115 T.C. No. 1
UNITED STATES TAX COURT
TUTOR-SALIBA CORPORATION, A CALIFORNIA CORPORATION, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 3110-98. Filed July 17, 2000.
Under the Tax Reform Act of 1986, Pub. L. 99-514, 100 Stat. 2085, Congress changed the reporting method for long-term contracts from the completed contract method to the percentage of completion method. Under the percentage of completion method of sec. 460(b), I.R.C., taxpayers are required to include in income during the years of construction a portion of the “estimated contract price.” In promulgating sec. 1.460-6(c)(2)(vi), Income Tax Regs., the Secretary concluded that the term “estimated contract price” includes amounts related to contingent rights and obligations, regardless of whether the “all events test” has been met. R, relying on the plain meaning of the statute and its legislative history, contends that the regulation is a valid interpretation of the statute that satisfies congressional intent. P contends that the all events test is a fundamental tax principle that cannot be ignored without an express mandate from Congress. - 2 -
Held: Sec. 1.460-6(c)(2)(vi), Income Tax Regs., is a reasonable interpretation of the statute, comports with the legislative history, and, accordingly, is valid.
Marilyn Barrett, for petitioner.
Steven M. Roth and Jonathan H. Sloat, for respondent.
OPINION
GERBER, Judge: Pursuant to Rule 121,1 this matter is before
the Court on petitioner’s motion for partial summary judgment.
The parties seek to determine, as a matter of law, whether
section 1.460-6(c)(2)(vi)(A) and (B), Income Tax Regs., is
invalid to the extent it contains no requirement that disputed
long-term contract claims meet the “all events test” to be
includable in the estimated contract price within the context of
section 460.
Summary judgment may be granted if the pleadings and other
materials demonstrate that no genuine issue exists as to any
material fact and that a decision may be entered as a matter of
law. See Rule 121(b); Sundstrand Corp. v. Commissioner, 98 T.C.
518, 520 (1992), affd. 17 F.3d 965 (7th Cir. 1994). There is no
genuine issue as to any material fact with respect to the
1 Unless otherwise indicated, all Rule references are to the Tax Court Rules of Practice and Procedure, and all section references are to the Internal Revenue Code in effect for the taxable years at issue. - 3 -
specific legal issue before us, and, accordingly, this matter is
ripe for judgment on the contested issue as a matter of law. See
Rule 121(b).
Background
Petitioner was organized pursuant to the laws of the State
of California on June 15, 1981. At the time its petition was
filed, petitioner’s principal place of business was in Sylmar,
California.
Petitioner is a general contractor in the construction
industry for public works projects, including highways and
government-owned buildings, and large-scale private developments,
such as office towers. Petitioner enters into contracts either
on a fixed price basis or on a cost-plus basis. All of the
contracts in issue in this case are fixed price contracts. In a
fixed price contract, contractors formulate their bids on the
basis of the information contained in the architectural and
engineering drawings, designs, and geological reports provided by
the contracting agency. Due to changes in drawings or designs,
customer-caused delays, errors in the specifications of the
drawings, designs, or reports, or other unanticipated delays,
additional work by the contractor is commonly required to
complete the job satisfactorily.
The contracts in question obligate petitioner to complete
the job, and if it failed to do so, petitioner would be liable to - 4 -
the government agency that is a party thereto (contracting party)
for damages. Each of the contracts provided for liquidated
damages in the event petitioner failed to complete the job or did
not otherwise fulfill its contractual obligations. The contracts
also provided for a retention of a specified percentage of the
contract price until the contracting party completed review of
the job and accepted it as completed. Petitioner submitted
certain change orders on the contracts in question that were
denied by the other contracting party. Petitioner followed the
required procedures for submitting claims and for appealing
adverse determinations on disputed claims.
For Federal income tax purposes, petitioner was subject to
section 460 for the reporting of income from long-term contracts.
While petitioner reported income from its long-term contracts
under the percentage of completion method, it employed the all-
events test to govern income recognition from disputed claims.
