it timely filed the Petition in this

case, Hyatt’s principal office was in Illinois. During the years at issue

Hyatt was the U.S. consolidated parent for the Hyatt group of companies

for federal income tax purposes. Petitioner’s wholly owned subsidiary,

Hyatt Corp., was its primary relevant operational subsidiary, housing

its executive-level personnel. We will refer to Hyatt, Hyatt Corp., and

other relevant subsidiaries collectively as petitioner. 3

II.

Petitioner’s Business

Petitioner is a well-known hospitality provider which owns,

leases, manages, and franchises hotel, residential, and timeshare

properties (Hyatt-branded hotels) in the United States and

internationally. During the years at issue petitioner owned (in whole or

in part) or leased a number of Hyatt-branded hotels. Petitioner was the

largest single owner of all Hyatt-branded hotels, owning approximately

20%–25% of all Hyatt-branded hotels during the years at issue. The

remaining approximately 75%–80% of Hyatt-branded hotels were

owned by a variety of third-party hotel owners (TPHOs). Some of the

TPHOs had entered into hotel management agreements with petitioner,

appointing petitioner as their agent to manage and operate a particular

hotel for a set term. In managed hotels, Hyatt employees would be

stationed on site and handle day-to-day operations. Under the

management agreements, the TPHO would pay petitioner a base fee,

consisting of a percentage of the hotel’s gross revenue, and an incentive

fee, consisting of a percentage of some profitability measure.

Other TPHOs entered into more limited franchise agreements

with petitioner, in which petitioner would license Hyatt intellectual

property for a set term to the TPHO, which would operate the hotel itself

2 Hyatt was formerly known as Global Hyatt Corp., before changing its name

in June 2009. In November 2009 Hyatt completed an initial public offering and became

a publicly traded company.

3 The Court issued protective orders adopting procedures to protect petitioner’s

trade secrets and other confidential information during this case. The facts set forth

in this Opinion have been adapted accordingly. All information included herein has

been determined by the Court not to constitute “trade secrets or other confidential

information” within the meaning of section 7461(b).

4

[*4] or engage a separate management company to do so. Under the

franchise agreements, the franchising TPHO would pay petitioner an

upfront application fee and monthly royalty fees consisting of a

percentage of its gross revenues (generally ranging from 4% to 6% and

escalating over the franchise agreement’s term).

The franchise

agreements typically included a provision by which petitioner expressly

disclaimed the existence of an agency relationship between it and the

TPHO.

The inventory of Hyatt-branded hotels was not static during the

years at issue. Certain hotels owned by TPHOs, whether managed or

franchised, sometimes removed their affiliation with the Hyatt brand,

in a process known in the hospitality industry as “deflagging.”

Deflagging was not an uncommon occurrence for petitioner (or for the

hospitality industry writ large), and hotels left the Hyatt chain during

the years at issue. Conversely, during the years at issue new TPHOs

entered into management or franchise agreements with petitioner.

Petitioner also acquired, leased, or entered into joint ventures that

added new Hyatt-branded hotels to the chain. During the years at issue

a small number of hotels already within the Hyatt chain shifted

ownership from a TPHO to petitioner itself or vice versa.

Petitioner maintained a number of different sub-brands intended

to appeal to different market segments. For instance, its Hyatt Place

line of hotels was marketed for business travelers, while its Park Hyatt

line was marketed for customers interested in a more upscale leisure

experience. During the years at issue the majority (approximately 50%)

of all Hyatt-branded hotels were marketed under the Hyatt Regency

sub-brand, which was marketed to both business and resort travelers.

Some of the sub-brands were traditional, full service hotels, while others

were select service hotels with only limited food and beverage amenities

and no business or banquet facilities. Certain sub-brands also marketed

residential apartment units and timeshare vacation properties. A key

aspect of petitioner’s business strategy was maintaining a consistent

positive customer experience across the hotels in each sub-brand.

III.

The Program

During the years at issue petitioner operated the Program as well

as the Fund. Petitioner initiated the Program in April 1987. Petitioner

created the terms and conditions of the Program for members; per the

terms, only an officer of petitioner was authorized to modify the terms.

The terms stated in relevant part that petitioner retained the right to

5

[*5] change significant aspects of the Program, including the points

requirements for member redemption of awards. 4 The terms also stated

that petitioner “has the right to end the [Program] by providing written

notice to then Active Members six months in advance.” Finally, the

terms stated that “[a]ccrued points do not constitute property of the

Member” and “are not transferable to another person for any reason.”

The Program was operated by a team of individuals employed by

petitioner’s marketing department. Proposed changes to the terms of

the Program were reviewed and approved by senior executives employed

by petitioner.

Pursuant to the terms, customers could enroll as Program

members and earn rewards points based on their eligible spending at

Hyatt-branded hotels. 5 Customers could become Program members by

visiting petitioner’s website, calling petitioner’s call center reservation

phone line, or physically visiting a Hyatt-branded hotel’s front desk.

During the years at issue members earned Program rewards points at a

rate of five points per dollar of eligible spending. Alternatively,

customers could opt to receive a number of travel miles, redeemable with

one of petitioner’s third-party travel partners. 6 Members could also

convert already-earned rewards points into travel miles with one of

petitioner’s travel partners. Petitioner would sometimes run limitedtime promotions in which members could earn bonus numbers of

rewards points or miles for a qualifying stay. Not all bookings at Hyattbranded hotels were eligible for rewards points. For instance, if a

member booked a stay through a third-party intermediary, such as

4 Hyatt exercised this right on occasion; for instance, in 2010 Hyatt added a

new rewards category that effectively required a higher rewards points balance to

redeem for stays at particular hotels.

5 If members met a particular amount of qualified spending at Hyatt-branded

hotels, they would graduate to becoming higher tier program members, which entailed

some additional perks during their stays.

6 Customers did not need to be Program members to receive travel miles for

their eligible spending, so long as they were members of a participating travel partner’s

corresponding frequent traveler program. The travel partners included a number of

domestic and foreign airlines and Amtrak. Petitioner had entered into a number of

agreements with the various travel partners in order to make travel miles available

for members, with petitioner being liable to make compensation payments to the travel

partner when miles were awarded.

6

[*6] Expedia or Booking.com, instead of through petitioner directly, that

member would not receive rewards points for the stay. 7

Members could redeem their rewards points to pay for hotel stays,

room upgrades, and other goods and services at Hyatt-branded hotels. 8

The various Hyatt-branded hotels were placed within tiered award

categories, which required set numbers of points for particular stays or

services. In 2009 the lowest award category for a one-night free stay

was 5,000 points, while the highest was 27,000 points. Effective June 4,

2010, petitioner reclassified the categories of a number of Hyatt-branded

hotels and added a new sixth category.

Members could not redeem rewards points for cash. During the

years at issue the Program’s terms and conditions did not state that

rewards points would expire. However, during the years at issue Hyatt

personnel involved with the Program had discussions about changing

the Program so that earned rewards points would expire if not redeemed

within a certain period. In 2012 petitioner implemented that change,

making rewards points expirable after a certain period of inactivity by

a member.

Petitioner considered the Program highly successful and a central

component of its marketing efforts. Petitioner’s internal analytics

indicated that Program members tended to stay at Hyatt-branded hotels

more frequently and longer. During the years at issue the Program

experienced incremental growth. At the end of 2009, the Program had

over 9 million members with members having booked 23.4% of total

room nights at Hyatt-branded hotels that year. By the end of 2011, the

Program had over 12 million members with members having booked

30.3% of total room nights at Hyatt-branded hotels that year. The

percentage of hotel stays booked by members varied for each hotel; for

instance, a flagship hotel, such as the Grand Hyatt New York (owned by

petitioner), would historically tend to have a higher percentage of stays

by members.

7 This arrangement was consistent with the financial self-interest of the hotel

owners, including petitioner, who would be charged additional commission fees for

stays booked through third-party intermediaries.

8 When a hotel deflagged from the Hyatt brand, members would no longer be

able to earn rewards points at that hotel and generally would not be able to redeem

already-earned rewards points at that hotel, even if a qualifying stay had been booked

before the deflagging date.

7

[*7] Petitioner created and controlled a Program manual detailing the

procedures and requirements for TPHOs’ participation in the Program,

which was made available to employees of both petitioner and the

TPHOs. Petitioner required that all Hyatt-branded hotels (including

international hotels) participate in the Program and did not allow

TPHOs to request refunds of payments made to the Fund. 9 Petitioner

also required that all Hyatt-branded hotels allocate a certain percentage

of total room inventory for potential redemptions by Program members.

Similarly, the Program manual stated that there were no blackout dates

for rewards stays booked by Program members, though the TPHOs

could request that the percentage of rooms reserved for Program

members be reduced during limited high demand periods, subject to

petitioner’s approval.

Petitioner’s primary communication to the managed hotels about

the Program was via system services disclosures included in their

annual business plans for each managed hotel. Over time, petitioner

changed the terms in the system services disclosures relating to the

Program, including a change in 2011 to specify that the assessment fee

charged to the hotel owners would be determined by Hyatt in its

discretion. Petitioner did not seek approval from the TPHOs for this

change.

Some older management agreements still in place during the

years at issue (most obviously agreements that predated 1987) did not

refer to the Program or the Fund. The management and franchise

agreements that did refer to the Program characterized it as a

mandatory service. The management and franchise agreements that

referred to the Fund had a clause generally describing how the Fund

was invested and what costs it was used to cover. Petitioner sometimes

entered into specific service agreements governing the participation in

the Program (as well as participation in other chainwide services

provided by petitioner) of TPHOs operating Hyatt-branded hotels

internationally.

A.

The Fund

Operating the Program involved a regular inflow and outflow of

payments between petitioner and the various owners of the Hyattbranded hotels. When a Program member opted to receive rewards

9 Hyatt subsidiaries that owned Hyatt-branded hotels also participated in the

Program, making payments into the Fund and receiving compensation payments.

8

[*8] points earned from a stay at a Hyatt-branded hotel, the hotel owner

would pay petitioner an assessment fee of four percent of the revenue

derived from that member’s stay (4% payments). In 2011 petitioner

determined to increase the assessment fee to 4.5% for full service Hyattbranded hotels, effective January 1, 2012. Petitioner intended for this

change to result in having a higher amount of the Fund available to pay

for Program advertising. When a Program member alternatively opted

to receive travel miles instead of rewards points, the hotel owner would

pay petitioner the actual cost of the miles (miles payments), as

negotiated and agreed to in the contracts between petitioner and the

third-party transportation partners. The 4% payments and the miles

payments were calculated and paid out to petitioner monthly, flowing

into a pair of bank accounts owned and operated by petitioner. 10

Petitioner also sold rewards points directly to customers, hotel owners,

certain car rental companies, and to Hyatt Vacation Club (its timeshare

business). The proceeds of these sales (sale payments) were also

deposited into the same bank accounts owned and operated by

petitioner. Petitioner described the balance of the 4% payments, miles

payments, and sales payments (collectively, Program payments), once

received, as the Fund.

Petitioner entered into agreements with several third-party

custodians to hold portions of the Fund; petitioner also entered into

agreements with several third-party investment advisers to invest

portions of the Fund. 11 Petitioner directed the general investment

strategy of the Fund, which was largely invested in marketable, fixed

income securities. The TPHOs did not have any input or control over

the choice of investment advisers or the Fund’s investment strategy.

During the years at issue the Fund accrued interest and realized gains

from investments. Petitioner received quarterly statements from its

custodians displaying the securities held and transactions made during

the previous quarter. Aside from annual Fund financial statements

provided by petitioner (discussed further below), the TPHOs did not

regularly receive communications about the performance of the Fund

investments.

10 These bank accounts were used only for Program payments, not general

corporate cash.

11 The agreements with the custodians and investment advisers represented

that the client was “Hyatt Corporation, As Agent for the Hotels Owned, Leased,

Operated, Managed, or Franchised By It, Its Subsidiaries, and/or Affiliates, d/b/a

Hyatt Gold Passport.”

