DOJ Brief Seeks to Limit Sec. 172(f)

A district court has ruled that workers' compensation claims and interest on Federal income tax deficiencies qualify under Sec. 172(f) as specified liability losses, eligible for a 10-year carryback (Host Marriott Corp., 113 FSupp 2d 790 (MD, 2000)). (For background information, see Tax Clinic, "Hotel Chain Entitled to $22 Million in Specified Loss Carrybacks," TTA, January 2001, p. 20.)

In its brief on appeal to the Fourth Circuit, the Department of Justice (DOJ) has argued that the lower court erred in finding that the tax deficiency interest deduction claimed by Host Marriott gave rise to a specified liability loss. The U.S. has not appealed the lower court's holding that Host Marriott derived a specified liability loss from deductions it claimed on its 1991 Federal return for payments of workers' compensation claims.

Scope of Provision

The DOJ argued first in its brief that Sec. 172(f)(1)(B)(i) does not have the broad scope imparted to it by the district court, but rather is limited to a narrow class of liabilities for which deductions are deferred for accrual-basis taxpayers under the economic performance rules enacted in 1984. According to the DOJ, Sec. 172(f)(1)(B)(i) has its genesis in Section 91 of the Deficit Reduction Act of 1984 (DRA). It notes that Section 91 enacted economic performance rules, which modified the pre-existing rules on deductions of expenses under the accrual-basis method, and simultaneously enacted various provisions in response to those economic performance rules. Therefore, the DOJ argued:

[o]ne such provision—the predecessor of Sec. 172(f)(1)(B)(i)—was the "deferred statutory and tort liability" provision enacted in section 91(d). The name of that provision, as well as its location in a section of the DRA that enacted the economic performance rules, indicates that the extended carryback period was an outgrowth of, and response to, the contemporaneously enacted modifications to the accrual accounting rules. Specifically, Congress targeted liabilities that accrued, and therefore gave rise to deductions under, the prior law, but for which deductions were "deferred" for an extended period of time under the contemporaneously enacted economic performance rules. That is why the statute requires at least a three-year gap between the act (or failure to act) that gives rise to a statutory liability and the taxable year when the deduction is taken."

Further, the DOJ argued that the district court erred in adopting a "mechanical" approach to statutory construction. Rather, it notes that both the Supreme Court and the Fourth Circuit, in Brown & Williamson Tobacco Corp., 529 US 120 (2000), have emphasized that in interpreting a statute, a court should not focus solely on its literal language, but also should analyze the context of the provision. Consequently, according to the DOJ, in interpreting Sec. 172(f), the district court should have considered that Congress limited the deferred liability provision to accrual-basis taxpayers and that the provision was placed in a section of the DRA that made revisions to the pre-existing rules of the accrual method. Therefore, the DOJ concluded that the taxpayer's interest deduction was not deferred by the economic performance rules. As a result, the deduction does not give rise to a specified liability loss.

Three-Year Period

The DOJ argued alternatively that, even assuming a deduction for interest on a Federal tax deficiency does give rise to a specified liability loss under Sec. 172(f), Host Marriott's specified liability loss does not include interest that accrued after the end of the 1987 tax year.

Sec. 172(f)(1)(B)(i) provides that a "specified liability loss" arises from a statutory liability only if "the act or failure to act giving rise to such liability occurs at least 3 years before the beginning of the taxable year." The DOJ argued that under the express terms of the statute, the interest that accrued against the taxpayer during the three-year period preceding the year in which it claimed its interest deduction (1991) cannot give rise to a specified liability loss.

Sec. 6601(a) provides that interest accrues on an unpaid tax liability from the date the liability arises until the date it is paid, while Sec. 6622 provides for daily compounding of interest. Therefore, when read in conjunction with each other, the DOJ argued, those provisions establish that interest on a Federal tax deficiency accrues on a daily basis. Consequently, in its brief, the DOJ concluded:

[b]ecause interest imposed by the Internal Revenue Code accrues on a daily basis, and the accrual of such interest may be terminated at any time by payment of the outstanding tax liability, a taxpayer is guilty of a separate "failure to act" that gives rise to a discrete interest "liability" for purposes of Sec. 172(f)(1)(B)(i) each day that the taxpayer fails to satisfy an outstanding obligation. As a result, any interest that accrues within three years of the beginning of the relevant taxable year cannot give rise to a specified liability loss under that provision.

From Richard C. Farley, Jr., J.D., LL.M., Washington, DC