Thus, petitioner did not include income from disputed claims when
estimating the total contract price under the percentage of
completion method, but petitioner instead reported as income only
the portion of disputed claims actually awarded to petitioner in
the taxable year in which either a settlement was entered into,
an arbitration award was determined, or a court rendered
judgment. - 5 -
Respondent contends that the income from the disputed claims
should be included in the total contract price as required by
section 1.460-6(c)(2)(vi), Income Tax Regs. Petitioner contends
that disputed claims should, as a matter of law, be reported in
accord with the all events test and included in income in the
taxable year in which income from the disputed claim is
ultimately awarded. Petitioner contends that, to the extent the
all events test has not been employed, section 1.460-6(c)(2)(vi),
Income Tax Regs., is invalid.
Discussion
Section 460 contains special rules for long-term contracts
and generally requires the use of the percentage of completion
method for tax reporting. To the extent that a taxpayer
underestimates the percentage completed or the amount includable
in income, section 460(b) provides for “look-back” interest to be
paid by the taxpayer.2
2 Sec. 460(b) provides:
(2) Look-back method.--The interest computed under the look-back method of this paragraph shall be determined by--
(A) first allocating income under the contract among taxable years before the year in which the contract is completed on the basis of the actual contract price and costs instead of the estimated contract price and costs,
(B) second, determining (solely for purposes of computing such interest) the overpayment or (continued...) - 6 -
Section 460 was enacted by the Tax Reform Act of 1986, Pub.
L. 99-514, sec. 804(a), 100 Stat. 2385. Prior to 1986, income
from long-term contracts could be accounted for under one of two
alternative methods: the percentage of completion method or the
completed contract method. Under the percentage of completion
method, income was recognized according to the percentage of the
contract completed during each taxable year. The determination
of the portion of the contract completed during the taxable year
could be made either by (1) comparing the costs incurred during
the year to the total estimated costs to be incurred under the
contract, or (2) comparing the work performed during the year
with the estimated total work to be performed. See sec. 1.451-
3(c)(2)(i) and (ii), Income Tax Regs.
2 (...continued) underpayment of tax for each taxable year referred to in subparagraph (A) which would result solely from the application of subparagraph (A), and
(C) then using the overpayment rate established by section 6621, compounded daily, on the overpayment or underpayment determined under subparagraph (B).
For purposes of the preceding sentence, any amount properly taken into account after completion of the contract shall be taken into account by discounting (using the Federal mid-term rate determined under section 1274(d) as of the time is so properly taken into account) such amount to its value as of the completion of the contract. The taxpayer may elect with respect to any contract to have the preceding sentence not apply to such contract. - 7 -
Under the completed contract method, the entire gross
contract price was included in income in the taxable year in
which the contract was finally completed and accepted. All costs
properly allocated to a long-term contract were deducted in the
year of completion. See sec. 1.451-3(d), Income Tax Regs.
Regulations under the completed contract method provided that any
disputed item of income which was properly allocable to a long-
term contract and which was not included in gross income in a
prior taxable year should be included in gross income in the
taxable year in which any such dispute is resolved. See sec.
1.451-3(d)(3), Income Tax Regs.
Section 460, enacted in 1986, as applicable to long-term
contracts entered into after February 28, 1986, required
taxpayers to compute income under either the “percentage of
completion capitalized cost method” or the percentage of
completion method. Under the percentage of completion
capitalized cost method, taxpayers were required to report 40
percent of the contract items under the percentage of completion
method of accounting and were permitted to report the remaining
60 percent of the contract items under their normal method of
accounting. The proportion of contract items required to be
reported under the percentage of completion method was
subsequently increased several times. Ultimately, by the
enactment of the Omnibus Budget Reconciliation Act of 1989, Pub. - 8 -
L. 101-239, 103 Stat. 2106, 100 percent of contract items for
long-term contracts entered into on or after July 11, 1989, had
to be reported under the percentage of completion method.
Under the percentage of completion method of accounting,
income from the contract must be reported over the life of the
contract, and expenses must be deducted in the year incurred.
The reportable income for each year is calculated as follows:
the total contract costs incurred through the end of the tax year
are divided by the total estimated contract costs, and then
multiplied by the total contract price; the product of this
multiplication is reduced by gross income from the contract
reported for prior years. See sec. 460; Cameron v. Commissioner,
105 T.C. 380 (1995), affd. sub nom. Broadway v. Commissioner, 111
F.3d 593 (6th Cir. 1997).