9

[*9] When a Program member redeemed rewards points at a Hyattbranded hotel, petitioner would pay a compensation payment to the

hotel owner out of the Fund. 12 Petitioner based the amount of the

compensation payment on two factors: the hotel’s occupancy rate during

the award stay and the hotel’s forecasted monthly average rate (FMAR)

for rooms. 13 As of January 2009, compensation payments were

calculated via a multitier compensation structure depending on

occupancy rate. If hotel occupancy during the award stay was nearly

full (as measured by a particular percentage threshold), the hotel owner

would receive compensation in an amount equal to a significant portion

of the FMAR (compensation level A). If hotel occupancy during the

award stay was not near to full, the hotel owner would receive

compensation equal to only a small portion of the FMAR.

Effective January 1, 2011, petitioner changed the formula for

compensation payments, which resulted in decreased annual amounts

of compensation payments made and thus had the effect of increasing

the amount of the Fund available for use by petitioner. 14 The TPHOs

did not have any control over the formula for the compensation

payments.

In addition to operating the Fund as a reserve for the

compensation payments, petitioner used the Fund to pay advertising

and administrative costs that it designated as related to operating the

Program. The administrative costs of the Program included (1) costs of

maintaining member call centers and contact centers; (2) the salaries

and benefits of employees involved in operating the Program; 15 and (3)

the cost of maintaining the Program’s member database. The member

database, which had been in existence since 1987 and was managed by

a third-party vendor, recorded extensive information related to

individual members and their stays at Hyatt-branded hotels and

12 In reality, compensation payments would often be recorded as a credit setoff

against the amount of Program payments due to petitioner in monthly invoices.

13 Every January, each Hyatt-branded hotel would submit its FMARs for the

coming calendar year, subject to adjustment by petitioner.

14 The change petitioner made in 2010, which reclassified the hotels in award

categories and added a new award category, resulted in decreased annual amounts of

compensation payments made to hotel owners and thus had the effect of increasing the

amount of the Fund available for use.

15 For certain employees that presumably spent only part of their time on

Program-related activities, only a portion of their salaries and benefits would be

designated as Program expenses.

10

[*10] maintained members’ rewards points balances. With regard to

individual members, the database would record information useful for

tailoring future stays to a member’s preferences. For instance, if a

member had demonstrated a preference for a particular beverage or type

of pillow, the member database could record that observation for use in

future stays. Petitioner’s marketing department also used the member

database to generate macro-level analytics about Hyatt customers,

which were then incorporated into targeted advertising of particular

customer demographics. Petitioner owned the member database and

considered it to be highly valuable in its business. The TPHOs did not

have any ownership interest in the database, nor did they have access

to the entirety of the member database; to access the narrow slice of

membership data related to stays at the particular TPHO-owned hotel,

a TPHO could request permission from petitioner. If a TPHO deflagged

from the Hyatt brand, it would not receive a copy of the data from the

member database. 16 Some of the administrative costs paid by petitioner

out of the Fund were made to other Hyatt entities to reimburse them for

expenses that were paid “for the benefit of the Program.”

As part of preparing annual budgets, Hyatt personnel determined

approximately how much of the Fund would be spent on administrative

costs and advertising in a given year upon the basis of projected Fund

balance in excess of an actuarial estimated reserve amount designated

to cover future compensation payments (discussed further below). Hyatt

personnel involved in the Program would designate particular expenses

as Program related and contact petitioner’s treasury department to

make a corresponding disbursement from the Fund. 17 The TPHOs did

not have any control on how the Fund was spent on administrative costs

or advertising.

If a TPHO deflagged from the Hyatt brand, that TPHO was not

entitled to any payment or reimbursement out of the Fund. Instead, the

proportionate amount of the Fund attributable to the deflagging TPHO

would remain available for making compensation payments or

satisfying administrative or advertising expenses.

16 The management and franchise agreements typically included a clause that

defined Program member information as confidential or proprietary (except to the

extent that a TPHO itself lawfully stored information in its own property management

database) and thus not usable by a TPHO upon expiration of an agreement’s duration.

17 If a particular expense was of a sufficiently high dollar amount, approval by

a more senior executive was required prior to disbursement.

11

[*11] B.

Program Advertising

Hyatt personnel determined how much would be spent on

Program advertising for a given year. Internal analysis by petitioner

during the years at issue indicated that every $1 spent on Program

advertising generated a return on investment of $8 in revenue. As noted

above, in 2011 petitioner increased the number of rewards points to be

redeemed for a stay at certain Hyatt-branded hotels. Petitioner

intended for this change to free up additional amounts of the Fund to

spend on Program advertising that would otherwise have been

earmarked to cover future rewards points redemptions.

Hyatt

personnel also determined whether the costs of a particular

advertisement should be borne by the Fund.

In making such

determinations, members of petitioner’s marketing department

involved in the Program would sometimes consult with members of

petitioner’s finance and legal departments. Sometimes Hyatt personnel

would determine that only a portion of the costs of a particular

advertisement should be paid by the Fund. The TPHOs did not have

any control over how petitioner spent the Fund on Program advertising.

A common example of Program advertising was sending

membership offer letters to customers of credit cards or airlines with

whom petitioner had partnered. For instance, one typical promotional

joint advertisement with Mastercard had the following tagline: “There

Are Thousands of Reasons to Stay at Hyatt. And Now Every Stay Comes

With 2,500 More.” Some Program advertising was primarily branded

with the Program’s own logo (the trademark of which was owned by

petitioner), while other advertising was primarily branded with Hyatt’s

own logo. Other Program advertising gave equal prominence to both the

Program and Hyatt logos. Program advertising also sometimes

displayed the logos of specific Hyatt sub-brands. Online or emailed

Program advertising typically included a link for customers to book a

stay on Hyatt’s website.

IV.

Financial Accounting and Reporting

A.

Fund Actuarial Analyses

A third-party accounting firm, PricewaterhouseCoopers (PWC),

prepared regular actuarial analyses of the Fund in order to determine

the amount necessary to cover future potential redemptions by Program

members. On the basis, in part, of the Program’s past rewards points

redemption rates, PWC would estimate the number of rewards points

12

[*12] that would be redeemed and determine a range of dollar amounts

that should be held in reserve for anticipated future redemptions. As

part of the actuarial analyses, PWC would also estimate the rate of

“breakage,” i.e., the numbers of rewards points that would never be

redeemed and thus never require a compensation payment out of the

Fund.

B.

Fund Financial Statements

Annual financial statements were prepared for the Fund (Fund

statements) in accordance with Generally Accepted Accounting

Principles (GAAP). A third-party accounting firm, Deloitte, audited the

Fund statements for the years at issue. The Fund statements included

income statements, which reported as revenue the following amounts

for the years at issue:

2009

2010

2011

Program

Payments

$63,168,430

$77,195,168

$103,383,532

Marketable

Securities

– Net Gain

7,214,521

7,510,716

7,208,255

Interest

Income

12,026,344

10,516,012

8,281,521

Total

Income

$82,409,295 $95,221,896 $118,873,308

The income statements reported expenses in a category entitled

“Provision for future award redemptions” in the following amounts:

2009: $38,131,732; 2010: $54,530,389; and 2011: $72,522,615.

The income statements also reported the remaining amounts of costs

and expenses:

13

[*13]

2009

Advertising

$21,165,826 $16,251,855 $10,620,650

Membership

Acquisition &

Enrollment/Fulfillment

2010

2011

3,679,263

4,749,127

—

—

Membership

Statements &

Processing

1,673,285

1,137,967

Call Center

—

—

6,806,864

17,763,862

18,555,852

8,195,723

Membership

Communication &

Marketing

General &

Administrative

13,607,160

7,121,477

—

The expense for the provision for future rewards points redemptions was

the largest expense on the income statements, ranging from 46% to 61%

of the total Fund expenses. For each of the years at issue, the income

statements reported a small dollar net loss. The Fund statements also

included balance sheets, which reported as liabilities a reserve for the

future rewards points redemptions, chosen from within PWC’s actuarial

range.

The Fund statements made a number of representations and

disclosures concerning the Program and the Fund.

The Fund

statements represented that petitioner used the Fund to cover the cost

of the administrative expenses of operating the Program, such as

employee salaries and benefits, rent, and office management expenses.

The Fund statements described the Fund as being owned by the Hyattbranded hotel owners during the period in which they participated in

the Program. The Fund statements also addressed income taxes, which

they described as being an obligation of each Hyatt-branded hotel

owner. The Fund statements were made available to TPHOs annually.

14

[*14] C.

Petitioner’s Form 10–K Financial Statements

Petitioner filed Form 10–K, Annual Report Pursuant to Section

13 or 15(d) of the Securities Exchange Act of 1934, with the Securities

and Exchange Commission for 2009, 2010, and 2011 that included

consolidated financial statements prepared in accordance with GAAP.

Petitioner’s Forms 10–K included the following footnote in relevant part:

The Hyatt Gold Passport Program (the “Program”) is our

loyalty program. We operate the Program for the benefit

of Hyatt branded properties, whether owned, operated,

managed, or franchised by us. The Program is operated

through the Hyatt Gold Passport Fund, which is an entity

that is owned collectively by the owners of Hyatt branded

properties, whether owned, operated, managed or

franchised by us. The Hyatt Gold Passport Fund (the

“Fund”) has been established to provide for the payment of

operating expenses and redemptions of member awards

associated with the Program. The Fund is maintained and

managed by us on behalf of and for the benefit of Hyatt

branded properties. We have evaluated our investment in

the Fund and have determined that the Fund qualifies as

a variable interest entity (“VIE”) and, as a result of the

Company being the primary beneficiary, we have

consolidated the Fund.

On its Form 10–K balance sheets, petitioner consolidated the

total amounts of assets and liabilities that constituted the Fund. The

Forms 10–K did not separately present the Fund assets and liabilities.

On its Form 10–K balance sheets, petitioner included the cash portion

of the Fund in the consolidated amounts reported for “Cash and cash

equivalents” rather than the line for “Restricted cash.” 18 On its Forms

10–K income statements, petitioner also consolidated the Fund’s annual

income and expense activity, after making certain adjustments and

eliminations for intercompany transactions. On its income statements,

petitioner reported a line item, entitled “Net gains (losses) and interest

income from marketable securities held to fund operating programs,” a

category which included the investment gains and interest attributable

to the Fund.

18 The amount of cash associated with the Fund was not separately stated or

disclosed on the Forms 10–K.

15

[*15] Deloitte audited petitioner’s financial statements for 2009, 2010,

and 2011 and issued unqualified opinions that the financial statements

presented petitioner’s financial position fairly and were materially

correct. In corresponding audit memoranda, Deloitte personnel noted

that the Fund redemption liability was the largest liability on

petitioner’s balance sheet and described its valuation as an audit risk.

D.

Hotel Owners’ Financial Statements

For some of the managed TPHO-owned hotels, petitioner would

prepare annual financial statements for the hotel as part of its

management services. Petitioner did not prepare annual financial

statements for any of the franchised TPHO-owned hotels. The income

statements in the financial statements petitioner prepared for managed

hotels reported the 4% payments made by the particular TPHO as

expenses.

V.

Tax Reporting

Petitioner filed consolidated Form 1120, U.S. Corporation Income

Tax Return, for each of the years at issue. Petitioner reported the

Fund’s assets and liabilities in the totals reported on its Schedules L,

Balance Sheets per Books. However, petitioner did not include the total

annual amounts of Program revenue 19 in gross income or claim

deductions with respect to the total annual amounts of Program

expenses. 20 In its capacity as hotel owner, petitioner included in gross

income the amounts of compensation payments that it was paid or was

due from the Fund for the years at issue. Petitioner’s Forms 1120 did

not purport to use the trading stamp method or include any statements

with respect to Treasury Regulation § 1.451-4.

