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General Dynamics Corp.; U.S. v.

Facts

General Dynamics Corporation used the accrual method of accounting for federal tax purposes and became a self-insurer for employee medical care in October 1972. The corporation established reserve accounts for medical claims that had not yet been filed by employees by the end of the year. After an IRS audit, General Dynamics filed an amended return claiming a deduction for these reserves, which the IRS disallowed. The Claims Court and the Court of Appeals affirmed the deduction, leading to the government's appeal to the Supreme Court.

Taxpayers, respondents herein, are the General Dynamics Corporation and several of its wholly owned subsidiaries (General Dynamics). General Dynamics uses the accrual method of accounting for federal tax purposes; its fiscal year is the same as the calendar year. From 1962 until October 1, 1972, General Dynamics purchased group medical insurance for its employees and their qualified dependents from two private insurance carriers. Beginning in October 1972, General Dynamics became a self-insurer with regard to its medical care plans.

Issue

Whether an accrual-basis taxpayer providing medical benefits to its employees may deduct at the close of the taxable year an estimate of its obligation to pay for medical care obtained by employees or their qualified dependents during the final quarter of the year, for claims which have not been reported to the employer.

The issue in this case is whether an accrual-basis taxpayer providing medical benefits to its employees may deduct at the close of the taxable year an estimate of its obligation to pay for medical care obtained by employees or their qualified dependents during the final quarter of the year, claims for which have not been reported to the employer.

Rule

Under the 'all events' test, an expense is deductible for the taxable year in which all events have occurred that determine the fact of the liability and the amount can be determined with reasonable accuracy.

As we noted in United States v. Hughes Properties, Inc ., 476 U.S. 593, 600 (1986) , whether a business expense has been 'incurred' so as to entitle an accrual-basis taxpayer to deduct it under 162(a) of the Internal Revenue Code , 26 U. S. C. 162(a) , is governed by the 'all events' test that originated in United States v. Anderson , 269 U.S. 422, 441 (1926).

Analysis

The Supreme Court determined that General Dynamics did not meet the 'all events' test because the liability for the medical claims was not firmly established by the end of the taxable year. The Court emphasized that the mere receipt of medical services did not create a liability unless the employees submitted claims for reimbursement, which was a necessary step for establishing the corporation's obligation to pay.

We think that this case, like Brown , involves a mere estimate of liability based on events that had not occurred before the close of the taxable year, and therefore the proposed deduction does not pass the 'all events' test. We disagree with the legal conclusion of the courts below that the last event necessary to fix the taxpayer's liability was the receipt of medical care by covered individuals.

Conclusion

The Supreme Court reversed the judgment of the Court of Appeals, concluding that General Dynamics was not entitled to the deduction because it failed to demonstrate that its liability for medical claims was firmly established as of the close of the 1972 tax year.

General Dynamics did not show that its liability as to any medical care claims was firmly established as of the close of the 1972 tax year, and is therefore entitled to no deduction.

Who won?

The United States prevailed in the case because the Supreme Court found that General Dynamics did not establish a firm liability for the medical claims by the end of the taxable year, thus disallowing the deduction.

The United States sought review of the question whether all the events necessary to fix liability had occurred. We granted certiorari, 476 U.S. 1181 (1986). We reverse.

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