Petition — Hilton Hotels Corp. v. United States

8 2- 404 meet prane Coa US.

JUL 26 1982

No. A-1115

IN THE

Supreme Court of the United States

October Term, 1981

HILTON HOTELS CORPORATION, successor to FLAMINGO

RESORT, INC.,

Petitioner,

vs.

UNITED STATES OF AMERICA,

Respondent.

Petition for Writ of Certiorari to the

United States Court of Appeals

for tue Ninth Circuit.

Stephin TT Morris

LIONEL SAWYER & COLLINS

and

LEVENFELD, EISENBERG, JANGER,

GLASSBERG AND Lippr

1700 Valley Bank Plazi

300 South Fourth Street

Las Vegas, Nevada 89101

(702) 385-2188

Attorneys for Petitioner.

Date: July 24, 1982

Parker & Son, Inc., Law Printers, Los Angeles. Phone 724-6622

i

Questions Presented for Review.

1. Should this Court review the decision of the Ninth

Circuit Court of Appeals, which, contrary to prior decisions

of this Court and the Tax Court and the long-standing po-

sition of the Internal Revenue Service, holds that a taxpayer

must accrue income and pay taxes upon mere promises to

pay, even though the taxpayer does not have a legally en-

forceable right to collect upon such promises under any

circumstances?

2. Should this Court review the decision of the Ninth

Circuit Court of Appeals, which departs from the clear,

certain, and administratively workable ‘‘all-events’’ test

articulated by this Court over one-half century ago (and

applied since then by this Court, the lower federal courts,

and the Internal Revenue Service) to determine when income

is realized by accrual basis taxpayers?

3. Should this Court review the decision of the Ninth

Circuit Court of Appeals, which creates serious uncertainty

for both taxpayers and the Internal Revenue Service in the

timing of deductions of business expenses for accrual basis

taxpayers, and which, if applied as written, may result in

hundreds of millions, if not billions, of dollars in business

expense deductions being accelerated to the substantial det-

riment of the United States Treasury?

Parties in the Court of Appeals.

Petitioner, Hilton Hotels Corporation, is the successor in

interest to Flamingo Resort, Inc., the plaintiff-appellant in

an action brought in the United States District Court for the

District of Nevada and subsequently appealed to the United

States Court of Appeals for the Ninth Circuit. The United

States of America is the defendant-appellee in the District

Court and in the Ninth Circuit Court of Appeals.

TABLE OF CONTENTS

Page

Questions Presented for Review ......................000 i

Parties in the Court of Appeals ..................0.cceeeees i

STII ‘viccnpsebisicininddin didaphiolemegdsscupeenseactnines 1

Grounds for Invoking This Court’s Jurisdiction ........ l

Constitutional Provisions, Statutes, and Regulations

PIL sicidndebuiibactasmidititeisdhaiithadcssdebieosindiesiod 2

NE OW IND doth nc cncctinictcbaccccsesccccevscseses 3

Reasons for Allowance of the Writ ....................... 9

I.

The Ninth Circuit Has Abandoned Legal Enforcea-

bility as an Essential Element for the Accrual of

Income, Thereby Creating a Conflict With Prior

Decisions of This Court, Other Courts of Appeal,

the Tax Court, and With the Long-Standing Posi-

tion of the Internal Revenue Service on the Meaning

and Application of the All-Events Test ............ 4

A. Decisions of This Court ................c000000 9

B. Long-standing Interpretation by the IRS ..... 12

i.

lise Ninth Circuit’s Decision Requires an Ad Hoc,

Uncertain, and Administratively Unworkable Ap-

proach to a Core Issue of the Income Tax Laws,

Which Is Significant to Millions of Taxpayers and

to the United States Treasury .................000000 16

ITIITIIIR dint cnccscathecmmdnanentoemminciiaceneioengrauanntiies 21

Page

APPENDIX

Decision of the United States Court of Appeals for the

NS IIE SOD App. p. 1

Memorandum Opinion Granting Defendant’s Motion

for Summary Judgment and Denying Plaintiff's

Motion for Partial Summary Judgment ............. 10

Judgment Filed February 28, 1980 ..................+. 36

Minutes of the Court Filed May 19, 1980 ............ 37

Order. Flamingo Resort, Inc., Plaintiff-Appellant,

v. United States of America, Defendant-Appellee.

No. 80-5318. Filed April 2, 1982. Petition for

Peeneeae TG TMMEGS nice sccsciscctevenscccsscccecess 38

Order. Desert Palace, Inc., Petitioner, v. Commis-

sioner of Internal Revenue, Respondent. Docket

No. 8531-74. Entered December 8, 1978 ......... 39

Supplemental Brief for Respondent. Desert Palace,

Inc., Petitioner, v. Commissioner of Internal Rev-

enue, Respondent. Docket No. 8531-74. Filed

NE Tie ITE Darsnsdeingbtisibdoncscccdnetesse ceronseuss 40

Reply Memorandum of Points and Authorities in Sup-

port of the Government’s Cross-Motion for Sum-

mary Judgment. Flamingo Resort, Inc., Plaintiff,

v. United States of America, Defendant. Civil No.

LV 76-19, RDF. Filed December 12, 1977 ....... 43

iv

TABLE OF AUTHORITIES CITED

Cases Page

Barker v. Magruder, 95 F.2d 122 (D.C. Cir. 1938) .. 13

Barker v. United States, 26 F. Supp. 1004 (Ct. Cl.

PEED: abcsudevnacgsspiunhienbipaceveingadndgsovevocertessvepes 13

Bell Electric Co., 45 T.C. 158 (1965) ..............20005 20

Brown v. Helvering, 291 U.S. 193, 54 S.Ct. 356, 78

Rae SUP EEIND hands soecvcgeecepcandcnescesees 19, 20, 21

Burke v. Buck, 31 Nev. 74, 99 P. 1078 (1909) ....... 5

Corbin v. O’Keefe, 87 Nev. 189, 484 P.2d 565

REEL: cba cqnndbiiitecdccsvonapoccésatinboumbadeinesguawente a

Craig v. Harrah, 66 Nev. 1, 201 P.2d 1081 (1949) ... 5

Desert Palace, Inc. v. Commissioner, 72 T.C. 1033

DUTT ixciccccdinensineenseuedianereoull 6, 7, 12, 13, 15, 16

Dixie Pine Products Co. v. Commissioner, 320 U.S.