Under section 460(b), a taxpayer is required to apply the
“look-back method” upon a contract’s completion (and possibly
again after a postcompletion event) to compensate the prejudiced
party (taxpayer or Government) for a taxpayer’s overestimation or
underestimation in applying the percentage of the completion
method. Under this method, the taxpayer recomputes its income
tax (theoretically--since, in reality, taxpayers do not amend any
tax returns) for each year of the contract using the actual
contract price and costs instead of estimates. Based on this
reconciliation, the taxpayer pays interest to the Government on - 9 -
any hypothetical underpayments of tax and receives interest from
the Government on any hypothetical overpayments of tax.
If an amount of revenue or cost attributable to a completed
long-term contract is properly taken into account in a
postcompletion year, section 460(b)(1)(B) requires a taxpayer to
reapply the look-back method in that postcompletion year unless
the taxpayer elects otherwise. For this purpose, section
460(b)(2) requires a taxpayer to discount the amount of revenue
or cost to its present value as of the contract’s completion date
and to redetermine the contract’s “actual contract price”.
Promulgated in October 1990, section 1.460-6(c)(2)(vi),
Income Tax Regs., 55 Fed. Reg. 41665-01 (Oct. 15, 1990),
provides:
(vi) Amount treated as contract price--(A) General rule. The amount that is treated as total contract price for purposes of applying the percentage of completion method and reapplying the percentage of completion method under the look-back method under Step One includes all amounts that the taxpayer expects to receive from the customer. Thus, amounts are treated as part of the contract price as soon as it is reasonably estimated that they will be received, even if the all-events test has not yet been met.
(B) Contingencies. Any amounts related to contingent rights or obligations, such as incentive fees or amounts in dispute, are not separated from the contract and accounted for under a non-long-term contract method of accounting, notwithstanding any provision in § 1.451-3(b)(2)(ii), (iii), (iv), and § 1.451-3(d)(2), (3), and (4), to the contrary. Instead, those amounts are treated as part of the total contract price in applying the percentage of completion method and the look-back method. For example, if an incentive fee under a contract to manufacture a satellite is - 10 -
payable to the taxpayer after a specified period of successful performance, the incentive fee is includible in the total contract price at the time and to the extent that it can reasonably be predicted that the performance objectives will be met, for purposes of both the percentage of completion method and the look- back method. Similarly, a portion of the contract price that is in dispute is included in the total contract price at the time and to the extent that the taxpayer can reasonably expect the dispute will be resolved in the taxpayer’s favor (without regard to when the taxpayer receives payment for the amount in dispute or when the dispute is finally resolved).
Sec. 1.460-6(c)(2)(vi)(A) and (B), Income Tax Regs. Thus, under
the regulation, the total contract price used in the percentage
of completion calculation includes any amounts attributable to
contingent rights or obligations.
Petitioner argues that (i) the regulation does not implement
the congressional mandate as required under applicable law; (ii)
the regulation attempts to “repeal”, without clear and explicit
congressional support, the all events test, which has been
recognized as a fundamental tax principle; (iii) respondent
attempts to usurp Congress and supersede the look-back method by
issuance of the regulation to address timing differences; and
(iv) the regulation is not reasonable in view of prior law and
usage and is not reasonable in application.3 Respondent argues
that it is reasonable to require a taxpayer to estimate the total
contract price of a long-term contract and, thus, to include a
3 Petitioner is not arguing that income arising out of contingencies and disputes be excluded from the look-back method. - 11 -
disputed claim related to that contract as soon as it is
reasonably estimated that income from the claim will be received.
Respondent maintains that the regulation’s inclusion of disputed
claims in the percentage of completion method satisfies
congressional intent and is therefore valid.
Validity of Sec. 1.460-6(c)(2)(vi), Income Tax Regs.
A. Standard of Review
Regulations are either legislative or interpretive in
character. See Estate of Pullin v. Commissioner, 84 T.C. 789,
795 (1985). An interpretive regulation is issued under the
general authority vested in the Secretary by section 7805,
whereas a legislative regulation is issued pursuant to a specific
congressional delegation to the Secretary. Section 1.460-
6(c)(2)(vi), Income Tax Regs., appears to be issued under the
regulatory authority of section 460(h). Respondent, however,
conceded that this regulation is interpretive. Accordingly, we
need not determine whether this regulation is legislative or
interpretive in nature. We note, however, that our holding would
be the same regardless of whether we use the standard employed
for legislative or interpretive regulations.
