UNITED STATES v. HUGHES PROPERTIES, INC.
Legal provision: Internal Revenue Code
ORAL ARGUMENT OF ALBERT G. LAUBER, JR. ON BEHALF OF THE PETITIONER
Chief Justice Burger: Mr. Lauber, you may proceed whenever you are ready.
Mr. Lauber: Mr. Chief Justice, and may it please the Court:
This case involves the proper time for claiming deductions by taxpayers that use the accrual basis of accounting.
Under this Court's decision, the proper time for accruing tax deductions is governed by the 1926.
As the Court noted 50 years ago, in Brown versus Helvering and more recently in Thor Power Tool Company in 1979, the all events test helps to serve the objectives of tax accounting.
Unidentified Justice: Well, Mr. Lauber, you refer to the Court enunciating a principle, and it was just a sentence in Justice Stone's opinion, wasn't it?
Mr. Lauber: Well, that's all it began its life as, but it has since taken on a kind of talismanic quality in tax jurisprudence.
It's one of the great traditional tests that has come down to us through the years.
And, the meaning of the test is what governs the time of taking accrued deductions by taxpayers, previous accrual, accrual basis.
I don't think Justice Stone intended it to have that quality, but it has been seized upon and elaborated by the Court itself in later years.
And the way the all events test helps to serve the objectives of tax accounting is to protect the fisc and to help achieve equality of treatment for taxpayers by insisting upon a high degree of certainty before deductions are permitted for tax purposes.
The all events test has two elements.
It requires that an item of expense be taken as a tax deduction, be accrued for the taxable year in which all the events have occurred that create on the part of the taxpayer a fixed and unconditional obligation to pay the expense, and secondly, which permit the amount of that payment to be determined with reasonable accuracy.
This case involves the proper application of the first component of the test, that is, the requirement that the taxpayer have at the end of the year a fixed obligation to make a payment.
The taxpayer here is a Nevada gambling casino that operates, on the casino floor, gambling devices called progressive slot machines.
A progressive slot machine is like an ordinary slot machine except that it has, besides its usual jackpot, an additional progressive jackpot whose amount is shown on a little meter on the face of the machine, and every time somebody plays the machine and loses, the meter goes up and it keeps on going up until somebody actually wins the jackpot.
In order to win a jackpot the player must gamble the required amount of money, which is the case of a multiple coin machine is the maximum amount that can be gambled.
And, he must pull the handle and come up with the winning combination of symbols.
The odds of winning a progressive jackpot are determined by the casino.
By adjusting the number of wheels on the machine, the number of symbols on each wheel, the number of winning symbols, the casino can determine the odds of winning the jackpot, and based on the expected frequency of the machine's play, it can predict a projected payoff date of any particular progressive jackpot.
Unidentified Justice: Mr. Lauber, can I interrupt you?
Does this case just concern progressive jackpots?
Why wouldn't it also concern regular jackpots, if you had a fixed amount that would be payable, predictably within--
Mr. Lauber: My understanding is that the regular jackpots tend to be in smaller amounts and are won much more frequently, and I don't believe the Nevada Gaming Commission regulates regular jackpots, only progressive jackpots.
So, respondents don't have the argument available to them here, that the Commission's regulations give them a fixed liability--
Unidentified Justice: --The regular jackpots, they just do that on a cash basis, then, presumably?
Mr. Lauber: --I couldn't be sure of that.
The projected payoff date for these jackpots can range from several months down the road to several years down the road.
The money corresponding to the jackpots does not sit physically in the machine.
The casinos typically collect the coins out of the machine a couple of times a week.
They are free to use that money and to earn income upon it, as they see fit, until a jackpot is actually won.
When a jackpot is won, the winner typically will go and seek payment from the cashier's cage at the casino.
Unidentified Justice: You demonstrate great familiarity, Mr. Lauber.
Mr. Lauber: Well, I have read the record.
I can't claim this is firsthand knowledge, but this is what is told to me by the record.
Unidentified Justice: I'm told that they bring it to you and pay you at the window, not at the cashier's window but right at the machine.
Mr. Lauber: Oh, did they come back and--
Unidentified Justice: So that everybody can see you and they can take pictures.
Mr. Lauber: --Now you know who--
Unidentified Justice: That is what I am told.
Mr. Lauber: --But it doesn't actually come out of the machine.
It comes over from a human being.
There is no dispute here that progressive jackpots intrinsically are the kind of expense that qualify for deduction as a proper expense of running a gambling business.
The only question here concerns the proper time for taking the deduction.
And the question is really one of timing.
It is an important question because of the time value of money, both from government and the taxpayers' point of view.
We contend that the proper year for conducting a progressive jackpot is a year in which the jackpot is actually won by the customer.
Respondent argues that the actual winning of the jackpot is irrelevant, and that its liability for the jackpots becomes established the minute the machine is placed on the gambling floor to begin with.
Unidentified Justice: Mr. Lauber, how does the Internal Revenue Service treat funds that are set aside by insurance companies out of premiums to pay off potential expected claims, and is there some correlation between the rules for that and the rules applicable here?
Mr. Lauber: Well, there is a lot to say about that.
The Revenue Code treats insurance companies in a unique manner.
There's a whole subchapter of the Code, Subchapter L, that just governs insurance companies, and Congress allows insurance companies alone of all taxpayers to claim current deductions for additions to reserves they establish to pay off life insurance and disability claims.