516, 64 S.Ct. 364, 88 L.Ed. 270 (1944) ............. 18

Dunes Hotel & Country Club of Las Vegas v. Mayo,

354 N.Y.S.2d 62 (N.Y. City Ct. 1974) .............. 5

Estate of Putnam v. Commissioner, 324 U.S. 393, 65

S.Ct. 811, 89 L.Ed. 1023 (1945) ...................... 11

Evans v. Cook, 11 Nev. 69 (1876) ....................... 5

Flamingo Resort, Inc. v. United States, 485 F. bas

SE TI, BUM . co ctbidehscnutnalinweetancobbdeses a

Flamingo Resort, Inc. v. United States, 664 F.2d 1387

RI: BOGE cpnccdicshcoccccghXishabaahoentveciidasece 8, 22

Gateway Transportation Co.. Inc. v. United States, 77-

1 U.S.T.C. 99131 (W.D. Wisc. 1976) ............... 20

Hamilton v. Abadjian, 179 P.2d 804 (Cal. 1947) ..... 5

Intercontinental Hotels Corp. (Puerto Rico) v. Golden,

BOO Hh FB Bar CEs BGG), disssscccsccccesces cess 5

Jewett v. Commissioner, .... U.S. ...., 102 S.Ct. 1082

RIE ctadilnckstincdis satiate dadcunicntnetedswcdeshaeh 15, 16

J. J. Little & Ives & Co., T.C. Memo 1966-68 ....... 20

LaSalle Portland Cement Co., 4 B.T.A. 438 (1926) .. 21

Lucas v. North Texas Lumber Co., 281 U.S. 11, 50

S.Ct. 184, 74 L.Ed. 668 (1930) ................... 9, 10

The Marquardt Corporation v. Commissioner, 39 T.C.

443 (1962), acq. 1965-2 C.B. 6, nonacq. as to an-

other issue, 1965-2 C.B. 7 ...............0005: 14, 15, 16

North American Oil Consolidated v. Burnet, 286 U.S.

417, 52 S.Ct. 613, 76 L.Ed. 1197 (1932) ........... 10

Readers’ Pub. Corp. v. United States, 40 F.2d 145 (Ct.

GD, FRG cic ciillbccscncysescscepenspndvncconcerevedasess 20

Reuben H. Donnelley Corp., 22 B.T.A. 175

CUED iiccannctctnssncdiecscsnabinbbisestpandipeatndctes 20, 21

Richmond Light & Railroad Co., 4 B.T.A. 91 (1926)

IIE i: iri Os chan dence bbdibinbbenieendbanamasemadosendsohene 4

Scott v. Courtney, 7 Nev. 419 (1872) ...........c.eeee 5

Sea Air Support, Inc. v. Herrmann, 96 Nev. 574, 613

PEE AMIE 5 cnneins yoccquan cnccenuhen estebecdapendaits 4

Security Flour Mills Co. v. Commissioner, 321 U.S.

281, 64 S.Ct. 596, 88 L.Ed. 725 (1944) ........ 17, 18

Spring City Foundry Co. v. Commissioner, 292 U.S.

182, 54 S.Ct. 644, 78 L.Ed. 1200 (1934) ...... 10, 19

Thriftimart, Inc., 59 T.C. 598 (1973) ..... ppikehivdakenbe 20

United States v. Anderson, 296 U.S. 422, 46 S.Ct. 131,

FO LBS. S47 (19SB) . seriinvseritesscccccccnceees 9, 15, 18

United States v. Byrum, 408 U.S. 125, 92 S.Ct. 2382,

33 L.Bd.2d 236 (1G7Z) ......ccecsccvccccsccvccecees 11, 12

United States v. Consolidated Edison Co., 366 U.S.

380, 81 S.Ct. 1326, 6 L.Ed.2d 356 (1961) .......... 18

Page

United States v. Leslie Salt Co., 350 U.S. 383, 76 S.Ct.

416, 100 L.Ed. 441 (1956) ..........ccccccecceceeeseees 16

United States v. Safety Car Heating & Lighting Co.,

297 U.S. 88, 56 S.Ct. 353, 80 L.Ed. 500

TEED csidiiauibveliccoschebtnqesbevebaathenoeaséocsescese 10, 11

Villafranca v. Commissioner, 359 F.2d 849 (6th Cir.