In order to prepare its Schedules M–3, Net Income (Loss)

Reconciliation for Corporations With Total Assets of $10 Million or

More, petitioner’s accounting personnel proportionally allocated the

Fund rewards points redemption reserve to each domestic hotel. 21 The

19 Program revenue is the sum of the Program payments received, the interest

accrued, and investment gains realized on the Fund during the years at issue.

20 On petitioner’s 2009 consolidated Form 1120, a small amount of Program

revenue and Program expenses (which netted to zero) was accidentally included in

gross income and claimed as deductions by petitioner because of a clerical error.

21 Petitioner’s accounting personnel first removed from the total the amount of

the reserve allocable to the international hotels.

16

[*16] allocation was intended to result in the estimated total amount of

4% and miles payments made by each domestic hotel that had not yet

been paid out by the Fund as compensation payments (i.e., the amounts

not yet satisfying the economic performance requirement for

deductibility). To allocate the reserve, petitioner’s accounting personnel

would first calculate a weighted average, by dividing each hotel’s net

life-to-date amount of Program payments and compensation payments

by the net life-to-date amount of Program payments and compensation

payments made by all currently participating hotels. Each hotel’s

weighted average percentage would then be applied to the yearend

rewards points redemption reserve, resulting in each hotel’s allocated

share. Next, petitioner’s accounting personnel would compare the

hotel’s prior year allocated share to the current year allocated share. If

there was a year-over-year increase in the hotel’s allocated share (i.e.,

more Program payments coming into the Fund than going out),

petitioner’s accounting personnel would determine to record a

downward adjustment to the hotel’s Program expense deduction in the

amount of the increase for federal income tax purposes. Conversely, if

there was a year-to-year decrease in the hotel’s allocated share,

petitioner’s accounting personnel would determine to record an upward

adjustment to the hotel’s Program expense deduction. Pursuant to the

allocations with respect to the Hyatt-owned hotels, petitioner made

adjustments on its Schedules M–3 to the Fund rewards points reserve

book expense. 22

During each of the years at issue petitioner issued standardized

letters to all of the domestic TPHOs. The letters described the structure

of the Program and the Fund and reported to each TPHO that owned a

managed hotel the dollar amount of Program payments made by the

TPHO in that year that related to future year compensation payments.

The letters recommended that the TPHOs consult their tax advisers to

decide how to treat the amounts for federal income tax purposes.

Petitioner’s personnel considered the amounts described in the letters

to be the portion of each TPHO-owned hotel’s allocated expenses that

would not be currently deductible for federal income tax purposes

because not yet paid out (i.e., not yet meeting the economic performance

requirement for deductibility).

In sum, with respect to the Program revenue and expenses,

petitioner thus took the tax position that it operated in two distinct

22 This again reflected the position that the economic performance requirement

was not met until payments were actually made out of the Fund.

17

[*17] capacities. In its role as “agent” for the hotel owners, petitioner

consistently did not include any Program revenue in gross income or

claim any deductions with respect to Program expenses. In its role as

owner of 20%–25% of the hotels, petitioner claimed deductions for its

(Schedule M–3 adjusted) share of Program expenses, for the tax year in

which compensation payments were made out of the Fund. Similarly,

in its role as owner of 20%–25% of the hotels, petitioner included in gross

income the compensation payments made to it out of the Fund.

In contrast, during the years at issue a substantial majority of the

domestic TPHOs deducted the 4% payments they made under the

Program on their federal income tax returns for the year they made the

payments into the Fund. Accordingly, those TPHOs’ returns reflected

the contrary position that economic performance had been satisfied with

respect to the 4% payments upon payment to petitioner. Petitioner did

not prepare federal income tax returns for any of the TPHOs during the

years at issue.

VI.

The Notice of Deficiency and the Petition

Respondent conducted an examination of petitioner’s returns for

the 2009, 2010, and 2011 tax years. On March 22, 2017, respondent

issued to petitioner a notice of deficiency, which made the following

determinations:

Tax Year

Deficiency

(Overpayment)

2005

$72,058,943

2008

3,227,772

2009

0

2010

(4,230,046)

2011

0

The deficiency amounts reflected respondent’s determination that

the Program revenue (net of deductible Program expenses paid out of

18

[*18] the Fund) was includible in petitioner’s income in the following

amounts:

Year

Amount

2009

$222,559,183

2010

(3,440,170)

2011

20,962,322

For each year, respondent determined the amount of Program

revenue by subtracting petitioner’s allocated share of the future rewards

points redemption liability (in its role as hotel owner) from the yearover-year total increase or decrease in the amount of the estimated

future rewards points redemption liability.

Put more simply,

respondent essentially used the increase or decrease in amount of the

redemption reserve as a proxy for the amount by which the Program

revenue exceeded or was exceeded by deductible Program expenses for

a given year.

Tax year 2009 reflected a transitional adjustment of $228,017,823

made by respondent under section 481(a) to account for amounts of

Program revenue (net of Program expenses paid out of the Fund) that

were not included in petitioner’s taxable income for tax years 1987

through 2004. As a result of the Program revenue determinations,

respondent adjusted the carryback of a net operating loss applied by

petitioner from tax year 2009 to 2005, which resulted in a deficiency for

tax year 2005. Similarly, as a result of the Program revenue

determinations, respondent adjusted the carryback of amounts of

allowable foreign tax credit and general business credit, which resulted

in a deficiency for tax year 2008. Ultimately, the section 481 adjustment

was the source of most of the determined deficiency.

Court.

On June 20, 2017, petitioner timely filed a Petition with this

19

OPINION

[*19]

I.

Burden of Proof

In general, the Commissioner’s determinations set forth in a

notice of deficiency are presumed correct, and the taxpayer bears the

burden of proving them erroneous. Rule 142(a)(1); Welch v. Helvering,

290 U.S. 111, 115 (1933); Pittman v. Commissioner, 100 F.3d 1308, 1313

(7th Cir. 1996), aff’g T.C. Memo. 1995-243. For this presumption to

adhere in cases involving receipt of unreported income, the

Commissioner generally must make a minimal evidentiary showing

connecting the taxpayer with the income-producing activity or

demonstrating that the taxpayer actually received unreported income.

See Walquist v. Commissioner, 152 T.C. 61, 67 (2019). We conclude that

respondent has made the requisite showing to shift the burden to

petitioner.

II.

Inclusion of Program Revenue in Gross Income

Section 61 broadly defines gross income as “all income from

whatever source derived.” We narrowly construe any exclusions from

this sweeping definition. See Commissioner v. Schleier, 515 U.S. 323,

328 (1995). Receipt and possession of property “constitutes taxable

income when its recipient has such control over it that, as a practical

matter, he derives readily realizable economic value from it.” James v.

United States, 366 U.S. 213, 219 (1961) (quoting Rutkin v. United States,

343 U.S. 130, 137 (1952)); see Burnet v. Wells, 289 U.S. 670, 678 (1933)

(“Liability may rest upon the enjoyment by the taxpayer of privileges

and benefits so substantial and important as to make it reasonable and

just to deal with him as if he were the owner, and to tax him on that

basis.”); Corliss v. Bowers, 281 U.S. 376, 378 (1930) (“[T]axation is not

so much concerned with the refinements of title as it is with actual

command over the property taxed—the actual benefit for which the tax

is paid.”); see also Rogers v. Commissioner, T.C. Memo. 2011-277, 102

T.C.M. (CCH) 536, 538 (“The economic benefit accruing to the taxpayer

is the controlling factor in determining whether a gain is income.”), aff’d,

728 F.3d 673 (7th Cir. 2013). “The mere fact that income received by a

taxpayer may have to be returned at some later time does not deprive it

of its character as taxable income when received . . . .” Nordberg v.

Commissioner, 79 T.C. 655, 665 (1982) (quoting Woolard v.

Commissioner, 47 T.C. 274, 279 (1966)), aff’d, 720 F.2d 658 (1st Cir.

1983); see Healy v. Commissioner, 345 U.S. 278, 282–83 (1953)

(observing that a later year judicial declaration of constructive trust on

20

[*20] funds cannot retroactively render funds nontaxable for year

received, when taxpayer initially had control and economic benefit); Ill.

Power Co. v. Commissioner, 792 F.2d 683, 689 (7th Cir. 1986) (“Where,

unlike the case of a trustee or a collection agent or a borrower, the

taxpayer’s obligation to refund or rebate or otherwise repay money that

he has received is contingent, the money is taxable as income to him.”),

aff’g in part, rev’g in part 83 T.C. 842 (1984). Conversely, courts have

long recognized that “a cardinal purpose of the income tax laws is to tax

the income to the person who has the right or beneficial interest therein,

and not to throw the burden upon a mere collector or conduit through

whom or which the income passes.” Cent. Life Assur. Soc., Mut. v.

Commissioner, 51 F.2d 939, 941 (8th Cir. 1931), rev’g 18 B.T.A. 667

(1930); see Pascarelli v. Commissioner, 55 T.C. 1082, 1091 (1971)

(observing that transferor’s retention of dominion and control over

transferred funds would suggest that transferee “acted merely as a

conduit” and “not as the beneficial owner”), aff’d, 485 F.2d 681 (3d Cir.

1973).

In Seven-Up Co. v. Commissioner, 14 T.C. 965, 979 (1950), this

Court recognized a particular exclusion from gross income, which has

come to be known as the trust fund doctrine. There, the taxpayer

created and maintained a collective fund for the purpose of paying for

national advertising of its signature soft drink beverage. Id. at 968–71.

Some third-party bottlers of the 7-Up beverage, who regularly

purchased 7-Up extract from the taxpayer, voluntarily contributed into

the fund, which was then used to pay for national radio and magazine

advertising. Id. at 970–71. The question before this Court was whether

the payments into the fund were includible in the taxpayer’s gross

income. Id. at 976. We characterized the payments made by the bottlers

as neither “for services rendered or to be rendered” by the taxpayer nor

“part of the purchase price of the extract.” Id. at 977. We concluded

that the payments were not includible in gross income, reasoning that

the taxpayer did not gain or profit because of the fully offsetting

restriction on its use of the fund. Id. at 979.

Since Seven-Up Co., this Court has refined the applicable legal

test, which now holds that when a taxpayer (1) receives funds in trust,

subject to a legally enforceable restriction that they be spent in their

entirety for a specific purpose and (2) does not profit, gain, or benefit

from spending the funds for that purpose, then the taxpayer may

exclude such funds from gross income. See Ford Dealers Advert. Fund,

Inc., Jacksonville Div. v. Commissioner, 55 T.C. 761, 771 (1971), aff’d,

456 F.2d 255 (5th Cir. 1972). When both elements of the trust fund

21

[*21] doctrine are present, the taxpayer is deemed to be a mere conduit

or custodian of funds and not the beneficial owner for federal income tax

purposes. See Florists’ Transworld Delivery Ass’n v. Commissioner, 67

T.C. 333, 345–47 (1976); N.Y. State Ass’n of Real Est. Bds. Grp. Ins.

Fund v. Commissioner (NYS Ass’n), 54 T.C. 1325, 1335 (1970); Dri-Powr

Distribs. Ass’n Tr. v. Commissioner, 54 T.C. 460, 478–79 (1970); Broad.

Measurement Bureau, Inc. v. Commissioner, 16 T.C. 988, 1001 (1951);

see also Affiliated Foods, Inc. v. Commissioner, 154 F.3d 527, 532–33

(5th Cir. 1998), aff’g in part, rev’g in relevant part and remanding T.C.

Memo. 1996-505. In applying the trust fund doctrine, we also draw upon

the reasoning of older precedents, particularly a line of cases involving

payments made by cemetery lot customers to cemetery associations for

perpetual care or capital improvements. See, e.g., Commissioner v.