So, they are allowed to deduct these reserves anticipatorily through a particular congressional statute that covers just insurance companies.
Ordinary taxpayers may equally be motivated to establish reserves on their books, but they can't deduct them because they're not allowed to by the Revenue Code.
There are some reserves, like bad debt reserves, that Congress has authorized, but generally speaking reserves are reserved for life insurance companies and casualty insurance companies.
Unidentified Justice: Is there any other broad category of business deductions that would potentially be affected by a decision here on the application of the all events test?
Mr. Lauber: Well, that could depend on how the decision was written.
This is an issue, as I mentioned to Justice Rehnquist, that's been around for a great number of years and there have been an awful lot of Court of Appeals cases that have construed the all events test as applied to accruals for Workmen's Compensation liabilities, tort claims, all kinds of things.
And the principle of what your need to have in fixed obligations to make a payment is very important in the tax law generally, and all these other obligations could be affected by it.
Now, Congress has amended the tax laws in 1984 to take care of some of those problems, Workmen's Compensation and the like, but generally speaking the old events test remains the basic judicial test that Congress has modified in some ways the years after '84.
So, the Court's decision would affect virtually all deductions claimed by accrual basis taxpayers.
Respondents' argument is that they should be allowed to accrue as a deduction for any year the net increase in the amounts shown on those jackpot meters for the year, as of midnight on the last day of their tax year.
That argument is based on the theory that it's very likely that somebody will eventually win the jackpot due to the laws of averages, and that when somebody does win the jackpot the amount they win will be at least as big as the amount on the year-end meter because Nevada regulations prohibit casinos from turning these meters back down to a lesser amount.
In analyzing this case we start from the premise that the type of liability presupposed by the all events test is not some kind of inchoate or abstract liability, but the obligation to make a payment.
This is what distinguishes the accrual method of accounting from the cash method.
Under the cash method an item is deductible when the taxpayer actually says the expense.
Under the accrual method, it is deductible when he incurs the obligation.
Unidentified Justice: Let me ask just one other preliminary question.
Would you not agree, and I know you would suggest it's not dispositive, but that sound accounting practices normally, for example, for disclosure for SEC purposes and the like would require setting up reserves for this kind of contingent liability?
Mr. Lauber: We agree with that.
In fact the accountants for the respondent required that a reserve be set up for these contingent liabilities at the end of the year, and they found that was consistent with generally accepted accounting principles, but this Court has often held, most recently in Thor Power Tool Company, and earlier in Triple-A, that the fact that a deduction, an accrual is proper for financial accounting purposes, is not dispositive for tax purposes because of very different objectives that the two accounting systems have.
In this case we think it is clear that respondent at the close of its tax year had incurred no obligation to pay the progressive jackpots to anyone.
Indeed, there is no one in the world who could at that moment assert any possible claim to those funds.
Unidentified Justice: Why should the identity of the eventual payee matter, as long as it's certain there will be a payee?
What difference does it make that you don't know specifically who, as long as you know someone will be getting it?
Mr. Lauber: Well, I would agree with the premise that the ultimate identity of the payee is not important.
But we think what precludes the deduction here is that nobody has won the jackpot.
It's not that someone has won and we don't know who.
Unidentified Justice: No, but you know that someone will, under the Nevada gaming regulations--
Mr. Lauber: --There is a probability that every time somebody pulls the machine programmed to pay off at one in 10,000, he has a one in 10,000 chance of winning.
That is true indefinitely into the future.
All we have here is a probability--
Unidentified Justice: --Well, Congress has made the very same kind of a determination in its treatment for insurance reserves.
There's a probability that we'll all die someday and they're going to let you set aside a certain portion of the premium.
Now, why isn't this essentially equivalent to that?
Mr. Lauber: --Well, I would agree it is quite similar in economic terms, but from a tax point of view they're very different because Congress has authorized insurance companies to set up these reserves for very sound reasons.
Congress has not authorized taxpayers to set up their own reserves for contingent liabilities based on mere probability of occurrence of these future events.
And that principle goes back to Justice Brandeis's opinion in Brown v. Helvering where the taxpayer was an insurance commission agent and he received insurance commissions.
And, he showed to the Court there was a great probability that he would have to refund large portions of those premiums in later years because of cancellations of the policies.
He showed that policies were always cancelled, every year.
The Court denied deduction for that reserve, pointing out the tax law requires not probabilities but certainties.
Unidentified Justice: Supposing, Mr. Lauber, that in this case it was demonstrated beyond peradventure, so to speak, on the basis of past performance how many people come in, what the machines are set for, but there was going to be a payoff, a certain number of payoffs on this jackpot within a given year.
Would your case be much different?
Mr. Lauber: I think it wouldn't really matter if the probability were based on the laws of averages, and the odds of winning, on past experience.
In either event our position would be that a mere projection that he likely will incur a liability is not sufficient to justify tax deduction.
Unidentified Justice: Supposing just hypothetically that the Government, surely mistakenly in your view, had stipulated in the trial court that it was certain that this thing would happen within the year.
Would you feel that you couldn't argue the same grounds then that you are arguing now?
Mr. Lauber: It certainly would happen within the next succeeding year?
Unidentified Justice: Yes.
Mr. Lauber: We would take the same position, Your Honor.
Unidentified Justice: What happens if you don't have a jackpot for two and a half years and then you close it up and throw that machine out?