SED cndkethccbpascthnonibitibndeutescscedatbscbdlbcdanidose 20

Weisbrod v. Fremont Hotel, 74 Nev. 227, 326 P.2d

SERRE SS ie a Se 5

West Indies v. First Nat. Bank, 67 Nev. 13, 214 P.2d

DEED cdbtesssecocbbeceenbsesoeitibcsewccsececececes 5

Wolpert v. Knight, 74 Nev. 322, 330 P.2d 1023

TIED ait toasted anpcanenonpatlnlinissettectbevee 5

World, Airways, Inc., 62 T.C. 786 (1974), aff'd 564

oe SS ae 20

OTHER AUTHORITIES CITED

Statutes and Treasury Regulations

NTT isniciitsadsablptiainladenanvegecesccorssedt 2

SL ED -diistsdiihen st tashtttacatehiontnscepergiuintels 2

PEATE EEIINID ccciccccal sapsionegiocemepesccesenaa 11, 12

es te ED a ctnitindbicneatenasbadboqpegeiseasnecs 2

ESTELLE. 4

Treasury Regulation § 1.166-1(C) ..............cccecceeees 19

Treasury Regulation § 1.446-1(c)(1)(ii) ......... 3, 12, 15

Treasury Regulation § 1.446-1(c)(2)(i) ...............000 16

Treasury Regulation § 1.451-I(a) .................c0ccc00 3

Treasury Regulation § 25.2511-1(C) ..........c.cccceeeees 15

Page

Other Authorities

Office Decision 1139, 5 C.B. 84 (July-December

SI idiontlincihoratatibini nda ssantian nilsiteninieds 13, 15, 21

Rev. Proc. 67-6, 1967-1 C.B. 576 .............ccceeeeees 13

Rev. Rul. 70-262, 1970-1 C.B. 122 ..............0c0000 20

Rev. Rul. 72-34, 1972-1 C.B. 132-33 ................... 19

Rev. Rul. 74-69, 1974-1 C.B. 113 .................ee eee 21

Rev. Rul. 74-621, 1974-2 C.B. 405, first published in

SPIES BP covcesccccnsdpepesoucqnosscssocccnceneet 13

ERRATA

HILTON HOTELS CORPORATION (Parent Company)

%

Hilton

Hilton Service Corporation

Statler Dallas Corporation

Main and Holcombe Corporation

Hilton Reservation Equipment Company

Beverly Hilton Joint Venture

Dallas Hilton Joint Venture

Commerce Garage Joint Venture

Compass Computer Services, Inc.

D. C. Statler Hilton Joint Venture

Hilton Burns Kona Partnership

Hilton Hawaiian Village Joint Venture

Los Angeles Hilton Joint Venture

New York Hilton Joint Venture

Rye Hilton Joint Venture

San Francisco Hilton Joint Venture

Tarrytown Hilton Joint Venture

Washington Hilton Joint Venture

Logan Hilton Joint Venture

International Rivercenter

University Plaza Ltd.

Parsippany Hilton Joint Venture

Miami Hilton Airport Venture

sruuusessseseessesssess |

No. A-1115

Supreme Court of the United States

October Term, 1981

HiLTON HOTELS CORPORATION, successor to FLAMINGO

Petitioner,

UNITED STATES OF AMERICA,

Respondent.

Petition for Writ of Certiorari to the

United States Court of Appeals

for the Ninth Circuit.

OPINIONS BELOW.

The opinion of the United States Court of Appeals for

the Ninth Circuit is reported at 664 F.2d 1387 (9th Cir.

1982), and is set out at page | of the Appendix (hereinafter

cited as “‘App. ...."’).

The opinion of the United States District Court for the

District of Nevada is reported at 485 F. Supp. 926 (D. Nev.

1980), and is set out at App. 10.

GROUNDS FOR INVOKING THIS COURT’S JURISDICTION.

The decision of the United States Court of Appeals was

issued January 7, 1982. Plaintiff-appeilant timely filed a

Petition for Rehearing En Banc, which was denied by the

United States Court of Appeals in an order entered April

2, 1982. A copy of the order is set out at App. 38. On June

ath Dottie

23, 1982, Justice Rehnquist signed an order allowing Hilton

until July 26, 1982 to file this petition.

The jurisdiction of the Court is invoked under 28 U.S.C.

§ 1254(1).

CONSTITUTIONAL PROVISIONS, STATUTES,

AND REGULATIONS INVOLVED.

Section 446 of the Internal Revenue Code, 26 U.S.C.

§ 446, provides, in relevant part:

(a) General rule. — Taxable income shall be com-

puted under the methoa of accounting on the basis of

been regularly used by the taxpayer, or if the method

used does not clearly reflect income, the computation

of taxable income shall be made under such method

as, in the opinion of the Secretary, does clearly reflect

income.

(c) Permissible methods. — Subject to the provisions

of subsections (a) and (b), a taxpayer may compute

taxable income under any of the following methods of

(1) the cash receipts and disbursements method;

(2) an . ccrual method;

(3) any other method permitted by this chapter;

or

(4) any combination of the foregoing methods

permitted under regulations prescribed by the

Secretary.

Section 451 of the Internal Revenue Code, 26 U.S.C.

$ 451, provides, in relevant part:

(a) General rule. — The amount of any item of gross

income shall be included in the gross income for the

taxable year in which received by the taxpayer, unless,

under the method of accounting used in computing

es

taxable income, such amount is to be properly ac-

counted for as of a different period.

Treasury Regulation § 1 .446-1(c)(1)(ii) provides, in relevant

part:

(ii) Accrual method. Generally, under an accrual

method, income is to be included for the taxable year

when all the events have occurred which fix the right

to receive such income and the amount thereof can be

determined with reasonable accuracy. Under such a

method, deductions are allowable for the taxable year

in which all the events have occurred which establish

the fact of the liability giving rise to such deduction

and the amount thereof can be determined with rea-

sonable accuracy. The method used by the taxpayer

in determining when income is to be accounted for will

be acceptable if it accords with generally accepted

accounting principles, is consistently used by the tax-

payer from year to year, and is consistent with the

Income Tax Regulations.

Treasury Regulation § 1.451-1(a) provides, in relevant part:

(a) General rule. Gains, profits, and income are to

be included in gross income for the taxable year in

which they are actually or constructively received by

the taxpayer unless includible for a different year in

accordance with the taxpayer’s method of accounting.

Under an accrual method of accounting, income is

includible in gross income when all the events have

occurred which fix the right to receive such income

and the amount thereof can be determined with rea-

sonable accuracy.

STATEMENT OF THE CASE.

The Internal Revenue Service asserted a deficiency in the

income tax payments of Flamingo Resort, Inc., for the pe-

riod from August 17, 1967, the date of its incorporation,

. t0 December 31, 1967. Hilton later acquired Flamingo and

—4—

succeeded to its rights and liabilities for the period in ques-

tion, as well as subsequent wears. On December 22, 1975,

Hilton, on behalf of Flamingo, paid the asserted deficiency

together with interest, which amouuts to $265,034.34, and

filed a claim for a refund in the same amount. Following

the denial of this claim by the Internal Revenue Service,

this action in the name of Flamingo was commenced in the

District Court to recover the overpayment, pursuant to 28

U.S.C. § 1346(a)(1).