An interpretive regulation, while entitled to deference, is
not entitled to as much deference as is accorded a legislative
regulation. See United States v. Vogel Fertilizer Co., 455 U.S.
16, 24 (1982). Moreover, the standard of deference accorded to - 12 -
an interpretive regulation sets only “the framework for judicial
analysis; it does not displace it.” United States v. Cartwright,
411 U.S. 546, 550 (1973). Under the traditional standard of
review, interpretive regulations are to be found valid if they
“‘implement the congressional mandate in some reasonable
manner’”. National Muffler Dealers Association, Inc. v. United
States, 440 U.S. 472, 476 (1979) (quoting United States v.
Correll, 389 U.S. 299, 307 (1967)).
A regulation may not contradict the unambiguous language of
a statute. See Citizen’s Natl. Bank v. United States, 417 F.2d
675 (5th Cir. 1969); Hefti v. Commissioner, 97 T.C. 180, 189
(1991), affd. 983 F.2d 868 (8th Cir. 1993). Unless an
interpretive regulation is unreasonable and plainly inconsistent
with the statute, it should be sustained. See Bingler v.
Johnson, 394 U.S. 741, 750 (1969). However, even if a regulation
does not directly contradict the language of the statute it
purports to interpret, the regulation may still be invalid if it
is fundamentally at odds with or inconsistent with the statute’s
origin and purpose.4 See United States v. Vogel Fertilizer Co.,
4 We are mindful that the choice among reasonable statutory interpretations is for the executive branch of Government and not the courts. See National Muffler Dealers Association, Inc. v. United States, 440 U.S. 472, 488 (1979). The issue is whether the Secretary’s interpretation of the statute is a reasonable one, not whether it is the best or only one. See Brown v. United States, 890 F.2d 1329, 1338 (5th Cir. 1989). When the regulation implements in some reasonable manner the congressional intent (continued...) - 13 -
supra at 26; CWT Farms, Inc. v. Commissioner, 79 T.C. 1054, 1062
(1982), affd. 755 F.2d 790 (11th Cir. 1985).
B. Analysis
Under the test articulated in Chevron U.S.A., Inc. v.
Natural Res. Def. Council, Inc., 467 U.S. 837 (1984), the first
question we must ask when reviewing an agency’s interpretation of
a statute is whether Congress has addressed the precise question
under consideration and has expressed its intent as to its
resolution. The examination should begin with the language of
the statute. See Consumer Prod. Safety Commn. v. GTE Sylvania,
Inc., 447 U.S. 102, 108 (1980); Abourezk v. Reagan, 785 F.2d
1043, 1053 (D.C. Cir. 1986).
In deciding whether the regulation comports with the
statute’s plain language, we look to the ordinary usage or
settled meanings of the words used in the statute by Congress.
See Lynch v. Alworth-Stephens Co., 267 U.S. 364, 370 (1925).
There is a strong presumption that Congress expresses its
intention through the language it chooses. See INS v. Cardoza-
Fonseca, 480 U.S. 421, 432 n.12 (1987). Section 460 contains the
4 (...continued) underlying a provision, courts are not at liberty to strike down the regulation merely because the taxpayer offers a more attractive statutory interpretation. See id. - 14 -
phrase “estimated contract price”.5 This language indicates that
Congress was aware of the fact that taxpayers were being required
to estimate when using the percentage of completion method in
accounting for long-term contracts. The fact that section
460(b)(2)(A) requires a taxpayer to substitute “actual contract
price and costs” for “estimated contract price and costs” when
applying the look-back method at the contract’s completion
underscores the fact that the total contract price used in the
percentage of completion method calculation is an estimate of the
total contract price and is likely to change during the
performance of the contract. This conceptual underpinning is the
antithesis of the all events test.6
The term “estimated” does not necessarily include, as
respondent contends, revenues from disputed claims. The term
“estimate,” however, does not preclude the possibility that
Congress intended that disputed claims be included. In any
5 The parties do not dispute the definition of the term “estimated”. According to the dictionary, “estimate” means to judge tentatively or approximately the value, worth or significance of; to determine roughly the size, extent, or nature of; or to produce a statement of the approximate cost of. See Merriam-Webster’s Tenth Collegiate Dictionary 397 (1997). 6 Furthermore, in a number of tax accounting cases, the Supreme Court has decided that estimates of anticipated expenses are not accruable as deductions under the all events test. See United States v. General Dynamics Corp., 481 U.S. 239, 243-244 (1987). The repeated use of the word “estimated” indicates that standard principles of accrual accounting, including the all events test, are not determinative. - 15 -
event, there is nothing in the regulation that contradicts the
plain language of the statute.