Mr. Lauber: I think, Justice Marshall, that although the rules of the Commission, Gaming Commission, don't speak to this, there is a policy that they can't just retire a machine from service willy-nilly.
The have to transfer--
Unidentified Justice: What if it burns down?
Mr. Lauber: --Then they're off the hook, if it is stipulated--
Unidentified Justice: Then they don't pay any taxes at all?
Mr. Lauber: --Well, if they had deducted that amount in the year one, when they shut the casino down they might have to recognize income under the tax benefit rule when they got relieved of the obligation.
But you're right, you're absolutely right that they would be relieved of the obligation, and if they went into bankruptcy, that they've stopped being a gambling casino, people have stopped playing the slot machines, they would be off the hook.
Unidentified Justice: Mr. Lauber, it seems to me that the possibility that a corporation or a business will go out of business or go bankrupt or have a disaster is always present for any accrual based taxpayer, and that shouldn't defeat the accrual deduction.
It just strikes me as very extreme position to argue.
Mr. Lauber: --That isn't our position.
Our position is, what precludes a deduction is not the fact that they have a liability now, which might be... they might be divested of if they go out into bankruptcy or go out of business, or lose their license.
Our position is, they can't deduct it because they have no present liability to make a payment.
It's not that they have a liability that they might get out of.
Their obligation is to pay a jackpot, and they have no obligation to pay a jackpot until somebody wins the jackpot.
So, it's the fact that nobody... at the end of the year nobody could claim those jackpot funds.
They have not parted with anything.
And we think that all the Nevada regulatory scheme requires is that, in a casino, keep the machines in play indefinitely without reducing the meter so that future patrons will have the opportunity to win a jackpot.
But, the Commission's regulations don't require them to pay a jackpot until somebody wins the jackpot.
It is that winning of the jackpot which creates the liability to make a payment.
Until then, all the casino has is an inchoate obligation to keep the machines in play on the floor, pending people's future play and possible future winning of the jackpot.
But, that obligation keeps--
Unidentified Justice: As I understand it, they don't even have that obligation because they could decide to go out of business.
Mr. Lauber: --That's right.
That would be another contingency that could relieve them.
But we're not relying on that mere possibility of going bankrupt.
Unidentified Justice: Well, I'm not suggesting... or even bankrupt.
Well, are there other cases where... well, let's take the bankruptcy for a minute, where a business would go bankrupt and have... of course, if it had a liability, recognized in the bankruptcy proceeding and have to be paid off, which would not be true here, that are there situations where a bankruptcy would... you could satisfy the test even though at the time of bankruptcy there would be no liability at all, which is what I understand to be the case here.
Mr. Lauber: I don't think so, and that's a very good point.
Our position is not that they might go bankrupt, but if they did go bankrupt no one could even come into bankruptcy court and assert a claim for these items.
The items would not escheat to the State.
They would go right back to the casino, the part of the bankruptcy estate.
They would not go to the State of Nevada.
And we think that's right.
Since no one can make a claim for these funds in any tribunal at the end of the year, that shows there is no present obligation.
To put it simply, we think an obligation presupposes an obligor and an obligee.
But, there is no obligee at the end of the year.
Unidentified Justice: It seemed to me that the issue... and I don't know that the case is answered, is whether the liability is unconditional if it can be avoided by going out of business.
And, it would be avoided here by going out of business, as I understand.
Mr. Lauber: It would be.
That's another way of phrasing the issue, but you get into trouble because you don't want to argue that the possibility of going out of business prevents an accrual, because then no one could ever accrue anything.
Unidentified Justice: It wouldn't prevent an accrual if you had a liability?
Mr. Lauber: Right.
And we think, in fact, that the going out of business example is kind of evidentiary, that there is no year and liability, because if it did go out of business they would be off the hook.
Unidentified Justice: We don't have any real possibility of casinos going out of business or going bankrupt.
Mr. Lauber: Well, they could go bankrupt and they can lose their license.
Unidentified Justice: When last did you hear of one?
Mr. Lauber: I don't think they go bankrupt, but they do lose their licenses sometimes because--
Unidentified Justice: I suppose somebody could burn the place down.
That's happened to more than one place.
Mr. Lauber: --But the point about the Commission's regulations, the regulatory scheme respondent relies on, is that they don't require a jackpot to be paid until the jackpot is won.
Here is might be useful to compare what life was like in casinos before 1972 when this rule about not turning meters back was promulgated.
Before that time, respondents seemed to agree that they had merely a contingent liability that they could not deduct for tax purposes.
They are resting their case entirely on the '72 rule saying they can't turn the meters back.
Unidentified Justice: That's right.
Mr. Lauber: But in our view, that rule saying you can't turn the meters back doesn't have any effect at all on the contingent nature of that liability.
The liability remains before and after that rule was issued in '72 to pay a jackpot if and only if the jackpot is won.
All that rule about, turn the meters back, goes to... is the amount of the liability.
It enables the casino to estimate the minimum amount of its contingent liability because it knows it can't turn the meter back from the amount shown at midnight on the last day of the tax year.
Which means, if it ever does incur the liability, it will be in at least that minimum amount.
That rule does not affect the contingent nature of the pre-existing obligation the casino had to pay the jackpot if and only if somebody wins.
We think a good way of analyzing these progressive jackpots is that they are prizes offered to the public to induce people to gamble on the slot machines.
The Gaming Commission's rules basically require the casino to keep that offer open indefinitely.
It required that it make an irrevocable offer of a prize.