Flamingo was the legal, licensed owner and operator

of a gaming resort in Las Vegas, Nevada, known as the

Flamingo Hotel and Casino. During the time in question,

Flamingo operated games of chance as a regular and

substantial part of its legitimate business activity. Many

patrons gambled with chips obtained in return for either

cash or a ‘‘marker’’ in the amount of the chips transferred

to the patron. A ‘‘marker’’ is, in form, a promise to pay.

Because markers issued for gambling purposes are legally

unenforceable, these instruments simply ‘‘mark’’ the amount

of gaming credit extended to a patron.

Exchanges of cash or markers for chips occurred either

in the “‘pit’’ area, where tne games of chance were con-

ducted, or at the ‘‘cage,’’ an enclosed portion of the gaming

area with cashiers’ windows resembling tellers’ windows

in a bank. This distinction gives rise to markers being termed

**pit markers’’ or ‘‘cage markers,’’ depending upon where

such exchanges occurred.

Markers, the consideration for which is used in gambling,

as well as any instrument given in payment of a gambling

debt, are and always have been absolutely void and unen-

forceable: under Nevada law, even in the hands of a holder

in due course. Sandler v. District Court, 96 Nev. 622, 614

P.2d 10 (1980); Sea Air Support, Inc. v. Herrmann, 96

Nev. 574, 613 P.2d 413 - 1980); Corbin v. O'Keefe, 87

Ber ce

Nev. 189, 484 P.2d 565 (1971); Wolpert v. Knigh:, 74 Nev.

322, 330 P.2d 1023 (1958); Weisbrod v. Fremont Hotel,

74 Nev. 227, 326 P.2d 1104 (1958); West Indies v. First

Nat. Bank, 67 Nev. 13, 214 P.2d 144 (1950); Burke v.

Buck, 31 Nev. 74, 99 P. 1078 (1909); Evans v. Cook, 11

Nev. 69 (1876); Scott v. Courtney, 7 Nev. 419 (1872).

Consequently, Flamingo could not enforce collectior of

such markers anywhere. Intercontinental Hotels Corp.

(Puerto Rico) v. Golden, 254 N.Y.S.2d 527 (N.Y. 1964);

Dunes Hotel & Country Club of Las Vegas v. Mayo, 354

N.Y.S.2d 62 (N.Y. City Ct. 1974); Hamilton v. Abadjian,

179 P.2d 804 (Cal. 1947).

Flamingo reported taxable income on the accrual method

of accounting. In computing its income tax liability for

1967, Flamingo did not treat its unpaid markers as assets

or revenue for tax purposes. The Internal Revenue Service

did, and increased Flamingo’s income for the year by in-

cluding as ‘‘casino receivables’? unpaid markers in the

amount of $676,432 on hand on December 31, 1967, less

$130,721 which was treated as an addition to Flamingo’s

reserve for bad debts. Flamingo instituted the District Court

action to recover the additional tax it was compelled to pay

for the tax period in question as a result of this assessment.

'The Nevada Court has certain with

to instruments in form but asserted to have been executed

in ofa transaction. See Craig v. Harrah, 66 Nev.

1, 6, 201 P.2d 1081, 1084 (1949). Consequently, an instrument cashed

at a casino may be enforceable, if its maker fails to establish that

g

Ue

Fy

Hit

¢

ocealisinen

by moving for summary judgment on all markers, contend-

ing that legal enforcesbility was irrelevant because the ex-

change of a marker for chips was, in essence, a loan from

Flamingo to its patron; that this ‘‘loan’’ and its subsequent

coliection, if collection occurred, were non-taxable events;

that when Flamingo won back chips ‘which te patron had

**borrowed’’) income was realized; and that the amount of

such ‘‘income’’ was measured by the amount of the marker.’

While these motions were under submission in the District

Court, the Government and an unrelated taxpayer were lit-

igating the identical legal issue on substantially identical

operative facts in the United States Tax Court. Desert

Palace, Inc. v. Commissioner, 72 T.C. 1033 (1979). In

Desert Palace, in which the Tax Court held for the taxpayer,

the Government unequivocally acknowledged that Flamingo

was correct in asserting that legal enforceability of a promise

to pay was eSScuc:2l to accrual of the promise as income.

In written response to questions posed by the Tax Court,

the Government stated.

Legal enforceability of casino receivables is a neces-

sary ingredient in determining when the petitioner’s

right to receive gambling income is fixed within the

meaning of Treas. Reg. § 1.446-1(c)(1)(ii). Under an

accrual method of accounting, income accrues only

when all the events have occurred which fix the tax-

payer’s right to receive such income. United States v.

Anderson, 269 U.S. 422 (1926); Spring City Co. v.

Commissioner, 292 U.S. 182 (1934). The unenforce-

ability of the gambling debts receivables affects the

accrual of income in that it presents a contingency

which precludes accrual of income under the all events

?The District Court eventually rejected of the Govern-

ng Resort. In. ¥- United Stes, F. Supp. 926, 937

ve 3

test of Treas. Reg. § 1.446-1(c)(1){ii). (Emphasis

added. ]

Tex Court’s Order, dated December 8, 1978, and Supple-

mental Brief for Respondent (the Government) in the Desert

Palace case, set out in full in the Appendix to this petition,

beginning at page 39 and page 40, respectively.

Thereafter, in this action in the District Court, the

Government reicerated this interpretation of the Treasury

Regulations involved:

The Desert Palace case deals with issues identical to

those in the instant case. It is true that the Goverisment

there argued that, due to the legal unenforceability of

pit markers, the taxpayer casino need not accrue in-

come upon the receipt of such markers. It is likewise

true that the Government there stipulated that outstand-

ing chips do not represent legal obligations of the ca-

sino. The latter point is a matter of Nevada law, and

we do not deviate in the slightest from those positions

in this case.