Cedar Park Cemetery Ass’n, 183 F.2d 553, 556–57 (7th Cir. 1950), aff’g

8 T.C.M. (CCH) 177 (1949); Portland Cremation Ass’n v. Commissioner,

31 F.2d 843, 845–46 (9th Cir. 1929), rev’g 10 B.T.A. 65 (1928); Am.

Cemetery Co. v. United States, 28 F.2d 918, 919 (D. Kan. 1928).

The parties dispute whether the Program revenue paid or due to

petitioner was properly excluded from petitioner’s gross income

pursuant to the trust fund doctrine. Petitioner contends that it was

legally restricted in its use of the Fund by (1) the applicable

management and franchise agreements, (2) a course of dealing between

it and the TPHOs, and (3) fiduciary duties arising by way of an agency

relationship between it and the TPHOs. Petitioner further contends

that it did not directly benefit from its use of Fund. Respondent asserts

in turn that petitioner’s use of the Fund was not so restricted and that

petitioner directly benefited from the Fund.

Petitioner also contends, in what it characterizes as an

alternative argument, that it is entitled to exclude the Program revenue

from gross income under the claim of right doctrine. See N. Am. Oil

Consol. v. Burnet, 286 U.S. 417, 424 (1932) (“If a taxpayer receives

earnings under a claim of right and without restriction as to its

disposition, he has received income . . . .”); Bates Motor Transp. Lines,

Inc. v. Commissioner, 200 F.2d 20, 24 (7th Cir. 1952), aff’g 17 T.C. 151

(1951); Diamond v. Commissioner, 56 T.C. 530, 541–42 (1971), aff’d, 492

F.2d 286 (7th Cir. 1974). We do not understand that doctrine to provide

an independent basis for exclusion of the Program revenue in these

circumstances. The trust fund doctrine is best understood as a more

tailored application of claim of right principles; if a taxpayer holds funds

in trust subject to a use restriction and for the primary benefit of others,

it naturally follows that such funds are not “received and treated by a

22

[*22] taxpayer as belonging to [it]”—i.e., without a claim of right. See

Healy v. Commissioner, 345 U.S. at 282; see also Seven-Up Co., 14 T.C.

at 977 (observing that payments into trust fund were not “earnings

received by [the taxpayer] under a claim of right and without restriction

as to disposition”); Na v. Commissioner, T.C. Memo. 2015-21, at *21–22

(characterizing Seven-Up Co. as an application of the claim of right

doctrine). We thus analyze the parties’ contentions under the more apt

framework of the trust fund doctrine.

Turning back to that doctrine, we start (and ultimately end) our

inquiry in reverse order, by first reviewing the nature of the benefit to

petitioner from the Fund. Accordingly, first assuming arguendo that the

Fund was received in trust subject to a legally enforceable restriction,

“our task is to determine whether the economic benefit to [petitioner] as

trustee is such that [petitioner] should be taxable on receipt of the

payments, notwithstanding whatever power the [TPHOs] may have to

enforce the trust terms under state law.” Angelus Funeral Home v.

Commissioner, 407 F.2d 210, 212 (9th Cir. 1969) (citing Gracelawn

Mem’l Park, Inc. v. United States, 260 F.2d 328, 332 (3d Cir. 1958)

(assuming that valid trust fund existed but concluding that funds were

“readily available to promote future capital improvements in the

taxpayer’s property” and thus includible in gross income)), aff’g 47 T.C.

391 (1967); see Nat’l Mem’l Park, Inc. v. Commissioner, 145 F.2d 1008,

1013 (4th Cir. 1944) (concluding that, even if fund had been shown to be

a valid trust fund, it would be includible in gross income because “the

benefit of the fund inured primarily to the [taxpayer]”).

Under the trust fund doctrine, any benefit inuring to the taxpayer

from use of a purported trust fund cannot be more than “incidental and

secondary.” See Angelus Funeral Home, 47 T.C. at 396, 398 (concluding

that taxpayer’s contractual option to use a purported trust fund to pay

for capital improvements to its facilities or to acquire real estate was “of

sole benefit to the [taxpayer] and of no conceivable benefit to the [the

trust fund contributors])”); Na, T.C. Memo. 2015-21, at *43 (citing

Pierson v. Commissioner, T.C. Memo. 1976-281, 35 T.C.M. (CCH) 1256,

1259, 1261) (characterizing benefit to taxpayer from use of funds as

“incidental” when spent only to facilitate her perceived duty to her

employer). “If a purported trustee has the right to use the funds for his

own benefit—even if that right is limited—no trust exists, and the funds

are includible in gross income.” Berry v. Commissioner, T.C. Memo.

2021-42, at *11 (citing Angelus Funeral Home, 47 T.C. at 398); see Na,

T.C. Memo. 2015-21, at *24 (“[I]f a taxpayer receives and disburses

funds strictly as an intermediary for transactions between other parties

23

[*23] and receives no material benefit from the funds, the taxpayer need

not include the funds in [its] gross income.”). For instance, if a

taxpayer’s use of the purported trust fund directly increases the value

of its property, the trust fund doctrine is typically inapplicable. See, e.g.,

United States v. Md. Jockey Club of Balt. City, 210 F.2d 367, 371 (4th

Cir. 1954) (holding that portion of horse race betting receipts set aside

in fund by taxpayer pursuant to state law were includible its gross

income when usable by taxpayer for capital improvements at its

racetrack). To illustrate, we borrow a (somewhat fitting) older

hypothetical:

If, upon the completion of an hotel, its directors created a

trust requiring twenty per cent of the proceeds of the

rentals from all rooms to be placed in trust for the purchase

of land for the building of a golf course, tennis courts and

swimming pool and providing that all fees exacted from

guests for the use of these facilities be paid into the trust

but that, upon the final payment for such facilities, they be

deeded to the hotel corporation in trust forever, could it be

reasonably argued that, although for the use and benefit of

hotel guests, the hotel corporation did not also benefit?

Gracelawn Mem’l Park, Inc. v. United States, 157 F. Supp. 516, 519–20

(D. Del. 1957) (holding that contributions to capital improvement fund

held by taxpayer-cemetery association were includible in taxpayer’s

gross income), aff’d, 260 F.2d 328 (3d Cir. 1958). In the hypothetical,

the fees paid by hotel guests would still constitute income to the hotel,

because its use of the fees directly enhanced the value of its property,

rather than incidentally doing so as a byproduct of benefiting the hotel

guests. See id.; cf. Angelus Funeral Home v. Commissioner, 407 F.2d at

212–13 (distinguishing between “incidental benefit” to taxpayer of

simply holding use-restricted funds and the direct benefit of using funds

to improve property); Gracelawn Mem’l Park, Inc., 260 F.2d at 332

(observing that taxpayer’s spending of purported trust fund on capital

improvements might be “convenient” or “more desirable” for customers

but that such spending was “for the corporation’s benefit”). In

determining the nature of the economic benefit to petitioner, our inquiry

is thus a practical one. See James, 366 U.S. at 219 (framing question as

whether taxpayer’s control over funds resulted in economic value “as a

practical matter”); Chi., R.I. & P. Ry. Co. v. Commissioner, 47 F.2d 990,

992 (7th Cir. 1931), rev’g 13 B.T.A. 988 (1928); Knowland v.

Commissioner, 29 B.T.A. 618, 624 (1933); see also Mount Vernon

Gardens, Inc. v. Commissioner, 298 F.2d 712, 716 (6th Cir. 1962) (“The

24

[*24] questions of control by, and inurement to the benefit of, the

taxpayer, are of prime importance.”), aff’g in relevant part, rev’g and

remanding 34 T.C. 598 (1960).

Respondent identifies several ways in which petitioner primarily

benefited from the Fund and asserts that the Program revenue was thus

includible in petitioner’s gross income. Ultimately, we agree with

respondent. We find that petitioner mandated that the TPHOs

participate in the Program and pay into the Fund, controlled the

amounts of Program payments in and compensation payments out of the

Fund, decided how to invest the Fund, accrued interest and realized

investment gains from holding the Fund, and determined whether

particular advertising or administrative costs would be paid for by the

Fund—all without oversight or input from the TPHOs. In turn we find

that petitioner benefited in a number of ways from how it exercised its

control over the Program and Fund. On the basis of these findings, we

conclude that petitioner had a sufficient beneficial economic interest and

thus should have included the Program revenue in gross income for the

years at issue. To illustrate the benefit to petitioner, we examine the

interplay of the various features of the Program and the Fund.

First, we find significant that petitioner controlled the up-front

amounts of 4% payments, miles payments, and sales payments, the

former two of which were mandatory for all TPHOs when a Program

member made a qualifying stay. With respect to the 4% payments,

petitioner exercised its control when it required full service hotel owners

to make larger 4% payments in 2011. That change increased the size of

the Fund available to petitioner and decreased the TPHOs’ profit

margins. The TPHOs could not prevent this change. Similarly, with

respect to the miles payments, petitioner directly negotiated agreements

with third-party transportation partners and then obligated hotel

owners to make reimbursing miles payments into the Fund when a hotel

guest chose to receive miles. Again, the TPHOs did not have input into

the choice of third-party transportation partners, the negotiated costs of

miles, or the number of miles received by customers for a stay.

Once the 4% payments, miles payments, and sales payments were

constituted as the Fund, petitioner had significant control and discretion

over spending. Petitioner controlled the investment of the Fund,

engaging custodians and investment advisers of its choice and dictating

the investment strategy and amounts to be invested—again without

oversight or input by the TPHOs. In turn any accrued interest or

25

[*25] realized gains from such investment remained within the control

of petitioner as an addition to the Fund.

Petitioner also had the discretion to increase its spending from

the Fund on whatever advertising and administrative costs it

designated as associated with the Program. 23 The record is devoid of

documentary evidence showing the specifics of how petitioner

determined which “administrative costs” and “advertising” would be

covered by the Fund. 24 Trial testimony by Messrs. Zidell and Stapp

suggested that, at a high level, it was largely a matter of discretion by

senior executives to designate particular costs as related to the Program,

in consultation with other Hyatt personnel, and then allocate or

disburse corresponding portions of the Fund. Petitioner’s discretion to

self-designate Program expenses in order to reimburse itself for

advertising costs weighs against a conclusion that the trust fund

doctrine is applicable.

See Sherwood Mem’l Gardens, Inc. v.

Commissioner, 350 F.2d 225, 230 (7th Cir. 1965) (focusing on taxpayer’s

“wide discretion in use” of purported trust fund and holding that the

fund was includible in gross income), aff’g 42 T.C. 211 (1964); Nat’l

Mem’l Park, Inc. v. Commissioner, 145 F.2d at 1012 (holding that

purported trust fund receipts were includible in gross income where

taxpayer had discretion as to what expenses would be paid “within the

wide range of general construction and improvement”); Memphis Mem’l

Park v. Commissioner, 28 B.T.A. 1037, 1043 (1933) (concluding

purported trust fund receipts were includible in gross income where “the

nature and extent” of the fund’s spending “was entirely within the

discretion” of the taxpayer), aff’d, 84 F.2d 1008 (6th Cir. 1936); cf.

Schochet v. Commissioner, T.C. Memo. 1982-416, 44 T.C.M. (CCH) 556,

564 (finding that taxpayer-trustees lacked discretion and control over

use of fund where they were required to spend fund as directed by

advertising committee); L.A. Cemetery Ass’n v. Commissioner, 2 B.T.A.

495, 497 (1925) (holding that trust fund was excludable from gross

income where taxpayer could “exercise no discretion in the accumulation

or distribution of the fund” because of state law restrictions). In

The only practical restraint on the amount of this spending arose from

petitioner’s decision to retain a reserve for future redemptions in an amount within

PWC’s range of actuarial estimates.

23

24 At trial, Jeffrey Zidell, the former vice president of the Program division, did

not testify to specifics of how petitioner calculated or ensured that such services were

indeed provided at cost. Mr. Zidell suggested generally that the primary internal

procedure was an annual budgetary process conducted by personnel involved in the

Program and senior executives.