But, they don't require the casino to actually pay the prize until somebody wins it, so while the casino has an irrevocable offer, that offer is still... its liability on the offer is still contingent until some lucky patron in effect accepts the offer by satisfying the preconditions for payment, which is to gamble a required amount of money and to come up with the winning combination of symbols on the slot machine.
It has to be both the offer and the acceptance of the offer before you have an obligation to make a payment, and that's what the tax law requires.
We think it would be quite a different case if the Nevada gaming authorities required a casino to pay an amount corresponding to the year-end jackpot totals to an escrow agent, or to a trustee, to be held for the benefit of future jackpot winners.
In that event it would be an obligation to make a payment to an independent party who would hold the money for the beneficiaries, ultimate winners of the jackpots, with the money never being able to revert back to the casino.
It would also be very different if respondent, to insure its obligations on the jackpots, were to pay... take out insurance policies covering its contingent liability on the jackpots and paid a premium to an insurance company.
They could deduct that premium.
If they took out a bond to cover their obligation, they could deduct their bonding fee paid to the third party.
What they can't deduct is a reserve they set up on their own books.
They still have the money, still earn income on the money, on the mere theory they may ultimately have to pay that money to somebody else.
They haven't externalized their obligation.
They've kept it completely within-house.
Unidentified Justice: In that Code case though, that this thing arose from, where the American Code... where the question was the First World War tax liability, now they said you could accrue that.
Mr. Lauber: I think that was the Anderson case.
Unidentified Justice: Anderson, yes.
Mr. Lauber: That's--
Unidentified Justice: You have the Anderson case.
They said you could accrue that, and these people certainly haven't transferred anything on their books, I don't think.
Mr. Lauber: --Well, what the Anderson court held is that... there was a munitions tax which was payable on the manufacturing and sale of munitions during the year.
And what the court held there was because the manufacturer had by definition finished manufacturing and selling munitions for the year, a midnight on the last day of the year, all the events required to give it an obligation to pay the tax had arisen by the end of the year.
The mere fact the tax was actually paid in April the following year, the court held was not relevant.
Unidentified Justice: Then it must be that the transfer of money on your books... or from your books to somewhere else, is not one of the events?
Mr. Lauber: That's absolutely right.
Under the cash basis the actual transfer of money is the crucial thing, you have to actually make payment.
Unidentified Justice: But for accrual taxpayers, it surely doesn't make any difference that the taxpayer has the use of the money in the meantime?
Mr. Lauber: But they must have incurred an obligation to pay the money to somebody else.
That is the key thing.
But what must... all of the events must have occurred to give you an obligation to make the payment.
Unidentified Justice: But then, why could your example about the escrow make it all that much different?
Mr. Lauber: Because there it would be an obligation to make a payment to an escrow agent or to a trustee who would hold the money, never come back to you, is gone irrevocably, to hold the money and distribute it to the ultimate jackpot winners years down the road.
That would be an externalization, would have incurred the obligation to pay that money to an independent third party.
That, we think, is the kay thing that you have to have for an accrual for tax purposes.
Unidentified Justice: May I just ask a rather simplistic question, and probably never get a simplistic answer.
Let's assume a taxpayer who agreed at the end of the year that it owed me $1,000, and then assume further, I just disappeared somewhere and he never had a chance to pay me.
Would that liability have accrued?
Mr. Lauber: If the taxpayer had signed a contract obligating himself--
Unidentified Justice: Let's say it's a contract obligation.
Mr. Lauber: --It would be proper to accrue the liability, and if you vanished and he never had to say it, he would then have income in later years.
Unidentified Justice: What would be the tax consequences?
Would the taxes be paid on the basis of the year in which that liability accrued, or would it be paid in some future speculative year on the assumption that maybe I'd disappeared for--
Mr. Lauber: No, it would be in the year it happened.
For example, if somebody performed work for you and you agreed to pay that, the painter or the plumber, and you didn't pay them during the year but you are obligated to them, you are an accrual basis taxpayer.
Even if the plumber vanished and never got paid, you would get a deduction for a proper accrual in the year you incurred the obligation to pay him.
Unidentified Justice: --Where would I get the deduction?
When would the taxpayer get the deduction?
Mr. Lauber: The year in which you incurred the obligation to pay--
Unidentified Justice: But is there any question about the fact that the obligation on accrued by the end of the year, in this case?
Mr. Lauber: --We think it has not, because the obligation issue is the obligation to make a payment of a jackpot and nobody has any claim to a jackpot until they win it.
I mean, your example, Justice Powell, the painter paints your house, he has a claim to payment because he painted your house.
Here, no one has any claim to this money until they win the jackpot.
That's the crucial difference.
Unidentified Justice: But so far as the casino is concerned, it owes that money to whoever identifies himself or herself at some later date.
Mr. Lauber: It owes the money to somebody who succeeds in winning the jackpot.
If people stop playing the machines the next day, it doesn't owe a penny to anyone.
What if people Just gave up gambling, some kind of new amendment that made gambling unconstitutional, they'd never owe the money to anyone.
Unidentified Justice: --I sort of like my example of disappearing.
Normally, of course, you take a deduction the same year you have the income, in other words, you charge your expenses against the income.
Mr. Lauber: That is what is a normal rule for financial accounting.
Unidentified Justice: How does the government benefit from your position?