Reply Memorandum of Points and Authorities in Support

of the Government’s Cross-Motion for Summary Judgment,

set out in full in the Appendix beginning at page 43, at page

47 (emphasis by the Government).

Notwithstanding this construction of its own Treasury

Regulation by the Government in two independent cases,

the District Court held that ‘‘the income represented by

casino receivables is accruable under the ‘all events’ test’’

because ‘‘legal enforceability is not a necessary element of

a fixed right to receive income.’ Flamingo Resort, Inc. v.

United States, 485 F. Supp. 926, 939 (D. Nev. 1980). On

this basis the District Court granted summary judgment to

the Government.

Flamingo appealed. The Ninth Circuit Court of Appeals

affirmed, agreeing with the District Court that because

a

Flamingo had a ‘‘reasonable expectancy of collection’’ of

many of its markers, ‘‘accrual was proper despite the ab-

sence of legal enforceability.’’ Flamingo Resort, Inc. v.

United States, 664 F.2d 1387, 1388, 1390 (9th Cir. 1982).

Hilton Hotels Corporation, as successor in interest to

Flamingo, now petitions this Court to review this conclusion

by a Writ of Certiorari to the United States Court of Appeals

for the Ninth Circuit.

vr Wa

REASONS FOR ALLOWANCE JF THE WRIT.

1.

THE NINTH CIRCUIT HAS ABANDONED LEGAL ENFORCE-

ABILITY AS AN ESSENTIAL ELEMENT FOR THE

ACCRUAL OF INCOME, THEREBY CREATING A CON-

FLICT WITH PRIOR DECISIONS OF THIS COURT,

OTHER COURTS OF APPEAL, THE TAX COURT, AND

WITH THE LONG-STANDING POSITION OF THE

INTERNAL REVENUE SERVICE ON THE MEANING

AND APPLICATION OF THE ALL-EVENTS TEST.

The conflict just described is real, as demonstrated in the

following paragraphs.

A. Decisions of This Court.

More than fifty years ago, this Court enunciated the test

which governs accrual accounting for income tax purposes

to this day. In United States v. Anderson, 269 U.S. 422,

46 S.Ct. 131, 70 L.Ed. 347 (1926), the question presented

was the deductibility of a tax, which had not been assessed,

and thus was not yet duc and payable. Holding that a de-

duction was nevertheless proper, this Court observed that

In a technical legal sense it may be argued that a tax

does not accrue until it has been assessed and becomes

due; but it is also true that in advance of the assessment

of a tax, all of the events may occur which fix the

amount of the tax and determine the liability of the

taxpayer to pay it.

269 U.S. at 441.

Four years later the Court applied this ‘‘all-events’’ test

to the corresponding question of the accrual of income for

income tax purposes. In Lucas v. North Texas Lumber Co.,

281 U.S. 11, 50 S.Ct. 184, 74 L.Ed. 668 (1930), an ex-

ecutory contract for the saie and purchase of certain real

property was entered into prior to the end of the tax year.

Closing of the transaction, including payment of the pur-

ee ee

chase price, was contingent only on the exchange of the

necessary papers, but this did not occur until the next year.

As a result, this Court refused to permit the taxpayer (the

vendor) to accrue the income represented by the purchase

price of the property because ‘‘The title and right of pos-

session remained in [the vendor] until the transaction was

closed. Consequently, unconditional liability of vendee for

the purchase price was not created in that year.’’ 281 U.S.

at 13.

At all times since these two decisions, unconditional

liability of the debtor has been an unwavering requirement

for the accrual of income and deductions for tax purposes.

Thus in North American Oil Consolidated v. Burnet, 286

U.S. 417, 52 S.Ct. 613, 76 L.Ed. 1197 (1932), this Court

rejected the Government’s contention that income should

be accrued prior to the entry of a court decree vacating a

receivership. In the Court’s view, the decree would be nec-

essary to establish the ‘‘right in the [taxpayer] company to

demand’’ payment of profits paid to the receiver (the income

in dispute). 286 U.S. at 423 (emphasis added).

Two years later, in Spring City Foundry Co. v. Com-

missioner, 292 U.S. 182, 54 S.Ct. 644, 78 L.Ed. 1200

(1934), this Court required the accrual of an account re-

ceivable in full, even though a petition in bankruptcy had

been filed against the account debtor, saying: ‘‘Keeping

accounts and making returns on the accrual basis, as dis-

tinguished from the cash basis, import that it is the right

to receive and not the actual receipt that determines the

inclusion of the amount in gross income. When the right

to receive an amount becomes fixed, the right accrues.”’

292 U.S. at 184-185 (emphasis in original).

Consistent with Spring City Foundry this Court in United

States v. Safety Car Heating & Lighting Co., 297 U.S. 88,

56 S.Ct. 353, 80 L.Ed. 500 (1936), precluded an accrual

_——_—*

ilies

basis taxpayer from including income received as a result

of patent infringement litigation as taxable income for the

year in which its claim arose, reasoning that ‘‘the existence

of any liability was contested and uncertain’’ until the in-

fringement issue was decided and ‘‘[t]he amount remained

contested and uncertain’’ until several years later, ‘‘when

there was a settlemen. of the liability. . . . Then for the

first time the profits flowing from the ‘infrincement became

taxable as income.’’ 297 U.S. at 93-94

And in the same vein in Estate of Putnam v. Commis-

sioner, 324 U.S. 393, 65 S.Ct. 811, $9 L.Ed. 1023 (1945),

this Court refused to require accrual to a deceased taxpayer)

of a corporate dividend on the date « f its declaration because

the dividend was payable and paid ‘o stockholders of record

on a later date. Noting that the identity of the recipient was

thus not determined as of the date of declaration, this Court

observed: ‘‘Such uncertainty destroys any conception of

accrual as. involving a right to receive or an obligation to

pay, elements which we think are essential for accruals

under our decisions.’’ 324 U.S. at 400 (emphasis added).