26

[*26] contrast, the TPHOs did not have oversight over which costs were

designated. Cf. Affiliated Foods, Inc. v. Commissioner, 154 F.3d at 532

(finding that co-op grocery store members chose which advertising

promotions would be paid for out of trust fund); Schochet, 44 T.C.M.

(CCH) at 560 (observing that advertising committee that directed

spending of trust fund was made up equally of personnel from primary

entity/franchisor and franchisees). Aside from access to the generalized

Fund financial statements, which summarized expenses at a high

categorical level, the TPHOs had no access to the details of what specific

expenses were being paid out of the Fund. Accordingly, we find that

petitioner essentially retained the right to reimburse itself out of the

Fund at its own discretion. In total, petitioner controlled (1) the

amounts of 4% payments, miles payments, and sales payments, (2) how

(and how much of) the Fund was invested, and (3) the designation of

expenses to be paid. 25 This significant control weighs in favor of the

inference that petitioner had a beneficial interest in the Fund.

We now consider specifically how petitioner benefited from its

control over the Fund. As noted above, we have previously encountered

similar collective funds in the trust fund doctrine context. However, this

case is unlike much of our other collective fund precedent in a key

respect. In both this case and Seven-Up Co., the entity holding the fund

is the primary entity/franchisor itself or a subsidiary of that primary

entity/franchisor, operating as a for-profit corporation. In similar

collective fund precedents, the taxpayer was typically a separate entity,

often a nonprofit, nonstock corporation or a formal trust, set up to hold

the fund separately from the primary entity/franchisor’s corporate

structure. See Ford Dealers Advert. Fund, Inc., 55 T.C. at 762 (nonstock

corporation); NYS Ass’n, 54 T.C. at 1326 (trust); Dri-Powr Distributors

Ass’n Tr., 54 T.C. 462–63 (trust); Schochet, 44 T.C.M. (CCH) at 557

(trust); Greater Pittsburgh Chrysler Dealers Ass’n of N. Pa. v. United

States, No. 76-218, 1977 WL 1100, at *1 (W.D. Pa. Mar. 10, 1977)

(nonstock corporation); cf. Florists’ Transworld Delivery Ass’n, 67 T.C.

at 334, 344 (applying trust fund doctrine to collective advertising fund

held by parent membership organization organized as a nonstock

25 Indeed, petitioner’s own Forms 10-K implicitly disclosed that it maintained

significant control over the Fund; by consolidating the Fund as a “variable interest

entity,” petitioner took the position that it had “[t]he power . . . to direct the activities

of [the Fund] that most significantly impact the [Fund’s] economic performance.” Fin.

Acct. Standards Bd., Statement of Fin. Acct. Standards No. 167, at 2 (June 2009),

https://fasb.org/Page/ShowPdf?path=fas167.pdf (setting out the applicable financial

accounting rules for when a reporting entity must consolidate another entity over

which it does not hold a majority voting interest).

27

[*27] corporation). In such cases, the structure, by way of trust

agreement provisions or a corporate charter or bylaws, precluded the

primary entity/franchisor from exerting formal, legal control over the

spending of the fund or directly profiting from use of the fund. See Ford

Dealers Adver. Fund, Inc., 55 T.C. at 762; Schochet, 44 T.C.M. (CCH) at

565. 26 Using a separate entity sidestepped the question of whether a

primary entity/franchisor’s possession and control of a fund itself might

preclude a finding of a trust fund if it substantially benefited from its

use. See, e.g., Neal D. Borden et al., Franchise Advertising Funds:

Structural, Tax, Operational, and Liability Issues, 10 Franchise L.J. 1,

37 (1990) (“[C]areful practitioners who are alert to the potential [tax]

exposure with pooled advertising funds continue to be cautious,

especially where no separate entity—a trust or nonstock corporation—

exists.”).

This structuring may also account for a key finding in Seven-Up

Co. itself. There, the taxpayer was a true wholesaler; its business was

selling extract to the bottlers, and it did not itself did sell any beverages

directly to consumers. Seven-Up Co., 14 T.C. at 966–67. We thus found

that the increased revenue attributable to collective advertising flowed

first to the various third-party bottlers that sold 7-Up to the advertisedto public, with a secondary “corresponding increase” then flowing to the

taxpayer as the bottlers purchased increased amounts of extract to meet

customer demand. Id. at 973. Accordingly, the taxpayer’s revenue

increased from the use of the collective advertising fund only if third

party bottlers’ sales increased first, and we ultimately concluded that

the taxpayer did not directly gain or profit from receipt of the payments

constituting the fund. Id. at 979.

With this backdrop, the uniqueness of petitioner’s position vis-àvis the Fund is clearer. During the years at issue, petitioner owned

20%–25% of the Hyatt-branded hotels and was the largest single owner

of such hotels. Because of that role, having Program advertising paid

for out of the Fund effectively shifted to the Fund the cost of at least

some of the advertising that petitioner otherwise would have paid for to

generate stays at its owned hotels—a direct benefit to petitioner. See

26 To be sure, we found in several of these cases that the parent/franchisor was

still somewhat involved as a practical matter. In Ford Dealers Advertising Fund, Inc.,

55 T.C. at 764, the parent/franchisor (Ford Motor Co.) initially collected fees from each

sale to a car dealer of a Ford car before remitting the fees to the taxpayer for the

advertising fund; in Schochet, 44 T.C.M. (CCH) at 557, the taxpayer, who was trustee

of the advertising fund trust, was also the majority shareholder and an officer of the

parent/franchisor.

28

[*28] Cato v. Commissioner, 99 T.C. 633, 644 (1992) (concluding that

entities were not mere conduits when receipt of funds relieved them of

budgetary obligation to otherwise pay for services); Lykes Energy, Inc. v.

Commissioner, T.C. Memo. 1999-77, 77 T.C.M. (CCH) 1535, 1538

(concluding that purported trust fund “served to shift the cost” of

customer-driving subsidy from taxpayer to its customers); see also Nat’l

Mem’l Park, Inc. v. Commissioner, 145 F.2d at 1013 (characterizing

purported trust fund as serving “merely as a reimbursing fund to cover”

taxpayer’s spending on capital improvements that were “carried out

without regard” to the fund’s existence); Memphis Mem’l Park, 28 B.T.A.

at 1041 (attributing significance to fact that taxpayer would have

incurred same expenditures regardless of whether purported trust fund

existed). In addition, increased revenue attributable to Program

advertising flowed to petitioner directly when guests stayed at owned

hotels. See Lykes Energy, Inc., 77 T.C.M. (CCH) at 1538 (concluding that

taxpayer’s spending of purported trust fund increased its “rate base,

number of customers, and sales”). Increased revenue would also flow to

petitioner indirectly, through the gross-revenue-based management and

royalty fees charged to the TPHOs. While these latter management and

royalty fees resemble the secondary “corresponding increase” in SevenUp. Co., 14 T.C. at 973, the increased revenue to petitioner in its role as

hotel owner is anomalous. This direct benefit weighs against a

conclusion that petitioner did not have a beneficial interest in the Fund,

particularly considering petitioner’s control over the content of the

Program advertising itself. We conclude that petitioner’s receipt of and

control over the Program advertising resulted in additional economic

value to petitioner as a practical matter.

The Program advertising also directly benefited petitioner beyond

the revenue from each individual hotel stay. As several of petitioner’s

witnesses explained, the long-term success of a chain hospitality

business like petitioner’s depends significantly upon maintaining and

increasing the goodwill that customers associate with the Hyatt brand.

See Int’l Multifoods Corp. & Affiliated Cos. v. Commissioner, 108 T.C.

25, 43–44 (1997) (“Goodwill is founded upon a continuous course of

dealing that can be expected to continue indefinitely . . . [and] is the

expectancy of continued patronage.”); Tele-Comms., Inc. & Subs. v.

Commissioner, 95 T.C. 495, 521 (1990), aff’d, 12 F.3d 1005 (10th Cir.

1993); Watson v. Commissioner, 35 T.C. 203, 213 (1960). As the owner

of the Hyatt trademarks, petitioner directly benefited from the Program

advertising, which included such trademarks and thus maintained and

enhanced the value of petitioner’s goodwill. See Int’l Multifoods Corp.,

108 T.C. at 42 (“[T]rademarks embody goodwill.”); H Grp. Holding, Inc.

29

[*29] v. Commissioner, T.C. Memo. 1999-334, 78 T.C.M. (CCH) 533, 560

(concluding that Hyatt brand name was valuable and “a drawing factor

for potential customers” to Hyatt’s international hotels); Nestle

Holdings, Inc. v. Commissioner, T.C. Memo. 1995-441, 70 T.C.M. (CCH)

682, 696 (“Trademarks lose substantial value without adequate

investment, management, marketing, advertising, and sales

organization.”), vacated and remanded, 152 F.3d 83 (2d Cir. 1998); see

also Coca-Cola Co. & Subs. v. Commissioner, 155 T.C. 145, 241 (2020)

(concluding that advertising of Coke products “enhanced the value” of

Coke trademarks). Not only did customer goodwill generate repeat hotel

stays and thus direct and indirect revenue for petitioner (as discussed

above), but it also granted petitioner additional contractual leverage in

its role as prospective franchisor or manager for hotel properties. Put

another way, petitioner could rely on the increased goodwill associated

with the Hyatt brand in negotiating higher royalties, management fees,

and other fees in new agreements reached with existing or prospective

TPHOs—a direct benefit to it. See Mount Vernon Gardens, Inc. v.

Commissioner, 298 F.2d at 716 (characterizing taxpayer’s use of

purported trust fund to increase value of its unsold inventory as “direct

benefit”); Memphis Mem’l Park, 28 B.T.A. at 1041 (concluding that

purported trust fund of payments from cemetery lot customers was

includible in gross income where taxpayer’s use of fund to improve its

property generated “a benefit through increased sales, at increased

prices” of taxpayer’s services to other cemetery lot customers); see also

Gracelawn Mem’l Park, Inc., 260 F.2d at 332 (“While a chapel [paid for

by a purported trust fund] . . . is convenient for people who have burial

rites to perform in bad weather, it is remembered that part of the income

of [the taxpayer] comes from charges made for services in connection

with burials.”).

Intuitively, an increase in customer goodwill (and thus the value

of a franchisor’s intellectual property) does not ultimately accrue to the

collective benefit of durational affiliates and franchisees like the

TPHOs. See Canterbury v. Commissioner, 99 T.C. 223, 249 (1992)

(concluding that McDonald’s franchisee did not retain any goodwill

“separate and apart from the goodwill inherent in the McDonald’s

franchise”); Zorniger v. Commissioner, 62 T.C. 435, 444–46 (1974); Akers

v. Commissioner, 6 T.C. 693, 700 (1946); see also Coca-Cola Co., 155 T.C.

at 252 (concluding that value derived from advertising of Coke brands

by affiliate exclusively belonged to taxpayer). A TPHO benefited from

flying the Hyatt flag only for so long as it was entitled to do so pursuant

to the duration of the applicable management or franchise agreement.

If a TPHO continued on with the Hyatt brand, any increased goodwill

30

[*30] value would presumptively be accounted for in higher contract

fees when the time for renewal of a management or franchise agreement

came around. Alternatively, if a TPHO deflagged from the Hyatt brand,

pursuant to the management or franchise agreement, the TPHO would

not retain nor have any financial claim on the value of any goodwill

generated from the Program advertising that it had partially funded.

See Montgomery Coca-Cola Bottling Co. v. United States, 615 F.2d 1318,

1332 (Ct. Cl. 1980) (“Since goodwill is considered to be the value of the

habit of customers to return to purchase a product at the same location,

the absence of the product would destroy the value of the habit . . . .”);

cf. Akers, 6 T.C. at 700 (characterizing General Motors franchise

agreements as making no provision “for payments for good will or goingconcern value in the event of their termination”). We conclude that

petitioner’s use of the Fund on Program advertising was a direct benefit

to petitioner.

