Law School Case Brief
Hillsboro Nat'l Bank v. Commissioner - 460 U.S. 370, 103 S. Ct. 1134 (1983)
The tax benefit rule will "cancel out" an earlier deduction only when a careful examination shows that the later event is indeed fundamentally inconsistent with the premise on which the deduction was initially based. That is, if that event had occurred within the same taxable year, it would have foreclosed the deduction.
These two consolidated cases presented the question of the applicability of the tax benefit rule to two corporate tax situations. In the first case, the Commissioner of Internal Revenue assessed a deficiency against Hillsboro National Bank where the Bank recognized no income after it had taken a deduction in the prior year for taxes imposed on its shareholders and paid by the bank and where the shareholders were subsequently granted a refund of those taxes by the state. The state of Illinois had imposed a property tax on shares held in incorporated banks, but Illinois amended its constitution to prohibit such taxes. Illinois courts held the amendment unconstitutional, and, pending disposition of the case in the United States Supreme Court, Illinois enacted a statute providing for the collection of the disputed taxes and the placement of the receipts in escrow. The Bank paid the taxes for its shareholders and took a deduction pursuant to 26 U.S.C.S. § 164(e), which permits a corporation to take a deduction for taxes levied on its shareholders and paid by the corporation. After the United States Supreme Court upheld the state constitutional amendment, the amounts in escrow were refunded to the shareholders. The Commissioner required the Bank to include as income the amount paid its shareholders from the escrow. The Tax Court held that the refund of the taxes, but not the payment of accrued interest, was includable in the bank's income. The United States Court of Appeals for the Seventh Circuit affirmed.
In the second case, the Commissioner increased a dairy corporation's income by $60,000 where Bliss Dairy, Inc., had deducted in the previous year the full cost of cattle feed purchased for use in its operations pursuant to 26 U.S.C.S. § 162(a) as an ordinary and necessary business expense and where Dairy, after adopting a plan of liquidation two days into the next taxable year, distributed its assets, including the cattle feed that was still on hand, to the shareholders. Dairy reported no income on the transaction, relying on 26 U.S.C.S. § 336, which shields a corporation from the recognition of gain on the distribution of property to its shareholders on liquidation. The Commissioner challenged Dairy's treatment of the transaction, asserting that Dairy should have taken into income the value of the grain distributed to the shareholders. Dairy paid the resulting assessment of $60,000 and sued for a refund. The United States District Court for the District of Arizona entered a judgment in favor of Dairy, which the United States Court of Appeals for the Ninth Circuit affirmed. The United States Supreme Court granted certiorari review to address the conflict in the appelllate courts.
Did the tax benefit rule ordinarily apply to require inclusion of income when events occur that are fundamentally inconsistent with earlier deduction?
The United States Supreme Court held that the tax benefit rule required the recognition of income in the case concerning the Dairy liquidation but not in the case concerning the tax refund to the Bank. Hence, in the case concerning the tax refund to the Bank, the Court simply reversed because a redetermination was sought in the Tax Court. The Court reversed the decision of the lower court and held that the deductible dividend was permitted when the money, though initially paid into the state treasury, ultimately reached the shareholder. In the liquidation case, the Court reversed the decision of the lower court and held that the Dairy must include in income the amount of the unwarranted deduction because 26 U.S.C.S. § 336 did not prevent the application of the tax benefit rule. The Court, therefore, remanded for a determination of the proper increase in taxable income.
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