That the Court’s repeated reference to ‘‘right to receive’’

in accrual cases means ‘‘legally enforceable right’’ is un-

- equivocally established by this Court’s recent decision in

United States v. Byrum, 408 U.S. 125, 92 $.Ct. 2382, 33

L.Ed.2d 238 (1972). In Byrum this Court considered the

meaning of “‘right . . . to designate’ in Section 2036 of

the Internal Revenue Code, 26 U.S.C. § 2036(a), and con-

cluded:

The term ‘right,’ certainly when used in a tax statute,

must be given its normal and customary meaning. It.

connotes an ascertainable and legally enforceable

power. . . . Here, the right ascribed to Byrum was the

power to use his majority position and influence over

the corporate directors to ‘regulate the flow of divi-

—_)

dends’ to the trust. That ‘right’ was neither ascertain-

able nor legally enforceable and hence was not a right

in any normal sense of that term.

408 U.S. at 136-137 (emphasis added).

In short, the Ninth Circuit's decision here is in conflict

with prior decisions of this Court regarding a core concept

of the income tax laws.

B. Long-sianding Interpretation by the IRS.

The principles set out in this Court’s opinions, which are

summarized above, are emboaied in Treasury Regulation

§ 1.446-1(c)(1)(ii), which states, in pertinent part:

Accrual method. Generally, under an accrual method,

income is to be included for the taxable year when all

the events have occurred which fix the right to receive

such income and the amount thereof can be determined

with reasonable accuracy. Under such a method, de-

ductions are allowable for the taxable year in which

~ all the events have occurred which establish the fact

of the liability giving rise to such deduction and the

amount thereof can be determined with reasonable

accuracy.

In the District Court in this case the Government re-

affirmed without qualification the interpretation of Treasury

Regulation § 1.446-1(c)(1)(ii), which it formally articulated

in writing in the Desert Palace case.

Legal enforceability of casino receivables is a neces-

sary ingredient in determining when the petitioner's

right to receive gambling income is fixed within the

meaning of Treas. Reg. § 1.446-1(c)(1)(ii). Under an

accrual method of accounting, income accrues only

when all the events have occurred which fix the tax-

payer’s right to receive such income. United States v.

Anderson, 269 U.S. 422 (1926); Spring City Co. v.

Commissioner, 292 U.S. 182 (1934). The unenforce-

—13—

ability of the gambling debts receivables affects the

accrual of income in that it presents a contingency

which prec ludes accrual of income under the all events

test of Treas. Reg. § 1.446-1(c)(1)(ii).

Supplemental Brief for Respondent in the Desert Palace

case, App. 41-42; see the Reply Memorandum of Points

and Authorities in Support of the Government's Cross-

Motion for Summary Judgment, in the District Court, App.

47.

The Government's position in the District Court in this

action and in the Tax Court in Desert Palace is a contin-

uation of and completely consistent with the position of the

Internal Revenue Service for the last sixty years. In 1921

the Bureau of Internal Revenue issued a public pronounce-

ment that a taxpayer who made usurious loans could not

report the interest income from the loan prior to the year

in which it was actually received because ‘‘the unpaid notes

held by him are not legal obligations of the makers and are

not collectible under due process of law.’’ Office Decision

1139, 5 C.B. 84 (July-December 1921). This Office De-

cision has never been said to be incorrect; it was not declared

obsolete until December 1974 (see Rev. Rul. 74-621, 1974-

2 C.B. 405, first published in 1974-52 LR.B. 14), despite

the directly contrary decisions, on identical facts, in Barker

v. Magruder, 95 F.2d 122 (D.C. Cir. 1938) and Barker v.

United States, 26 F. Supp. 1004 (Ct. Cl. 1939), relied upon

by the Ninth Circuit and the District Court in this case.’

Nor had the Service’s position changed by 1974, which

was seven years after the tax period involved here. In 1965

14

the Commissioner acquiesced in the key portion of the Tax

Court's decision in The Marquardt Corporation v. Com-

missioner, 39 T.C. 443 (1962), acq. 1965-2 C.B. 6, non-

acq. as to another issue, 1965-2 C.B. 7. In Marquardt

Corporation the Tax Court refused to require a taxpayer

customarily reimbursed by Boeing Aircraft Company for

cost overruns to accrue the reimbursements when the over-

runs occurred because Boeing was not legally obligated to

make such reimbursements under its contract with the tax-

payer. The Tax Court declared:

Under the accrual method of accounting, an item of

income accrues when the taxpayer h: _—sitixed uncon-

ditional right to receive it. It is the right to receive and

not the actual receipt of an amount which determines

its accruability. Spring City Co. v. Commissioner, 292

U.S. 182 (1934); Estate of Putnam v. Commissioner,

324 U.S. 393 (1945). Until the right to an amount

becomes accruable through the fixing of the right to

receive, the taxpayer is under no “ligation to return

it as income.

We are concerned with the facts as they existed on

December 31, 1953. [Citation omitted. ] As of that date,

petitioner had no fixed or unconditional right to receive

any sum in excess of that authorized by Boeing... .

There is little doubt that petitioner hoped and desired

that it would get paid. However, this is not the test of

accruability. The question is whether petitioner had a

fixed or unconditional right. Spring City Co. v. Com-

nt

The facts do not support this contention. Even if

petitioner had customarily overexpended, this unilat-

eral action would not fix Boeing’s obligation to pay,

the thing necessary to require accrual. . . . Further-

morc, respondent’s argument overlooks the fact that

the discretion to pay or not was in Boeing, not peti-

tioner.

39 T.C. at 451-452 (emphasis in original).

In view of the Commissioner’s acquiescence in this por-

tion of Marquardt Corporation, the Government's inter-

pretation of Treasury Regulation § 1.446-1(c)(1){ii) pre-

sented in this case to the District Court, and to the Tax

Court in Desert Palace, represents a position the Commis-

sioner has maintained for over 60 years, since first asserting

it in O.D. 1139, 5 C.B. 84 (July-December 1921), five

years prior to this Court’s decision in United States v.