As stated above, even if a regulation does not clearly
contradict the language of the statute it purports to interpret,
the regulation may still be invalid if it is fundamentally at
odds with or inconsistent with the statute’s origin and purpose.
See United States v. Vogel Fertilizer Co., supra at 26; CWT
Farms, Inc. v. Commissioner, supra at 1062. Because the use of
the word “estimated”, alone, does not reveal the congressional
intent, we must determine whether the regulation harmonizes with
and implements the congressional mandate in some reasonable
manner.
There is no doubt about Congress’ concern that the completed
contract method of accounting for long-term contracts permitted
an unwarranted deferral of the income from those contracts. See
S. Rept. 99-313 (1986), 1986-3 C.B. (Vol. 3) 140; Staff of the
Joint Comm. on Taxation, General Explanation of the Tax Reform
Act of 1986, at 527 (J. Comm. Print 1987). Congress sought to
limit the tax deferral obtainable through use of the completed
contract method by requiring taxpayers to report income from
long-term contracts on a percentage of completion method. It was
recognized that use of the percentage of completion method could
produce harsh results for taxpayers where an overall loss was
experienced or where actual profits were significantly less than - 16 -
projected. Thus, Congress provided for a “look-back” to account
for variances between the estimated and the actual figures.
Although there is no specific support in the legislative
history for respondent’s position, use of the terms “expected”
and “anticipated” lends support to respondent’s position and is
helpful to our consideration. The House report described the
intended operation of the percentage of completion method as
follows:
Income from all long-term contracts must be reported under the percentage of completion method based on the expected costs rather than physical completion. Thus, the amount of gross income from a long-term contract recognized in a particular taxable year generally is that proportion of the expected contract price that the amount of costs incurred through the end of the taxable year bears to the total expected costs, reduced by amounts of gross contract price that were included in gross income in previous taxable years. [H. Rept. 99- 426 (1986), 1986-3 C.B. (Vol. 2) 630; emphasis added.]
In describing the operation of the look-back method, the
Staff of the Joint Committee on Taxation added:
In the taxable year in which the contract is completed, a determination is made whether the taxes paid with respect to the contract in each year of the contract were more or less than the amount that would have been paid if the actual gross contract price and the actual total contract costs, rather than the anticipated contract price and costs, had been used to compute gross income. [Staff of Joint Comm. on Taxation, General Explanation of the Tax Reform Act of 1986, at 528 (J. Comm. Print 1987); emphasis added.] * * * - 17 -
While it is clear that Congress intended the total contract
price to be computed by means of an estimate, the legislative
history contains no reference to disputed or contingent items.
Furthermore, there is no explicit indication as to whether the
all events test applies. There is a reference to contingent
items in the General Explanation of the Tax Reform Act of 1986,
which contains the statement that “For purposes of the ‘look-
back’ method, the contract price shall reflect all amounts
received under the contract, including amounts received after the
contract completion date as a result of disputes, litigation or
settlements relating to the contract.”7 Id.