Mr. Lauber: Well, where we benefit is that the deduction that they wish to have is deferred until they pay the jackpot, maybe three or four years away, and because the deduction today is worth more for the tax period than a deduction five years from now.
Unidentified Justice: So, the government gets the use of the money until--
Mr. Lauber: Exactly right.
That's always the issue in all events tax cases, because... which is always a proper time for taking deductions.
So, all these cases always involve the time value of money.
Taxpayers want to get deductions in year one, we want them to have deductions in year ten.
Unidentified Justice: --But if in a future year the taxpayer has no money, it loses the benefit of the liability?
Mr. Lauber: I'm sorry, I missed that question.
Unidentified Justice: Some year an individual will come along and pull a jackpot.
Then that year happened to be a year in which the casino lost money.
Mr. Lauber: It would have--
Unidentified Justice: It wouldn't have any income to charge it off against.
Mr. Lauber: --I think with the... it could have a loss that year which you could then carry back ten years and carry forward.
You must remember that casinos have dozens and dozens of these machines on the floor and they all tend... some are paying off this year, some are paying off next year, and they result in a fairly constant flow of income and expense to the casino.
It's not like they have a cataclysmic event in one year that destroys them.
There are always other machines that are not paying off at that time.
So, the likelihood of a casino having to pay a jackpot and not being able to get a tax benefit from it is extremely unlikely, because they can carry forward and back their tax losses.
We think that what respondent's position boils down to is the argument that they have a probability of incurring a liability in the future to Day these jackpots.
That should be sufficient to justify a deduction for tax purposes.
But this Court has rejected that argument repeatedly over a 50-year period.
Brown versus Helvering, as I mentioned before, the taxpayer argued there was a probability it would have to make refunds of a certain portion of the insurance premiums, but the Court rejected that argument.
Chief Justice Burger: Mr. Lilienstern.
ORAL ARGUMENT OF O. CLAYTON LILIENSTERN ON BEHALF OF THE RESPONDENT
Mr. Lilienstern: Mr. Chief Justice, and may it please the Court:
There is one additional requirement which is necessary in order for us to accrue the deduction which we seek to accrue in this case, and that is that, quite apart from the all events test, the accrual must result in a clear reflection of income.
That relates, we believe, to some of the questions that were, asked about the period of time between the accrual and the payoff.
The record of the case indicates that that period of time was four and a half months.
We're saying this because there are other cases, generally from the lower courts, in which the period of time between the accrual and the payoff could be perhaps as much as 20 years.
Those cases, we suggest, don't deal with the notion of the all events test, which is what we are talking about here today.
They deal with the concept of the clear reflection of income.
Unidentified Justice: What kind of transactions would these 20-year deferrals be?
Mr. Lilienstern: I beg your pardon?
Unidentified Justice: What kind of transactions would these--
Mr. Lilienstern: Well, one example, there's a Mooney Aircraft case in which an aircraft manufacturer gave a bond at the time it sold a plane which was to mature at the time the plane was retired from service.
The estimate was that the average life of these aircraft would be 20 to 30 years.
The Court, in the Mooney Aircraft case, the Fifth Circuit, held the all events test is satisfied because there is an irrevocable obligation in the year the bond was given, but under Section 446(b) of the Code, there was no clear reflection of income.
Unidentified Justice: --That isn't a very common transaction, is it?
Mr. Lilienstern: No, Your Honor.
It is not common.
That is not common.
As a matter of fact, in our case here the government... neither the government, nor have any of the lower courts suggested that our transaction, the way we accrue it, given the period of time between payoffs, is other than a clear reflection of income.
Unidentified Justice: Is that money that's taken from these machines every night, is that put in the pool with all the other money, or is that segregated?
Mr. Lilienstern: Well, Justice Marshall, for the years in question here, 1973 to 1977, there was no identifiable fund.
In 1979 the Nevada Gaming Commission passed a regulation which required that that he maintained in an identifiable form, in cash equivalency.
We think, however, that that regulation doesn't really bear on the issue of our liability here.
We say that under the regulation, and in fact Justice Rehnquist suggested something about a stipulation the court below... in the claims court the Government stipulated... this case is here on Cross Motions for Summary Judgment.
In the claims court the government stipulated that upon the adoption of Nevada Gaming Regulation 5-110, which is the one that is cited throughout our briefs, the liability became fixed.
This is contained in the Joint Appendix.
The government's Motion for Summary Judgment attaches in support the affidavit of its counsel in the claims court, and the exhibit to that affidavit.
That exhibit was our pretrial submission in the claims court.
And, one contention of fact by us which was adopted by them, because all of these facts were stipulated, one contention was that once the increased jackpot amount is displayed on the machine, the increased jackpot amount becomes a fixed liability which cannot be avoided.
Unidentified Justice: Where do we find that?
Mr. Lilienstern: Your Honor, that is at pages 15 and 16 of the Joint Appendix, the Motion of the United States for Summary Judgment on page 15, the affidavit of counsel on page 16.
Then our pretrial submission is attached to that.
The actual language read appears at page 42 of the exhibit.
Now, in the courts below the government took the position, somewhat like the question concerning bankruptcy.
They took the position that, look, even if you accrue this liability--
Unidentified Justice: Before you leave that, I want to be sure I follow you.
Mr. Lilienstern: --Yes, Your Honor.
Unidentified Justice: You referred as to page 42 which is Plaintiff's Memorandum of Contentions of Fact and Law, Contentions of Fact... this is a government document, is it?