Anderson, supra. The Ninth Circuit’s opinion is in irrec-

oncilable conflict with this long-standing administrative

interpretation and appears to ignore this Court’s recent dec-

laration on the weight to be accorded the Commissioner’s

interpretation of his own regulation.

In Jewett v. Commissioner, ... U.S. ..., 102 S.Ct. 1082,

1090 (1982), this Court reviewed in depth the history of

Treasury Regulation § 25.2511-1(c), promulgated in 1958,

and adopted the Commissioner's position saying:

The Commissioner's interpretation of the regulation

has been consistent over the years and is entitled to

respect. This canon of construction, which generally

applies to the Commissioner’s interpretation of the In-

ternal Revenue Code, see Commissioner v. Portland

Cement Co. of Utah, 450 U.S. 156, 169, 67 L.Ed.2d

140, 101 S.Ct. 1037, is even more forceful when ap-

—l6o—

plied to the Commissioner’s interpretation of his own

regulation.

See also United States v. Leslie Salt Co., 350 U.S. 383,

396-397, 76 S.Ct. 416, 100 L.Ed. 441 (1956).

i.

THE NINTH CIRCUIT’S DECISION REQUIRES AN AD HOC,

UNCERTAIN, AND ADMINISTRATIVELY UNWORK-

ABLE APPROACH TO A CORE ISSUE OF THE INCOME

TAX LAWS, WHICH IS SIGNIFICANT TO MILLIONS OF

TAXPAYERS AND TO THE UNITED STATES TREAS-

URY.

The Tax Court decisions in Desert Palace and Marquardt

Corporation, discussed above, put that court in square con-

flict with the Ninth Circuit's decision in this case. Although

the Ninth Circuit opinion arises out of an industry operating

in only two states and on its face does not address the accrual

of deductions from income, it would be a grave mistake to

deem the opinion as being of little national significance, or

as having minimal impact on private compliance with, and

public administration of, the income tax laws. To the con-

trary, this is a case of profound significance in tax law and

to the Government and all accrual basis taxpayers. Four real

First, it is common knowledge that a great number of

taxpayers, including many of the Nation’s mavor businesses,

report income and expenses on the accrual basis. As a matter

of fact, every business which maintains an inventory for

sale must use the accrual method. Treasury Regulation

§ 1.446-1(c)(2)i).

Second, legal enforceability as a prerequisite to the

accrual of income is an issue of general concern. The issue

is not limited to casino gaming or to the banking industry

and its skirmishes with state usury laws. As demonstrated

by the Marquardt Corporation case (manufacturig), the

aw eS

issue may arise in any industry. The common, recurring

fact pattern is simply this: Payor, in its discretion, regularly

makes payments (without the legal obligation to do so) to

- an accrual basis taxpayer.

The ubiquity of this fact pattern leads to the third reason

this case is of great national significance: The long-

established approach to accrual of income — the approach

mandated by this Court’s opinions and the long-standing

interpretation of the Internal Revenue Service — is founded

on ‘legal enforceability.’’ That term has meaning, shape,

and substance to taxpayers in complying with the federal

tax laws and to the Internal Revenue Service in adminis-

tering them. Until the Ninth Circuit’s opinion, both tax-

payers and the Service had in the easily understood and

applied standard of ‘‘legal enforceability’’ a tool that cut

relatively cleanly between accrual and non-accrual and

which made for fairness and certainty, primary goals of the

tax laws. As pointed out in Security Flour Mills Co. v.

Commissioner, 321 U.S. 281, 285-286, 64 S.Ct. 596, 8

L.Ed. 725 (1944), the tax iaw must be neutral; exceptions

should not be made ‘‘for the benefit of the Government or

the taxpayer . . . because so to do would, in a given in-

stance, work a supposedly more equitable result to the Gov-

ernment or to the taxpayer.”’

In stark contrast, the Ninth Circuit’s approach is ad hoc,

uncertain, and administratively unworkable. Under the

Ninth Circuit’s newly-fashioned approach, an expectation

of payment can operate to elevate a taxpayer's legally unen-

forceable expectation to a ‘‘fixed right to receive’’: Fla-

mingo collected up to 96 percent of its markers; hence it

must accrue all markers. But what of 95 percent or 89

percent or 73 percent? How consistent must the payment

history be? No more than 5 percent deviation from the mean?

10 percent? 50 percent? And how long a payment history?

Six months, twelve months, five years? These questions

must be answered on a case-by-case basis under the Ninth

Circuit’s approach.“

The fourth reason for the belief that this case is significant

offers, in our opinion, the strongest justification for this

Court to review the Ninth Circuit’s decision: The decision

destroys the Government's ability to control and limit the

timing and character of deductions from income for business

expenses by accrual basis taxpayers. This could have a

devastating effect on the Treasury. The reasor for this result

is simple and irrefutable: Accrual of income and accrual of

deductions are simply two sides of the same coin; the same

principles which govern the accrual of income also govern

the accrual of expenses. Indeed, the venerable ‘‘all-

events’’ test and the notion that legal liability is a central

requirement for accrual accounting were first enunciated by

this Court in the context of the deductibility of expenses.

United States v. Anderson, supra; see also, United States

v. Consolidated Edison Co., 366 U.S. 380, 81 S.Ct. 1326,

6 L.Ed.2d 356 (1961); Security Flour Mills Co. v. Com-

missioner, 321 U.S. 281, 64 S.Ct. 596, 88 L.Ed. 725

(1944); Dixie Pine Products Co. v. Commissioner, 320 U.S.

516, 64 S.Ct. 364, 88 L.Ed. 270 (1944). In sum, if mere

expectations without legal enforceability require accrual of

income (as the Ninth Circuit held), they will also permit

accrual of deductions.°

That result of the Ninth Circuit’s opinion reveals two

glaring, significant flaws in the opinion. First, the decision

“We are not creating a parade of horribles here; nor is this mere

thetoric. This is the reality of the Ninth Circuit's decision.