This same rationale holds true for other petitioner-owned

intellectual property that the Fund paid for, namely the Program

member database. Again, petitioner’s witnesses characterized the

Program member database as a key, valuable facet of petitioner’s efforts

to maintain and enhance customer goodwill. On the micro level, the

member database recorded specifics about customer preferences that

allowed hotel staff to tailor hotel stays to particular customers and thus

encourage individualized brand loyalty and repeated future stays across

the Hyatt chain. On the macro level, the aggregate customer analytics

generated by the member database were highly useful to petitioner in

its marketing efforts and decision making. The member database was

owned and maintained by petitioner, and deflagging TPHOs were not

entitled to retain the confidential data about members that visited its

hotel. We conclude that petitioner’s use of the Fund to generate and

maintain customer goodwill primarily benefited itself, as opposed to the

TPHOs.

Finally, we turn to petitioner’s back-end control over the timing

and amounts of compensation payments out of the Fund to hotel owners.

Under the Program member terms and conditions, petitioner had the

discretion to raise the bar for rewards points redemptions, make

rewards points expirable, change the awards category for certain hotels,

and create other conditions that would tend to increase the available

balance of the Fund and decrease the amount and frequency of

31

[*31] compensation payments. 27 In 2010 petitioner exercised that

discretion by raising the number of rewards points required for a stay

at certain award categories of hotels. In 2011 petitioner also changed

its formula for calculating compensation payments to the TPHOs. Each

of these changes decreased the number of compensation payments going

back out to the TPHOs and increased the amount of the Fund available

for whatever petitioner designated as advertising and administrative

costs. Petitioner’s right to defer and decrease the compensation

payments further demonstrates how it was ultimately able to control the

Fund in order to primarily benefit itself.

To sum up, given the totality of petitioner’s control and discretion

over the Program and the Fund and how its use of the Fund directly

benefited it, petitioner has failed to establish that the trust fund

doctrine is applicable to it. We conclude that petitioner was more than

just a mere intermediary or conduit, passively holding funds and then

remitting them on for the convenience of others, with only an incidental

benefit to itself. Cf. Cent. Life Assur. Soc., Mut. v. Commissioner, 51

F.2d at 941. Instead, petitioner had a sufficient beneficial economic

interest in the Fund to be liable for tax. Given this conclusion, we need

not address whether the Fund was received in trust subject to a use

restriction that was legally enforceable by the TPHOs. 28 See Angelus

Funeral Home v. Commissioner, 407 F.2d at 213 (assuming use

restriction was enforceable but concluding that restriction allowed

taxpayer “to benefit itself more than incidentally” and therefore did not

preclude inclusion in gross income). We conclude that the trust fund

doctrine exception is inapplicable and hold that petitioner must include

the Program revenue in gross income.

27 In 2012 petitioner did in fact change the Program to make rewards points

expire after a certain period, which had the effect of reducing the number of future

rewards points redemptions and thus compensation payments to TPHOs.

28 We view petitioner’s contentions on this point with some skepticism, given

the record before us. See Ill. Power Co. v. Commissioner, 792 F.2d at 689 (“The

underlying principle is that the taxpayer is allowed to exclude from his income money

received under an unequivocal contractual, statutory, or regulatory duty to repay it, so

that he really is just the custodian of the money.” (Emphasis added.)). In any event,

however, we think it prudent not to unnecessarily wade into the murky and unfamiliar

waters of state law and equitable principles. Cf. Jenkins v. Commissioner, T.C. Memo.

2021-54, at *26.

32

[*32] III.

Section 481 Adjustment

Section 481(a) provides that, when a taxpayer computes its

taxable income “under a method of accounting different from the method

under which the taxpayer’s taxable income for the preceding taxable

year was computed, . . . there shall be taken into account those

adjustments which are determined to be necessary solely by reason of

the change in order to prevent amounts from being duplicated or

omitted.” Put more simply, if “income escapes taxation because of a

change in the accounting method,” the Commissioner is empowered

under section 481(a) to “make an adjustment by including the omitted

income in the year of the change.” Graff Chevrolet Co. v. Campbell, 343

F.2d 568, 570 (5th Cir. 1965). Section 481 remedies some of the

practical problems posed by annualized tax accounting; for instance,

“[b]ecause different tax accounting methods provide for different dates

on which income or deductions are recognized, a switch in accounting

methods can create a situation in which a taxpayer is able to deduct the

same expense—or is required to recognize the same income—in two

separate tax years.” Nat’l Life Ins. Co. & Subs. v. Commissioner, 103

F.3d 5, 7 (2d Cir. 1996), aff’g 103 T.C. 615 (1994); see Suzy’s Zoo v.

Commissioner, 114 T.C. 1, 13 (2000), aff’d, 273 F.3d 875 (9th Cir. 2001);

Pursell v. Commissioner, 38 T.C. 263, 269–71 (1962) (discussing purpose

and legislative history of section 481), aff’d, 315 F.2d 629 (3d Cir. 1963).

The Commissioner’s authority under section 481 is not limited by

section 6501(a), which otherwise provides the general rule of limitations

on his assessment authority. See Graff Chevrolet Co., 343 F.2d at 572

(“Section 481 is designed to prevent a distortion of taxable income and a

windfall to the taxpayer stemming from a change in accounting at a time

when the statute of limitations bars reopening the taxpayer’s returns

for earlier years.”); see also Peoples Bank & Tr. Co. v. Commissioner, 415

F.2d 1341, 1344 (7th Cir. 1969), aff’g 50 T.C. 750 (1968); Superior Coach

of Fla., Inc. v. Commissioner, 80 T.C. 895, 912 (1983). However, this

otherwise broad authority is bounded by the requirement that any

adjustments to include omitted income be solely due to a change in the

taxpayer’s method of accounting. See Rankin v. Commissioner, 138 F.3d

1286, 1288 (9th Cir. 1998) (“[Section 481] adjustments are made only to

compensate for the change in method of accounting.”), aff’g T.C. Memo.

1996-350. Given the extraordinary authority posed by section 481, “we

examine carefully each instance in which the Commissioner invokes” it.

Pinkston v. Commissioner, T.C. Memo. 2020-44, at *10–11.

33

[*33] The parties dispute whether petitioner’s treatment of the Fund

constituted a method of accounting and thus whether the inclusion of

Program revenue in gross income (and corresponding taking of

deductions) constitutes a change in method of accounting subject to

section 481 adjustment. As evinced by the parties’ stipulations, 29 which

we accept as binding admissions, see Rule 91(a) and (e), resolution of

this issue is determinative of the bulk of the deficiency at issue in this

case, which is otherwise time-barred from assessment.

To reiterate, a section 481 adjustment is permitted only if omitted

or duplicated income is due solely to a change in the taxpayer’s method

of accounting. The phrase “change in method of accounting” is not

expressly defined in the Code. The applicable regulation states that a

“change in method of accounting to which section 481 applies includes a

change in the over-all method of accounting for gross income or

deductions, or a change in the treatment of a material item.” Treas. Reg.

§ 1.481-1(a)(1). The regulation then directs us to section 446(e) and

Treasury Regulation § 1.446-1(e) for further rules as to what constitutes

a change in method of accounting. See Treas. Reg. § 1.481-1(a)(1).

Treasury Regulation § 1.446-1(e)(2)(ii)(a) defines a “material item” as

“any item that involves the proper time for the inclusion of the item in

income or the taking of a deduction.” The regulation then inversely

provides that “a change in method of accounting does not include

adjustment of any item of income or deduction that does not involve the

proper time for the inclusion of the item of income or the taking of a

deduction.” Id. subdiv. (ii)(b).

In determining whether a taxpayer’s treatment constitutes a

material item, we apply the lifetime income test. Under this test, we

first ask whether the taxpayer’s existing treatment would have

“permanently avoided the reporting of income over the taxpayer’s

lifetime income or merely postponed the reporting of income.” Primo

Pants Co. v. Commissioner, 78 T.C. 705, 723 (1982) (citing Graff

Chevrolet Co., 343 F.2d at 572); see Knight-Ridder Newspapers, Inc. v.

United States, 743 F.2d 781, 798 (11th Cir. 1984) (“The essential

characteristic of a ‘material item’ is that it determines the timing of

29 The parties stipulated that the period of limitations on assessment expired

before the issuance of the notice of deficiency for tax years 1987 through 2004, 2006,

and 2007; the parties similarly stipulated with respect to tax years 2005 and 2008,

while also stipulating that the period of limitations remained open with respect to

assessments of deficiency under section 6501(h) (net operating loss carrybacks) for

2005 and under section 6501(i) (reported foreign tax credit carrybacks) and (j) (general

business credit carrybacks) for 2008.

34

[*34] income or deductions.”); Fla. Progress Corp. & Subs. v.

Commissioner, 114. T.C. 587, 603 (2000), aff’d, 348 F.3d 954 (11th Cir.

2003); Pelaez & Sons, Inc. v. Commissioner, 114 T.C. 473, 489 (2000)

(deeming taxpayer’s decision to deduct rather than capitalize expense “a

timing question and not a one-time inclusion or deduction”), aff’d, 253

F.3d 711 (11th Cir. 2001); Wienke v. Commissioner, T.C. Memo. 2020143, at *29 (“An item is ‘material’ when it affects the timing of reporting

income or deductions, as opposed to ‘how much income is reported, or

whether a deduction would ever have been appropriate.’” (quoting

Rankin v. Commissioner, 138 F.3d at 1288)). If “an accounting practice

does nothing more than postpone the reporting of income,” it is a

material item. Fla. Progress Corp., 114 T.C. at 603; see also Huffman v.

Commissioner, 126 T.C. 322, 343 (2006) (concluding that erroneous

original treatment would not result in “permanent omission of income”

where error would “self correct” in the aggregate over time), aff’d, 518

F.3d 357 (6th Cir. 2008); Hawse v. Commissioner, T.C. Memo. 2015-99,

at *29. If the taxpayer’s treatment is in fact a material item, we proceed

to the second question: whether a change in the taxpayer’s treatment of

the material item would result in no more or less income to the taxpayer

over the course of its lifetime. See, e.g., Primo Pants Co., 78 T.C. at 723–

24. If the change would not affect the taxpayer’s lifetime income, it

implicates timing and is a change in method of accounting. The U.S.

Court of Appeals for the Seventh Circuit—to which an appeal in this

case would lie, absent stipulation to the contrary, see § 7482(b)(1)(B),

(2)—has recognized the rationale for the lifetime income test in the

context of section 481:

When a taxpayer uses an accounting method which

reflects an expense before it is proper to do so or which

defers an item of income that should be reported currently,

he has not succeeded (and does not purport to have

succeeded) in permanently avoiding the reporting of any

income; he has impliedly promised to report that income at

a later date, when his accounting method, improper though

it may be, would require it. Section 481, therefore, does not

hold the taxpayer to any income which he has any reason

to believe he has avoided, and does not frustrate the policy

that men should be able, after a certain time, to be

confident that past wrongs are set at rest.

Peoples Bank & Tr. Co. v. Commissioner, 415 F.2d at 1344 (quoting

Note, Problems Arising from Changes in Tax-Accounting Methods, 73

35

[*35] Harv. L. Rev. 1564, 1576 (1960)); accord Graff Chevrolet Co., 343

F.2d at 571–72.

The parties base their respective positions on competing versions

of the lifetime income test. Petitioner contends that, because its prior

return treatment permanently excluded the Program revenue and never

claimed deductions with respect to Program expenses, timing issues

were not implicated and thus its treatment was not a material item. In

contrast, respondent argues that the change in petitioner’s tax

treatment of the Fund would not affect the aggregate amount of

petitioner’s lifetime taxable income (i.e., gross income minus deductions,

see § 63(a)). In respondent’s more results-based view, both petitioner’s

prior and current treatment of the Fund as a whole (i.e., encompassing

both income and deduction components) would result in zero aggregate

lifetime taxable income to petitioner, thus implicating questions of

timing rather than inclusion.

