A Texas couple recently won a novel U.S. Tax Court case involving tax deductions for landfills.
The married couple operate a landfill outside of Austin using an S corporation which they co-own with relatives.
The IRS disallowed deductions that the couple’s company took for future cleanup costs because the company is a cash-method taxpayer and the IRS contends that the deductions are only available to accrual-method taxpayers.
The tax court disagreed.
The taxpayers in Gregory v. Commissioner of Internal Revenue (PDF) run a landfill outside of Austin and use the cash-method for accounting purposes.
As landfill operators, the taxpayers must pay the reclamation and cleaning costs if (or when) they close down the landfill.
The taxpayers took a deduction under Internal Revenue Code section 468, which allows landfill operators to deduct a portion of their estimated landfill cleanup costs each year, even if the payment of those costs is far into the future.
As the court puts it:
“A current deduction for a future expense is a good deal for most taxpayers, and the disagreement between the parties here is simple—who counts as a “taxpayer” under section 468? The [landfill owners] think a “taxpayer” means any taxpayer, including cash-method taxpayers. But the Commissioner thinks it means only taxpayers who use the accrual method.”
Cash-method vs. accrual-method tax accounting
The cash-method of tax accounting involves reporting income for the tax year in which it is actually or constructively received. Cash-method taxpayers generally deduct business expenses in the year in which they are paid. Non-cash expenses of depreciation, depletion and losses can also be deducted.
By contrast, accrual-method taxpayers generally report income during the year it is earned and deduct expenses in the year that the expenses are incurred.
The definition of “taxpayer” in section 468
Internal Revenue Code section 468 provides for a deduction by a “taxpayer” without further specifying which tax accounting method the taxpayer uses.
The court noted that there is a simple and very broad definition of “taxpayer” in the definitions section at the end of the Internal Revenue Code:
(14) Taxpayer.—The term “taxpayer” means any person subject to any internal revenue tax.
This definition does not distinguish between entities that use different tax accounting methods, and the term “person” encompasses S corporations such as the Texas landfill company.
An exception to the default definition of “taxpayer” would apply if section 468 “distinctly expresses a different definition of taxpayer” that is “manifestly incompatible” with the default definition. However, the tax court did not find this exception to apply here:
“Taxpayer” is one of the most basic terms in the Code. It is also one that Congress itself knows how to modify as context requires. Congress could have—as it has on numerous occasions—said “accrual method taxpayer,” but it chose in section 468 to say “taxpayer” instead. It’s difficult to believe that Congress forgot to modify such a basic term, and really meant “accrual method taxpayer,” when it actually said “taxpayer.”
Finally, the court takes an extensive tour through various textual interpretation and legislative history arguments offered by the parties, but it’s ultimately the plain text of the Internal Revenue that proves to be decisive here. The Texas couple won their case in July.
- Gregory v. Commissioner of Internal Revenue (PDF) 149 T.C. No. 2.
- Internal Revenue Code, “26 U.S. Code § 468 – Special rules for mining and solid waste reclamation and closing costs.” Legal Information Institute at Cornell Law School.
Photo: Celestine Ngulube