Mr. Lilienstern: Your Honor, no.
It is our document which was incorporated by reference in the affidavit, the only affidavit they had in support of their motion for summary judgment in the claims court.
If you look at page 15, the affidavit of counsel in the claims court is there.
"The Affidavit of David C. Hickman. "
in the exhibit there too.
Unidentified Justice: So, that the defendant relies on that?
Mr. Lilienstern: Yes, Your Honor.
Unidentified Justice: And that's the government's--
Mr. Lilienstern: Yes, Your Honor.
I mean, there was really no dispute.
We were attempting to stipulate facts, and there seemed to be at that time no dispute as to this issue.
In the lower courts the government made an assertion that it no longer--
Unidentified Justice: --But it says it's a fixed liability which cannot be avoided.
That simply isn't correct, because if you went out of business it would be avoided.
Mr. Lilienstern: --Well, Your Honor--
Unidentified Justice: Isn't that right?
Mr. Lilienstern: --No... well, it is a fixed liability as of the time it's accrued.
Now, there's a body of case law, as Justice O'Connor said, any--
Unidentified Justice: Stick to my question.
Mr. Lilienstern: --Yes, Your Honor.
Unidentified Justice: If you went out of business, say the place burned down and you totally terminated business, would the liability have to be paid or not?
Mr. Lilienstern: The liability would not have to be paid but the tax benefit rule would require that--
Unidentified Justice: That's quite a different point.
Mr. Lilienstern: --Yes, Your Honor.
Unidentified Justice: So, it is not correct that there is a fixed liability which cannot be avoided.
It would be avoided by going out of business.
Mr. Lilienstern: Well, Your Honor, for purposes of the all events test, we say... in fact, the government... and this Court conceded in its reply memo that contention of events like that, remote, speculative events are not to be considered in determining the snapshop issue of whether or not there's a fixed liability.
I don't believe they disagree with us on that, Your Honor.
I think they would concede that.
In fact, they have conceded--
Justice Stevens: They may not disagree with you, but you have just acknowledged to me that it is not correct, that this is a fixed liability which cannot be avoided, because it would be avoided by going out of business.
Mr. Lilienstern: Well, we put summary judgment evidence into the record, Your Honor, concerning the revenues of the casino.
We had affidavits to the effect that these are ongoing operations and are not likely to go out of business.
As the case reaches this Court, that's unrefuted.
I will concede that if we want to speculate, these casinos or really any other business could theoretically avoid liabilities by going out of business.
Unidentified Justice: Well, can you give me another example of a proper accrual under the all events test in which the liability would be avoided by going out of business or going into bankruptcy?
I'm not saying, not have to pay the liability, but the existence of the liability would he terminated by terminating the business.
Mr. Lilienstern: Your Honor, I'm not saying that the existence of the liability would be terminated.
I'm saying that the requirement that it be sayable would be terminated.
Unidentified Justice: If you went out of business, to whom would the liability be owed?
Mr. Lilienstern: If you go out of business the liability will not he paid to anyone.
Unidentified Justice: To whom would it be owed?
Mr. Lilienstern: At the time it's accrued, it is owed to a player.
If you go out of business before the jackpot is won, it will not be said to the player.
Unidentified Justice: Would it be owed to anyone at the time you went out of business?
Mr. Lilienstern: At the time you went out of business, no, Your Honor.
The regulations, Justice Stevens, which we say fixes our liability, effectively precludes us from taking any voluntary action which would result in our failing to pay the liability when it's accrued.
And we say that out of the all events test, that's really the test, want to insure that when individuals or entities take these deductions that there's a degree of certainty that they will be paid.
In fact, the evidence in this case shows that all of the accrued Liabilities were in fact paid.
That remote contingency, I suggest, would exist in any situation, and any accrual basis taxpayer could be saddled with that.
Unidentified Justice: But you say, in any situation.
But I asked you if you could Give me a case in which the all events test was satisfied, even though the taxpayer could have avoided the creation of the liability by terminating voluntarily his business entirely, and I haven't heard you cite a case.
Mr. Lilienstern: If his assets are... if he is in bankruptcy and if his assets are insufficient to satisfy... if it's a contractual liability--
Unidentified Justice: I'm not talking about satisfying the liability.
I'm talking about whether there would be a liability on the statement of assets and liabilities filed in the bankruptcy court, or whatever it might be.
If he burns down his business voluntarily, says,
"I want to retire, I'm 85 years old, I don't want to run a gambling place any more. "
He burns down his business.
In that situation is there any case... and he has no liability when he does it... is there any case you can cite me which says that the all events test is satisfied?
Mr. Lilienstern: --But, Your Honor, I am afraid I must disagree with your premise, and that is, you said there is no liability when he does it.
We say there is this liability that is imposed by state law.
I think your question goes to what we interpret the government's argument as being, that is, the only sort of liability which would satisfy the all events test is a bilateral contractual obligation.
We say that's not so, because the all events test doesn't require that.
The government is really trying to add to the existing all events test the notion that the obligation must be payable.
Now, in U.S. v. Anderson, the first case, the obligation there was not payable at the time the accrual was taken.
This was an excise tax case on munitions.
The taxpayer sought to deduct the excise tax in the year following the manufacture and sale.
In 1916 the munitions were manufactured and sold.
The tax was not due until it was assessed the following year.
The taxpayer took the position that the government is taking here.
It said, wait, until this is payable by the assessment, the tax is not going... cannot be accrued.