Because disputed claims are includable in the look-back
computation, an earlier inclusion of disputed claims will result
in smaller underpayments and interest. Thus, requiring taxpayers
to treat disputed claims as part of the contract price as soon as
it is reasonably estimated that they will be received harmonizes
with the statute’s overall purpose, as reflected by its
7 While the General Explanation of the Tax Reform Act of 1986 does not rise to the level of legislative history because it is prepared by congressional staff after enactment of the statute, it has been considered highly indicative of what Congress did, in fact, intend and we take it into consideration. See Staff of Joint Comm. on Taxation, General Explanation of the Tas Reform Act of 1986 (J. Comm. Print 1987); Estate of Wallace v. Commissioner, 965 F.2d 1038, 1050-1051 n.15 (11th Cir. 1992); FPC v. Memphis Light, Gas & Water Div., 411 U.S. 458, 472 (1973) (indicating that the General Explanation of the Tax Reform Act is a probative contemporary indication of the effect of a statutory provision). - 18 -
legislative history. Based on indications in the legislative
history that Congress was concerned with taxpayer deferral of
income, a regulation requiring all revenues to be reasonably
estimated and included in the total contract price comports with
that congressional intent.8
Petitioner makes several contrary arguments. First, it
contends that implicit in the enactment of the look-back method
is congressional approval of the all events test. The all events
test, which was developed as case law and embodied in
regulations, applies to accrual method taxpayers and is used in
determining the taxable year in which items of income or
deductions are properly reported by such taxpayers. Under
section 1.451-1(a), Income Tax Regs., income is includable 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 reasonable accuracy. Under the all events test,
disputed claims to income are not accruable until a settlement is
8 We also note that the regulation has been in existence without relevant change since its promulgation in 1990, and during its existence Congress has amended section 460 without amending section 460(b) to alter the regulation’s interpretation of the statute. Under the successive reenactment doctrine, if Congress reenacts without change the statutory language that has been construed by the agency administering that statute, Congress’ decision not to change that statutory language may be persuasive evidence that the agency’s construction is the one intended by Congress. See Commodity Futures Trading Commn. v. Schor, 478 U.S. 833, 845-846 (1986). - 19 -
entered into or a judgment is rendered and all appeals are
exhausted. See United States v. Safety Car Heating & Lighting
Co., 297 U.S. 88 (1936). Petitioner contends that a fundamental
tax principle cannot be “repealed”9 by respondent without
explicit congressional authorization, and no such authorization
is present in this case.
It is true that Congress did not explicitly state that the
all events test should not apply with respect to contingent items
for purposes of long-term contracts. However, because the
section 460 version of the percentage of completion method is a
self-contained, statutorily created form of accounting method
which varies substantially from prior accrual accounting
methodology, we do not believe that an explicit statement from
Congress regarding the all events test is necessary to validate
the regulation. The section 460 approach to the percentage of
completion method is the method of accounting that Congress chose
for the reporting of long-term contract income in order to modify
the deferral of income previously permitted. While section
1.451-3(d)(3), Income Tax Regs., incorporated aspects of the all
events test under the completed contract method, Congress is free
to change the method of accounting with respect to long-term
9 Petitioner’s use of the term “repealed” is a misnomer because the all events test was developed as a principle of case law and embodied in regulations. Congress has implicitly approved of this principle by not subsequently legislating otherwise. - 20 -
contracts without retaining the all events test or explicitly
stating that the all events test is not to be utilized.
Petitioner also contends that the section 460(b)(1)(B)
parenthetical language “with respect to any amount properly taken
into account after completion of the contract, when such amount
is properly taken into account” indicates an intent to include
the all events test as part of the percentage of completion
method. While this language does contemplate the resolution of
some items after the year the contract is completed, there is no
indication that Congress intended this language to incorporate
the all events test in the percentage of completion method of
section 460. The phrase “amount properly taken into account
after completion of the contract” could include amounts properly
taken into account for reasons unrelated to the all events test.
For example, it is possible for a long-term contract to be
complete for tax purposes even though the taxpayer reasonably
expects to incur additional unforeseeable costs in a post-
completion tax year. It is also possible that contingent items,
such as disputed claims, cannot be reasonably estimated before
the completion of the contract, in which case revenue from those
disputed claims would not be taken into account until after the
completion of the contract. Moreover, the parenthetical language
indicates an intent to use the all events test for purposes of
adjusting the “actual” contract price. Cf. sec. 460(b)(2); sec. - 21 -
1.460-6(c)(1)(ii)(A), Income Tax Regs. However, the “actual”
contract price is to be contrasted with the “estimated” contract
price, the latter of which is not governed by the all events
test. Thus, we decline to read the parenthetical language as
evidence of congressional intent to apply the all events test to
taxpayers’ disputed claims for purposes of computing the
estimated contract price.