We reject respondent’s formulation of the lifetime income test in

that it disregards the preliminary question of whether a taxpayer’s

existing treatment constituted a material item. We largely agree with

petitioner’s formulation of the lifetime income test, which accords with

the text of the regulation 30 and our precedents. 31 See Gen. Motors Corp.

30 As we read the regulatory text, “a change in the treatment of any material

item” can occur only if a material item (i.e., “any item which involves the proper time

for the inclusion of the item in income or the taking of a deduction”) already exists in

the first instance. See Treas. Reg. § 1.446-1(e)(2)(ii)(a), (iii) (example 7) (labeling

taxpayer’s existing treatment a material item before concluding that a “change in such

practice or procedure is a change of method of accounting”).

31 Despite respondent’s contentions otherwise, our decision in Johnson v.

Commissioner, 108 T.C. 448 (1997), aff’d in part, rev’d in part, 184 F.3d 786 (8th Cir.

1999), is not to the contrary. In Johnson, we concluded that a car dealer taxpayer’s

initial erroneous exclusion of part of the proceeds of prepaid car service contracts

implicated timing issues (i.e., postponement of income) at step one of the lifetime

income test. Id. at 494. We noted the possibility that particular amounts of the

proceeds might never be included in gross income (for instance, if a customer canceled

a service contract and received a refund) but observed that the treatment still

implicated timing because, in such instances, the taxpayer’s practice “resulted in

permanent exclusion only where a deduction would have been allowable for a later

period.” Id. at 495. The taxpayer’s initial exclusion of the items of income thus

implicated timing issues in all instances, because the underlying position was one of

temporary deferral and only became permanent in the event of later contingencies.

See Peoples Bank & Tr. Co. v. Commissioner, 415 F.2d at 1344 (observing that a section

481 adjustment is appropriate where a taxpayer’s original treatment “impliedly

promised to report that income at a later date”). This made the “exclusion” akin to an

36

[*36] & Subs. v. Commissioner, 112 T.C. 270, 296 (1999) (“An

accounting practice that involves the timing of when an item is included

in income or when it is deducted is considered a method of accounting.”);

Wayne Bolt & Nut Co. v. Commissioner, 93 T.C. 500, 511 (1989) (“Since

[the taxpayer’s] pre-1982 method of determining inventory involved the

proper time for reporting income, it was a ‘material item.’”); Starer v.

Commissioner, T.C. Memo. 2022-124, at *15 (“Where a taxpayer’s

accounting practice permanently avoids reporting of income and

accordingly distorts its lifetime income, the practice is not a method of

accounting and section 481(a) is inapplicable to a change of the

accounting practice.” (citing Schuster’s Express, Inc. v. Commissioner,

66 T.C. 588 (1976), aff’d, 562 F.2d 39 (2d Cir. 1977))). To reiterate,

consistent with the purpose of section 481, we understand the lifetime

income test to require looking first to whether the taxpayer’s original

treatment of an item implicated timing. See Peoples Bank & Tr. Co. v.

Commissioner, 415 F.2d at 1344 (framing the question as whether the

taxpayer’s erroneous original treatment “impliedly promised” to report

future income). Only when a taxpayer’s original treatment implicates

timing (i.e., acceleration or postponement of income) do we proceed to

analyzing whether a proposed change would distort the taxpayer’s

lifetime income. See Knight-Ridder Newspapers, Inc., 743 F.2d at 798–

99 (characterizing taxpayer’s reserve as “an item which affected the

timing of a deduction” and concluding that it was a material item and

method of accounting).

Framed in these terms, resolution of this issue is clearer.

Petitioner’s consistent, total exclusion of the Program revenue and

nontaking of deductions for Program expenses did not involve timing, at

least so long as the Program continued in perpetuity. See Tate & Lyle,

Inc. v. Commissioner, 103 T.C. 656, 668 (1994) (“The total exclusion of

an item from the recipient’s gross income is a question of

characterization that is unrelated to the taxpayer’s method of

accounting.”), rev’d on other grounds, 87 F.3d 99 (3d Cir. 1996);

Hamilton Indus., Inc. v. Commissioner, 97 T.C. 120, 126 (1991) (stating

that a taxpayer does not use a method of accounting where it “entirely

accelerated deduction and thus a material item within the meaning of the regulations.

See Treas. Reg. § 1.446-1(e)(2)(ii)(a); cf. Knight-Ridder Newspapers, Inc., 743 F.2d at

799 (analyzing reverse situation where taxpayer erroneously deducted up-front

contributions to a reserve and observing that “an equal amount of income” is

essentially taxed later upon payment out of the reserve due to the “absence of

deductions” that would otherwise have properly been taken). In contrast, petitioner’s

treatment of the Fund was a position of permanent, total exclusion from gross income

and nontaking of deductions, which did not implicate timing issues.

37

[*37] avoids the inclusion of income in any year”); Saline Sewer Co. v.

Commissioner, T.C. Memo. 1992-236, 63 T.C.M (CCH) 2832, 2834

(concluding that taxpayer’s consistent exclusion of certain fees from

gross income was “clearly not a timing issue” implicating section 481).

The only remaining question is how petitioner would have treated

any remaining portions of the Fund in the event the Program was

terminated. See Rankin v. Commissioner, 138 F.3d at 1289 (recognizing

timing issue where any remaining money in already-deducted thirdparty fund would have resulted in income inclusion in the event of

termination of fund); Knight-Ridder Newspapers, Inc., 743 F.2d at 799

(recognizing timing issue where already-deducted reserve would have

been includible in gross income in the event of a “Day of Armageddon”

when reserve was abandoned); Pinkston, T.C. Memo. 2020-44, at *15 n.5

(“In determining whether an item postpones or accelerates the reporting

of income, courts have generally assumed that relevant future events

. . . will ultimately occur.”); cf. Schuster’s Express, Inc., 66 T.C. at 596

(finding no method of accounting, where Commissioner bore burden of

proof, because taxpayer’s existing treatment did not involve any

“procedure or intention” to include excessive deduction amounts in gross

income in future tax years).

Petitioner produced testimony from Hyatt personnel and expert

testimony from an accounting expert, all of which professed that any

remaining balance of the Fund would have been refunded to the

participating hotel owners in the event of Program termination, and

thus petitioner would still not have reported the Fund in gross income

or taken deductions. We find that testimony to be credible as to

petitioner’s position and largely uncontroverted by respondent.

Communications between petitioner and its external auditors at

Deloitte and several state revenue agencies reinforced this testimony.

In such communications, which were made in the context of auditing

petitioner’s annual financial statements and addressing its potential

state tax exposure, respectively, petitioner’s representatives repeatedly

represented that the balance of the Fund would be refunded to

participating hotel owners in the event of Program termination.

Further, contractual terms in some of the applicable agreements with

TPHOs represented that any amounts remaining in the Fund on

termination would be distributed to the then-participating Hyattbranded hotel owners. On the record before us, we see no reason to

doubt that petitioner would have continued to adhere to its erroneous

exclusionary treatment of the Fund, even in the event of Program

38

[*38] termination. 32

Cf. George K. Herman Chevrolet, Inc. v.

Commissioner, 39 T.C. 846, 848–49 (1963) (discussing analogous

practice by which General Motors refunded collective advertising fund

to car dealers upon termination of advertising program). We conclude

that petitioner’s prior treatment of the Program revenue was not a

material item and thus not a method of accounting. Consequently, we

will not sustain respondent’s determination of a section 481 adjustment.

Respondent argues that, absent a section 481 adjustment,

petitioner will, for the years at issue and future years, be entitled to

deduct compensation payments relating to Program revenue

permanently excluded from gross income, resulting in a windfall for

petitioner. It is true that respondent has conceded that result for

purposes of the years at issue. 33 But we do not see why the same

treatment would necessarily be appropriate in future years after our

decision. A number of doctrines (e.g., the duty of consistency or clear

reflection of income principles) may prevent a taxpayer from claiming a

deduction when the corresponding income has not been subject to tax,

see, e.g., Kielmar v. Commissioner, 884 F.2d 959, 965 (7th Cir. 1989),

aff’g Glass v. Commissioner, 87 T.C. 1087 (1986); Hintz v. Commissioner,

712 F.2d 281, 284 (7th Cir. 1983), aff’g T.C. Memo. 1981-425, and

respondent is free to assert their application in a future case. That he

did not do so here is no fault of petitioner’s and does not entitle

respondent to a section 481 adjustment when the requirements of that

section are unmet.

32 We note that, even in the unlikely event that all TPHOs deflagged from the

Hyatt brand before such a Program termination, petitioner would still have been able

to pay out the balance of the Fund to its own subsidiaries in their capacity as hotel

owners.

33 See Respondent’s First Amendment to Answer, at 1 (“Hyatt Corporation

must report the Program income in the year received or accrued under IRC § 448 and

IRC § 451, and the expenses of the Program are deductible per IRC § 162 and IRC

§ 461.”); Respondent’s Pretrial Memorandum, at 53 (“[I]f the Court were to determine

that Hyatt Corporation must recognize the Program Revenue and Program expenses

beginning in the taxable year 2009 but section 481 did not apply to this change in

reporting, Hyatt Corporation would be able to deduct amounts paid from the Program

Assets consisting of pre-2009 net Program Revenue whose receipt was not recognized

as income.”); Respondent’s Simultaneous Opening Brief, at 197 (“Were it held

otherwise, Hyatt Corporation would receive a significant windfall, because Hyatt

Corporation would never recognize over $200 million in income and yet be able to

deduct its spending of this income.”).

39

[*39] IV.

Trading Stamp Method

The general rule for accrual method taxpayers is that a liability

is incurred and thus taken into account for federal income tax purposes

once it has satisfied the all events test. See, e.g., Hoops, LP v.

Commissioner, T.C. Memo. 2022-9, at *9–10, aff’d, 77 F.4th 557 (7th Cir.

2023). Under the all events test, a liability is incurred for the taxable

year when (1) “all the events have occurred that establish the fact of the

liability”; (2) “the amount of the liability can be determined with

reasonable accuracy”; and (3) “economic performance has occurred with

respect to the liability.” Treas. Reg. § 1.461-1(a)(2)(i); see § 461(h). The

economic performance requirement does not apply “to any item for

which a deduction is allowable under a provision of this title which

specifically provides for a deduction for a reserve for estimated

expenses.” § 461(h)(5). The regulations instruct that, for accrual

method taxpayers, applicable statutory or regulatory provisions and

guidance may also otherwise prescribe when an incurred liability is

taken into account.

See Treas. Reg. §§ 1.461-1(a)(2)(i), 1.4461(c)(1)(ii)(A).

A longstanding regulatory provision offers a narrow, de facto

exception to the all events test for an accrual method taxpayer that

(1) “issues trading stamps or premium coupons with sales” and (2) “such

stamps or coupons are redeemable by such taxpayer in merchandise,

cash, or other property.” 34 Treas. Reg. § 1.451-4(a)(1); see Cap. One Fin.

Corp. v. Commissioner, 133 T.C. 136, 197 (2009), aff’d, 659 F.3d 316 (4th

Cir. 2011). If both conditions are applicable, the taxpayer may offset

against gross receipts from such sales an amount equal to “[t]he cost to

the taxpayer of merchandise, cash, and other property used for

As the historical analog to modern rewards points, trading stamps and

premium coupons were generally physical pieces of adhesive paper issued by a retailer

as promotions with sales of their product; once collected in a sufficient number, the

stamps or coupons were redeemable for a product chosen from the retailer’s store or a

catalog. See FTC v. Sperry & Hutchinson Co., 405 U.S. 233, 236–38 (1972); Safeway

Stores, Inc. v. Okla. Retail Grocers Ass’n, 360 U.S. 334, 338 (1959); Tanner v. Little,

240 U.S. 369, 370–72 (1916); Sateriale v. R.J. Reynolds Tobacco Co., 697 F.3d 777, 783–

84 (9th Cir. 2012); Sperry & Hutchinson Co. v. O’Neill-Adams Co., 185 F. 231, 233–34

(2d Cir. 1911); Colgate & Co. v. United States, 66 Ct. Cl. 510, 514–16 (1928); see also

Giant Eagle, Inc. v. Commissioner, T.C. Memo. 2014-146, at *12 (holding that reward

discounts on purchase price were not premium coupons), rev’d on other grounds, 822

F.3d 666 (3d Cir. 2016); Staff of J. Comm. on Tax’n, 95th Cong., General Explanation

of the Revenue Act of 1978, JCS-7-79, at 244 (J. Comm. Print 1979) (“Ordinarily, a

discount coupon is individually redeemable, while the premium coupon is intended to

be collected and redeemed in large numbers for a single product.”).

