Background
Facts
The corporation used the accrual method of accounting for federal tax purposes; its fiscal year was the same as the calendar year. From 1962 until October 1, 1972, the corporation purchased group-medical insurance for its employees and qualified dependents from two private insurance carriers. Beginning in October 1972, the corporation became a self-insurer with regard to its medical care plans. Instead of continuing to purchase insurance from outside carriers, it undertook to pay medical claims out of its own funds, while continuing to employ private carriers to administer the medical care plans.
An accrual-basis employer—a corporation which filed a consolidated federal income tax return with several subsidiaries--(1) reimbursed employees for certain medical expenses of employees and their qualified dependents; (2) established reserve accounts to reflect the employer's liability for medical care which had been received by covered individuals during the last quarter of 1972, but still not paid for by the employer as of December 31, 1972; (3) calculated the amount of the reserve based upon an estimate of the aggregate liability to be incurred for the period in question; and (4) claimed the estimated reserve as a business expense in an amended 1972 federal income tax return.
Audit
The Internal Revenue Service (IRS) audited appellee corporation's 1972 tax return. The corporation filed an amended return, claiming it was entitled to deduct its reserve as an accrued expense, and seek a refund. The IRS disallowed the deduction.
Claims Court
General Dynamics challenged the disallowance and sought a federal income tax refund in the Claims Court, which sustained the deduction and expressed the view that (1) there was no dispute that expenses incurred by the employer in connection with its employee medical-benefit plans were deductible as ordinary and necessary business expenses under 162(a), so that the issue in the case was the timing of the deduction; and (2) deduction of the reimbursement reserve on the 1972 return satisfied the "all events" test, where (a) the fact of the employer's liability was established when a qualified employee or dependent received covered medical services, (b) the subsequent acts of claims filing and processing were ministerial in nature, not conditions precedent to liability, and (c) the employer's aggregate-estimate system for determining the amount of liability was logical and reasonable (6 Cl. Ct 250).
The United States Court of Federal Claims is a United States federal court that hears monetary claims against the U.S. government. It is the direct successor to the United States Court of Claims, which was founded in 1855, and is therefore a revised version of one of the oldest federal courts in the country.
Federal Circuit
On appeal, the United States Court of Appeals for the Federal Circuit affirmed, largely on the basis of the Claims Court opinion.
The United States Court of Appeals for the Federal Circuit is a United States court of appeals headquartered in Washington, D.C. The court was created by Congress with passage of the Federal Courts Improvement Act of 1982, which merged the United States Court of Customs and Patent Appeals and the appellate division of the United States Court of Claims, making the judges of the former courts into circuit judges. The Federal Circuit is particularly known for its decisions on patent law, as it is the only appellate-level court with the jurisdiction to hear patent case appeals.
Opinion of the court
The issue before the Court on certiorari was whether an accrual-basis taxpayer providing medical benefits to its employees could 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 had not been reported to the employer.
The Supreme Court reversed the judgment of the Federal Circuit, disallowing the deduction for employee medical expenses incurred, but not reported to the employer, in 1972. In an opinion by Justice Marshall, the Court held that, under 162(a) of the Code, the accrual-basis employer did not satisfy the "all events" test so as to enable the employer to deduct at the close of 1972 an estimated reserve for the employer's obligation to reimburse employees or their qualified dependents for covered medical expenses incurred but not reported to the employer during the final quarter of 1972, where (1) the last event necessary to fix the employer's liability was the filing of a claim with the employer; (2) the employer had failed to demonstrate that any of the reserve represented claims which had been filed prior to the close of 1972 but not yet processed; (3) the fact that the employer might have been able to make a reasonable estimate of how many claims would be filed for the last quarter of 1972 might justify such a reserve as an appropriate accounting measure, but did not, by itself, warrant a tax deduction; and (4) if the "all events" test permitted deduction of an estimated reserve representing claims that were actually likely but not yet reported, Congress would not have needed to maintain an explicit provision (26 U.S.C. 832(b)(5), 832(c)(4)) that insurance companies could deduct such reserves.
Thurgood Marshall was an American lawyer, serving as Associate Justice of the Supreme Court of the United States from October 1967 until October 1991. Marshall was the Court's 96th justice and its first African-American justice. Prior to his judicial service, he successfully argued several cases before the Supreme Court, including Brown v. Board of Education.
Dissent
Justice O'Connor, joined by Justices Blackmun and Stevens, wrote a dissent chastising the majority for adopting a rigid version of the "all events" that retreated from prior holdings, arguing that the decision will "unnecessarily burden[] taxpayers by further expanding the difference between tax and business accounting methods without a compelling reason to do so."
Sandra Day O'Connor is a retired Associate Justice of the Supreme Court of the United States, who served from her appointment in 1981 by President Ronald Reagan until her retirement in 2006. She was the first woman to serve on the Court.
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