The tax is not yet due.
The government took the position in Anderson that we're taking here, and said the liability exists at the and of the manufacturing and sale, similar to the end of our tax year here by the operation of the machines.
Because at that point, all events necessary to fix the liability had occurred.
The government is trying to turn that around and say in our situation, we must impose on the all events test the additional requirement of payability, and that that payability would exist at the time a customer pulls the winning handle of the slot machine.
So, we say that we are on all fours with the Anderson case, and that to adopt the government's position would really reconstruct Anderson in a different way than it's existed on the books since 1926.
As to the question of how other... so-called regular slot machines are treated, let me see if I can illustrate our liability argument in that way.
The only reason we say we're able to accrue the liability for the progressive slot machines is because of the existence of the Nevada regulation, statutes and policies which are discussed in our briefs.
Those pertain only to the progressive slot machines.
We also have summary judgment evidence in the form of affidavits that the reason for the existence of those regulations is that because the jackpot amount increases with each play on all the casino customers, that the Commission views that as being an investment, if you will, by the players in the jackpot amounts.
Regular slot machines don't have any such regulations.
We would say, as to the regular slot machines, we're not entitled to and we do not accrue those liabilities.
Those could be taken off the floor at any time.
Those could be removed, and any jackpots on regular nonprogressive machines could be taken off at any time, but we're not permitted under the regulations to remove the progressive slot machines.
Once they're on the casino floor and are put into play, they must stay there until they're won.
Now, in this case we're not trying to anticipate and to accrue as an expense the amount of the eventual payout.
We are simply taxing the amount which exists or the machine at the end of our fiscal year.
The winning of the jackpot is the equivalent, we believe, of the assessment of the tax in Anderson.
The winning of a jackpot doesn't fix the liability.
It does identify a payee, but the record... and our briefs are replete with cases which indicate that you don't really have to be able to identify a payee.
We know that there will be a payee.
We don't have to identify that payee by name.
The economic and the practical effect of the regulation is that we're going to have to pay that jackpot, and in fact the record indicates that we did pay all of these progressive jackpots.
What the government is trying to do, we believe, is to impose some of the requirements which were established in the 1984 legislation, which is the referred to as the Tax Reform Act of 1984 on the one hand, or the Tax Deficit Act of 1984 on the other, which established in addition to the existing law and regulations on the all events, test, it established a principle of economic performance.
We believe the government is trying to... is asking this Court to judicially legislate in this case a principle that is the practical equivalent of the economic performance of the 1984 legislation which is applicable only to deductions that occur after July of 1984.
There is, however, a--
Unidentified Justice: Suppose an accrual basis taxpayer signs a promissory note that, in one year that's payable, six months later in another year.
Does he accrue that, the first year?
Mr. Lilienstern: --If that's an enforceable obligation in year one, he may accrue that.
Unidentified Justice: Well, what if at the time the payment comes along and he claims that it was a fraud, and it's determined that he never did owe the money, he's relieved of his obligation?
Mr. Lilienstern: In the second year the tax benefit rule, I believe, would require that he would take any income that--
Unidentified Justice: What it means is that it is void ab initio, he never had an obligation?
Mr. Lilienstern: --Well, I'm responding to how the Internal Revenue Service would construe it.
Unidentified Justice: Well, I know, but I would think in that case, and according to their argument, that you would never be able to accrue that liability because of the possibility that it might be a fraudulent transaction and he never had an obligation.
Mr. Lilienstern: Well, as I said earlier--
Unidentified Justice: Wouldn't that be their argument?
Mr. Lilienstern: --I'm not sure, Your Honor.
I wouldn't want to speak for them.
But the law is absolutely clear that these remote contingencies such as bankruptcy or a defense for promissory note, those are not sufficient to destroy accrual at the time the accrual is taken.
Unidentified Justice: Well, there's another one.
What happens if the machine breaks completely, I mean, just breaks down and has to be replaced?
Mr. Lilienstern: All right.
If the machine breaks down, under the regulations and policy the machine can be taken off the floor for a brief period of time and repaired.
Unidentified Justice: That's not my question.
It's broken permanently.
Mr. Lilienstern: All right.
Then the amount of that jackpot must be added to another machine.
If it has $100 on it, that $100 must be put on an adjacent machine to give a total of $200.
The liability must remain on the machines, on the floor.
Unidentified Justice: How could someone determine that that is carried out?
Who determines that they do make the transfer?
Mr. Lilienstern: Your Honor, the Nevada gambling industry is one of the most highly regulated industries in this country.
The affidavit of Mr. Griffith in the Joint Appendix indicates that they count the jackpots twice a day.
They have to file reports with the Gaming Commission, I believe weekly.
It's very highly regulated, for two reasons.
One, of course, in any industry where there's a lot of cash exchanging hands, it's to everyone's benefit to have it highly regulated.
But in the case of progressive slot machines, as I alluded to earlier, there is a notion... there is an investment concept here.
Since players are putting their money in, and increasing the amount of the jackpot, the Commission wants to insure that those jackpot totals remain available for players to win on the floor.
So, I think there's no question about that, Mr. Chief Justice, that it's highly regulated and that that duty imposed by the Nevada Gaming Commission is complied with.
The government relies on the Nightingale case.
It's a Ninth Circuit case that preceded ours.
It's, in all its material respects, like ours factually.
Nightingale cited a number of cases including this Court's Brown versus Helvering opinion, which involved cancellation of... accruing of liabilities for anticipated insurance policy cancellations.