34

40

[*40] redemptions in the taxable year” plus “the net addition to the

provision for future redemptions during the taxable year.” Treas. Reg.

§ 1.451-4(a)(1). The “provision for future redemptions” is “the number

of trading stamps or coupons outstanding as of the end of such year that

it is reasonably estimated will ultimately be presented for redemption,”

multiplied by “the estimated average cost” of “acquiring the

merchandise, cash, or other property needed to redeem such stamps or

coupons.” Id. para. (b)(1). A “net addition” exists if the current tax year’s

provision for future redemptions exceeds the previous tax year’s

provision for future redemptions. Id. subpara. (2).

Accordingly, the trading stamp method effectively accelerates

what otherwise would have been future year deductions and serves as

an exception to the general rule that reserves for contingent liabilities

are not deductible. See Brown v. Helvering, 291 U.S. 193, 200–01 (1934);

Lucas v. Am. Code Co., 280 U.S. 445, 452 (1930). The regulation’s

purpose is to match sales revenues with the expenses incurred in

generating those revenues (i.e., effectively treating the future

redemption cost of stamps or coupons as part of the present cost of goods

sold). See Tex. Instruments, Inc. v. Commissioner, T.C. Memo. 1992-306,

63 T.C.M. (CCH) 3070, 3071; see also United States v. O.J. Morrison

Stores of Fairmont, 99 F.2d 77, 79 (4th Cir. 1938). Accordingly, the

trading stamp method recognizes the economic reality that an initial

sale price will reflect both “the value of the goods currently delivered

and the value of the coupon that can be applied toward a future

purchase.” W. Eugene Seago & Edward J. Schnee, Tax Accounting for

Coupons Under the Special Rules in the Regulations, 112 J. Tax’n 295,

297 (2010).

As applied to this case, the trading stamp method would allow

petitioner to offset against gross receipts both (1) the cost of current year

redemptions (i.e., current year compensation payments) and (2) the net

addition to the estimated cost of future tax year redemptions that

corresponds to rewards points issued to members during the taxable

year. The parties vigorously contest whether petitioner is entitled to

adopt the trading stamp method. The parties’ primary disagreement

rests on the question of whether the rewards points were redeemable in

“merchandise, cash, or other property,” as required by the regulation. 35

35 Respondent also raises several other procedural issues that he claims

independently bar petitioner’s adoption of the trading stamp method. Given our

41

[*41] Respondent argues that petitioner has failed to establish that the

trading stamp method is applicable, because the rewards points at issue

were redeemable for services (i.e., hotel stays and air travel), rather

than “merchandise, cash, or other property.” See Treas. Reg. § 1.4514(a)(1). Petitioner contends that the rewards points were redeemable

instead for the right to receive a hotel stay or airline miles, which

petitioner contends are both “other property” within the meaning of

Treasury Regulation § 1.451-4(a)(1). Petitioner characterizes the former

as an intangible property right “in the form of a reservation to use a

hotel room at a particular time and place at no charge.” Petitioner also

emphasizes that a member can redeem her own rewards points for

another person’s hotel stay, which, petitioner claims, is an assignment

of a property right.

As a matter of state law (largely as viewed through the prism of

federal bankruptcy law), the majority view is that hotel guests are

contractual licensees possessing a license to use hotel premises. See,

e.g., Young v. Harrison, 284 F.3d 863, 868–69 (8th Cir. 2002) (South

Dakota law); Patel v. Northfield Ins. Co., 940 F. Supp. 995, 1002 (N.D.

Tex. 1996) (Texas law); Great-W. Life & Annuity Assur. Co. v. Parke

Imperial Canton, Ltd., 177 B.R. 843, 858 (N.D. Ohio 1994) (Ohio law);

Hari Ram, Inc. v. Magnolia Portfolio, LLC (In re Hari Ram, Inc.), 507

B.R. 114, 122–23 (Bankr. M.D. Pa. 2014) (Pennsylvania law); Casco N.

Bank, N.A. v. Green Corp. (In re Green Corp.), 154 B.R. 819, 823–24

(Bankr. D. Me. 1993) (Maine law); Mid-City Hotel Assocs. v. Prudential

Ins. Co. of Am. (In re Mid-City Hotel Assocs.), 114 B.R. 634, 640–41

(Bankr. D. Minn. 1990) (Minnesota law); Kearney Hotel Partners v.

Richardson (In re Kearney Hotel Partners), 92 B.R. 95, 99 (Bankr.

S.D.N.Y. 1988) (Nebraska law). A minority of courts consider hotel

guests to possess leasehold interests, albeit short ones, in their hotel

rooms. See In re Old Colony, LLC, 476 B.R. 1, 21–23 (Bankr. D. Mass.

2012) (Wyoming law); In re Churchill Props. VIII Ltd. P’ship, 164 B.R.

607, 609 (Bankr. N.D. Ill. 1994) (Iowa law); see also Travelers Ins. Co. v.

First Nat’l Bank of Blue Island, 621 N.E.2d 209, 213–14 (Ill. App. Ct.

1993) (characterizing hotel receipts as “rent” and suggesting that

distinction between hotel guest and a tenant is insubstantial). In other

contexts, airline rewards miles are understood to be intangible property.

See United States v. Loney, 959 F.2d 1332, 1336 (5th Cir. 1992)

(construing “property” in federal wire fraud statute to encompass airline

miles); Ficken v. AMR Corp., 578 F. Supp. 2d 134, 143 (D.D.C. 2008)

conclusion below on the merits of whether the trading stamp method is applicable, we

need not address these issues.

42

[*42] (characterizing party’s airline miles as a “credit with the airline”

and thus an intangible property right).

We need not resolve whether a hotel stay is better characterized

as a license or a leasehold. Regardless of the proper characterization,

the regulatory text does not support a broad reading that a license or

leasehold (or airline miles) would qualify as “other property” within the

meaning of the regulation. In determining the plain meaning of the

catchall category in the phrase “merchandise, cash, or other property,”

the interpretive canon of ejusdem generis is particularly useful. See

AptarGroup Inc. v. Commissioner, 158 T.C. 110, 116 (2022) (“We

interpret regulations using canons of statutory construction . . . .” (citing

Austin v. Commissioner, 141 T.C. 551, 563 (2013))). The canon counsels

that when “a more general term follows more specific terms in a list, the

general term is usually understood to ‘embrace only objects similar in

nature to those objects enumerated by the preceding specific words.’”

Epic Sys. Corp. v. Lewis, 138 S. Ct. 1612, 1625 (2018) (quoting and citing

Circuit City Stores, Inc. v. Adams, 532 U.S. 105, 115 (2001), and citing

Nat’l Ass’n of Mfrs. v. Dep’t of Def., 138 S. Ct. 617, 628–29 (2018)); see

Agro-Jal Farming Enters., Inc. v. Commissioner, 145 T.C. 145, 154

(2015); cf. Mancini v. Commissioner, T.C. Memo. 2019-16, at *19

(describing this Court’s longstanding interpretation that the catchall

category in the phrase “fire, storm, shipwreck, or other casualty” in

section 165 “must mean something like the specific terms that precede

it”), aff’d, 851 F. App’x 769 (9th Cir. 2021).

Applying the canon here readily illustrates the flaw in petitioner’s

broad interpretation of the catchall category. 36 In the tax law,

“merchandise” has long been understood as a term of art, meaning

“goods held for sale” by the taxpayer. See RACMP Enters., Inc. v.

Commissioner, 114 T.C. 211, 221–22 (2000) (noting that all relevant

definitions of “merchandise” “refer to property that is held for sale, not

simply property that is sold”); King Solarman, Inc. v. Commissioner,

T.C. Memo. 2019-103, at *22, aff’d, 840 F. App’x 74 (9th Cir. 2020);

Wilkinson-Beane, Inc. v. Commissioner, T.C. Memo. 1969-79, 28 T.C.M.

(CCH) 450, 456, aff’d, 420 F.2d 352 (1st Cir. 1970). Cash is understood

as “[m]oney or its equivalent,” i.e., “[c]urrency or coins, negotiable

checks, and balances in bank accounts.” Cash, Black’s Law Dictionary

36 The related canon of noscitur a sociis (“a word is known by the company it

keeps”) similarly counsels that we “avoid ascribing to one word a meaning so broad

that it is inconsistent with its accompanying words.” Gustafson v. Alloyd Co., 513 U.S.

561, 575 (1995).

43

[*43] (11th ed. 2019). Understanding “other property” to broadly

encompass all manner of property rights eclipses the carefully

delineated “merchandise” and “cash” categories and renders them

surplusage—an undesirable interpretive outcome. See Yates v. United

States, 574 U.S. 528, 545–46 (2015) (applying ejusdem generis so as to

preclude broad reading of phrase “tangible object” that would have

rendered statute’s prior use of terms “record” and “document”

surplusage); Sutherland v. Commissioner, 155 T.C. 95, 103–04 (2020).

Further, given the regulation’s use of “or” in the phrase “merchandise,

cash, or other property,” we presume that the categories are disjunctive

and carry nonoverlapping, separate meanings. See United States v.

Woods, 571 U.S. 31, 45–46 (2013). Applying ejusdem generis carefully

gives separate effect to all three categories, by limiting the scope of

“other property” to property similar in nature to “merchandise” and

“cash,” such as, at a high level of generality, tangible property. 37 The

canon thus strongly suggests at the outset that this narrower reading is

the better one.

Treasury Regulation § 1.451-4(b)(1)(iii) lends contextual support

to the narrower reading. Subdivision (iii) provides that the taxpayer

may include in its offset to gross receipts the “transportation or other

necessary charges in acquiring possession of the goods.” (Emphasis

added.) Subdivision (iii) further specifies that the costs of “transporting

merchandise or other property from a central warehouse to a branch

warehouse” or “storing the merchandise or other property” may not be

included in the offset and are instead subject to either section 162 or

263. Id. (emphasis added). The provision thus repeatedly contemplates

“other property” in tangible terms, speaking of physical possession,

transportation, and storage. We find that subdivision (iii) further

reinforces the application of ejusdem generis by suggesting that a

common characteristic of the three categories is tangibility.

We thus interpret the catchall category to apply only to property

similar in nature to “merchandise” and “cash.” We reject petitioner’s

contention that the catchall category encompasses the hotel stays or

airline miles redeemable by petitioner’s Program members.

Accordingly, we conclude that the trading stamp method is not available

37 One reasonable reading, which we note but do not expressly adopt, is that

“other property” contemplates physical goods that are not “merchandise” in the hands

of the taxpayer. We need not determine the exact scope of the “other property” category

here and expressly limit our conclusion to rejecting petitioner’s contention that it

broadly encompasses the intangible property at issue.

44

[*44] to petitioner with respect to the years at issue; petitioner must

defer its cost recovery until the taxable year for which compensation

payments give rise to a deductible expense.

V.

Conclusion

We hold that for the years at issue (1) the Program revenue was

includible in petitioner’s gross income; (2) petitioner’s treatment of the

Fund was not a method of accounting subject to section 481 adjustment;

and (3) petitioner was not entitled to adopt the trading stamp method.

To reflect the foregoing,

Decision will be entered under Rule 155.