*This will be the conclusion of not only creative and imaginative tax

, advisers, and but of the most conservative and literal

of group. This of the Ninth Circuit's opinion cannot be

ignored

icliees

is tlatly contrary to prior decisions of this Court and the

long-standing public interpretation of them by the Internal

Revenue Service, which permit deduction of only those

expenses which meet the all-events test, and which reject

the Ninth Circuit’s ‘‘mere expectations’’ concept. In Brown

v. Helvering, 291 U.S. 193, 54 S.Ct. 356, 78 L.Ed. 725

(1934), this Court rejected the deductibility of reserves for

anticipated refunds of insurance premiums due to policy

cancellations, saying that:

The liability . . . arising from expected future can-

cellations was not deductible from gross income be-

cause it was not fixed and absolute. In respect to no

particular policy written within the year could it be

known that it would de cancelled in a future year. Nor

could it be known that a definite percentage of all the

policies will be cancelled in the future years. Experi-

ence taught that there is a strong probability that many

of the policies written during the taxable year will be

so cancelled. But experience taught also that we are

not dealing here with certainties.

a bad debt deduction only if is a bona fide debt, also states: *‘A

bona fide debt is a debt which arises from a debtor-creditor relationship

ne ee ee aren oy Oe ee oe

minable sum of .”* (Emphasis -)

It would be , if not unconstitutional, to apply the Ninth

Circuit's opinion to require Flamingo to pay taxes on unenforceable

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—20—

In effect, the Ninth Circuit’s opinion in this case, if al-

lowed to stand, may overrule Brown v. Helvering and herald

the end of years of consistent application of the all-events

test, which is both fair and easily understood by taxpayers

and the Government. For the first time millions — if not

billions — of dollars of reserves for future expenses will

be deductible. Examples of such reserves for statistically

determinable expenses which would be deductible for the

first time, and the cases or Internal Revenue Service rulings

which heretofore have held such are not, include: reserve

for future warranty service [Bell Electric Co., 45 T.C. 158

(1965)]; reserve for self-insurers for future workmen’s com-

pensation claims [Thriftimart, Inc., 59 T.C. 598 (1973);

Revenue Ruling 70-262, 1970-1 C.B. 122}; reserve for

liability for accidents [Richmond Light & Railroad Co., 4

B.T.A. 91 (1926)]; reserve for future required maintenance

expense [World Airways, Inc., 62 T.C. 786 (1974), affd

564 F.2d 886 (9th Cir. 1977)]}; reserve by cargo carriers for

cargo loss and damage claims [Gateway Transportation

Co., Inc. v. United States, 77-1 U.S.T.C. 99131 (W.D.

Wis. 1976) (not officially reported)]; reserve by publishers

for returns of unsold books [/. J. Little & Ives & Co., T.C.

Memo 1966-1968]; reserve for returns of unsold magazines

from distributors [Readers’ Pub. Corp. v. United States,

40 F.2d 145 (Ct. Cl. 1930)); reserve for anticipated teaching

expenses under contracts for dance instruction [Villafranca

v. Commissioner, 359 F.2d 849 (6th Cir. 1966)]; reserve

for sales commission due when payment received from cus-

tomers [Reuben H. Donnelley Corp., 22 B.T.A. 175

eR

(1931)}; reserve for return of returnable bags [LaSalle Port-

land Cement Co., 4 B.T.A. 438 (1926)].’

In sum, the Ninth Circuit’s approach is in direct conflict

with the fundamental principles underlying both this Court’s

decision in Brown v. Helvering, supra, and the publicly

announced position of the Internal Revenue Service through

rulings, bulletins, and Treasury Regulations.

Because the Ninth Circuit’s opinion revlaces ‘‘legal en-

forceability’’ with ‘‘mere expectation’ as the definitive test

for the accrual of income and deductions, taxpayers will

now have a powerful device for manipulating the timing of

their deduction of business expenses’and for manipulating

the amount of taxes paid by them. We believe this unhappy

prospect was a major factor in causing the Internal Revenue

Service to adhere to “‘legal enforceability’ for 60 years of

consistent administrative interpretation and in this very case.

The Ninth Circuit simply ‘‘missed’’ this point and the pro-

found impact of its decision on the Federal fisc.

CONCLUSION.

For taxpayers in the Ninth Circuit, there no longer need

be a liability that is fixed, absolute, and certain for accrual

of income and the deduction of expenses. A strong prob-

"In Rev. Rul. 74-69, 1974-1 C.B. 113, the Internal Revenue Service

ee re are: sapere Saaans Wy > teins oe

chine operator could not be accrued as current expenses because payment

of them could not be legally enforced. The Service ruled that a gambling

machine operator who gave winning customers coupons redeemable in

merchandise from cooperating , whom the operator then paid

for the merchandise could not deduct the value of the coupons when

issued. The could deduct the value of the coupons only ‘“when

the liable to pay the participating merchant for

sundhandes GotS to endiemn Gee axaguns” Tien exued on toteaap

tion.

Inasmuch as Rev. Rul. 74-69 was issued in the same year that Office

Decision 1139 was declared obsolete, see page 11, supra, for discussion,

it is clear that the Commissioner did not change his insistence on legal

enforceability as a prerequisite to accrual.

ia.

ability, a mere ‘‘expectation,’’ may now require accrual,

depending on a factfinder’s conclusion on the presence or

absence, according to the Ninth Circuit, of ‘‘unique facts

and practical considerations.’’ 664 F.2d at 1389. This is not

the way in which the tax laws can be meaningfully acted

on by taxpayers or applied by the Internal Revenue Service,

nor should it be.

This Court should grant a Writ of Certiorari to the United

States Court of Appeals for the Ninth Circuit to review its

decision in this case.

Respectfully submitted,

LIONEL SAWYER & COLLINS

and

LEVENFELD, EISENBERG, JANGER,

GLASSBERG AND LIPPITZz

By STEVE Morris

Attorneys for Petitioner.