Furthermore, the language relied on by petitioner is
employed in the context of how the look-back method operates.
Taxpayers are required to apply the look-back method to any
amounts that are taken into account after completion of the
contract. Thus, if income is received and properly accounted for
5 or 10 years after completion of the contract, those revenues
are discounted back to the year of completion, and the look-back
method is applied. Such application would likely result in
underpayment interest due by the taxpayer if post-completion
revenues were not included in the estimated total contract price
at the time it was reasonably expected that they would be
received by the taxpayer.
In addition, requiring the inclusion of an estimate of
disputed claims in the total contract price as soon as the
taxpayer reasonably expects to receive them will reduce the
likelihood that a taxpayer will have to pay look-back interest.
The purpose of the look-back method is to offset the time-value - 22 -
effects of using estimates during the life of a contract that may
differ from the actual amounts determined upon completion.
Because the all events test does not recognize income until it is
fixed and determinable, requiring use of the all events test
would render moot any “estimating” of the total contract price,
lead to additional timing differences (income deferrals) and
likely require taxpayers to pay more look-back interest.
Moreover, the statute by its plain language calls for the use of
“estimated” contract price and costs.
Petitioner relies on Professional Equities, Inc. v.
Commissioner, 89 T.C. 165 (1987), contending that we should
declare the “contingent items” regulation invalid to the extent
it purports to regulate the contents of a long-term contract’s
total contract price. We do not view Professional Equities, Inc.
as support for invalidation of the subject regulation. The
temporary regulation considered in Professional Equities, Inc.
was designed to overturn a long line of precedent beginning with
the holding in Stonecrest Corp. v. Commissioner, 24 T.C. 659
(1955). In Stonecrest Corp., we held that the “assumed” and
“subject to” rules in the regulations interpreting former section
453(c) did not apply to wraparound mortgages. The regulation at
issue in Professional Equities, Inc. was at variance with the
Stonecrest Corp. line of cases as well as being at odds with the
language of the statute. In Professional Equities, Inc. v. - 23 -
Commissioner, supra at 180, we invalidated the temporary
regulation and concluded that the Secretary did not have
discretion to “reach a result contrary to the basic objective of
the statute by requiring the recognition of additional gain
beyond what is proportionately reflected in the payments received
during the first year.”10 The regulation we consider here is a
reasonable interpretation of the statutory intent and in harmony
with the overall purpose of the legislative initiative. Thus, we
do not view Professional Equities, Inc. as instructive with
regard to the validity of the subject regulations.
Finally, petitioner argues that the subject regulations
should be declared invalid because of the alleged difficulty for
taxpayers to determine when they have a reasonable expectation of
recovery on a disputed claim. We recognize that the regulation’s
“reasonable expectancy” standard may result in difficulties in
the determination of when a contingent item can be reasonably
expected to be received. By promulgating such a regulation,
respondent may be called upon to determine when it is reasonably
foreseeable that a contingent item will be received by a
taxpayer. This may not be an easy task, and in petitioner’s
case, there is no indication whether respondent will prevail in
such a controversy. However, difficulty of this kind is not a
10 The Court also noted that the regulation was “tortuously complex” and was not compatible with the goals of the statute. - 24 -
reason to invalidate the regulation; the determination of when a
contingent item can be reasonably expected to be received can be
made on a case-by-case basis. The regulation is a reasonable
interpretation of, and plainly consistent with, the underlying
statute.11
In light of the foregoing, we hold that section 1.460-
6(c)(2)(vi), Income Tax Regs., is valid because it harmonizes
with the plain language, origin, and purpose of section 460.
We have considered the parties’ remaining arguments and find
them either irrelevant or unnecessary for resolving the parties’
controversy. To reflect the foregoing,
An order will be issued
denying petitioner’s motion for
partial summary judgment.
11 Although petitioner’s position may also be a reasonable interpretation, we are constrained to uphold the regulation if it has a reasonable basis in the statutory history, even though petitioner’s challenge may have some logical force. See Pagel, Inc. v. Commissioner, 91 T.C. 200, 218 (1988), affd. 905 F.2d 1190 (8th Cir. 1990).