In that case, we simply say there's no fixed liability.
There is no way to determine in that case whether indeed, based on estimates or otherwise, the policies would in fact be cancelled.
In our case we don't rely on estimates.
We have the amount we say we can accrue, on the machines.
It's referred to as a meter but it's really a large display meter.
That is the amount of the progressive jackpot which must be maintained in play and which the evidence shows will be paid out on the average of four and a half months.
Once the machine is in play--
Unidentified Justice: I don't know that your case is so much different than Brown on that percentage, because they have a stipulated percentage in Brown of 23 percent on the basis of past experience.
And, isn't that pretty much what your probability is?
Mr. Lilienstern: --Well, Justice Rehnquist, our probability is 100 percent of the amount shown.
We don't rely on estimates.
We know that we are going to pay the total of all the amounts reflected at the end of the fiscal year.
Unidentified Justice: But it's an estimate as to when you will pay them?
Mr. Lilienstern: Well, we don't estimate when we're going to pay it.
No, the four and a half months is a retrospective average.
That was a computation made, and is in the Summary Judgment--
Unidentified Justice: Well, but supposing it came out that the retrospective calculation showed 14 months.
Certainly, you couldn't deduct it in the next year.
Mr. Lilienstern: --No, Your Honor.
You deduct it in year one.
You accrue it in year one.
Unidentified Justice: Well, supposing this thing had showed 26 months.
Could you still have deducted it?
Mr. Lilienstern: You deduct it in year one.
Now, the greater--
Unidentified Justice: But only the amount that's shown at the end of year one?
Mr. Lilienstern: --Only the amount shown at the end of year one, that's correct, Justice Rehnquist.
In other words, at the end of year one if it shows $100, at the end of your fiscal year, you accrue $100.
By the time it pays off it might have gone to $400 and you will in fact pay the $400.
We're not trying to deduct that $400.
We're accruing only the amount that exists at the end of our fiscal year.
And, as the period of time goes into the future, we recognize... not in this case but we recognize in other situations, there may well be the problem of a clear reflection of income.
And the 1984 legislation is in part at least designed to impose an additional requirement to the all events test which would prevent the accrual of these liabilities when the period of time into the future is very great.
There is an exception to that, which is the recurring item exception, which imposes an eight an a half month period, and we believe we would be fully satisfied in that case.
Unidentified Justice: Mr. Lilienstern, as I understand it the Internal Revenue Service has regulatory authority to determine whether the accrual of counting system is properly reflecting income.
Mr. Lilienstern: That's correct, Justice O'Connor.
Unidentified Justice: How does that authority fit into this question?
Mr. Lilienstern: --Well, in our case they have not challenged that our accrual clearly reflects income.
That really is not an issue here.
The Commissioner, however, does the authority under Section 446(b) to in effect disallow an accounting system if he determines that it does not clearly reflect income.
But that... that authority combined with the '84 legislation has really given the Internal Revenue Service some new teeth, we think.
We don't know how the basic legislation there would apply to us.
It talks in terms of property.
There is a suggestion that money is not property, and we really don't know pending the promulgation of regulations where we're going to come out on that, but we... and it's really not involved in this case, but it seems clear to us that we're talking about the exception, which means we would be permitted to continue to accrue the progressive slot machine liabilities.
In its reply brief the government gave an example of a golf tournament, an irrevocable pledge in year one by a company to sponsor golf tournaments, perhaps as long as ten years in the future.
We believe that if the obligation is irrevocable and the tax... the all events test is satisfied.
Again, though, the longer you go into the future, the more likely it is there could be a problem with clear reflection of income.
But just to set us where we stand, from their example and their brief, we believe that... and the example in which the payments of the golf tournaments could extend ten years into the future, we believe there that the all events test was satisfied but that the taxpayer there might well have an additional problem.
The reason... really the reason for the all events test is to insure that taxpayers won't obtain deductions for expenditures that might not ever occur, and we think we satisfy that, and we don't just mean you have to look retrospectively in order to see that we did pay all of those amounts that were accrued.
We think we satisfied, because the sanction that can be imposed on a casino if it doesn't pay the amounts on its progressive slot machines are far out of proportion to the amount in controversy in this case.
A casino can lose its license.
It can be fined up to $250,000.
It is this notion of state law and the--
Unidentified Justice: Well, what if a casino does lose its license for some other transgression?
What about this supposed liability?
Mr. Lilienstern: --If the casino is sold, it is the policy of the Gaming Commission... that's typically what happens.
One entity will lose the license.
They don't board the casino up.
Someone else comes in and assumes the license.
So, it's... to my knowledge it's always an instance in which the license is transferred.
Unidentified Justice: And then what happens?
Mr. Lilienstern: If it's transferred, either the Jackpots must be paid prior to the transfer, which it sounds like in your example it would not be, or they must be assumed by the purchaser of the casino.
They are not extinguished.
Unidentified Justice: But... this may never happen, but if a casino just decided... a corporate entity owning a casino just wanted to liquidate and they just decided to sell all assets and liquidate, what about the machines?
Mr. Lilienstern: And there's no surviving entity?
Well, in that situation, Judge--
Unidentified Justice: Say they put the machines right on the auction block and they're bought.
Does anybody then assume the liability on that machine?
Mr. Lilienstern: --The liabilities are not assumed on these machines, and the tax consequences would be, of course, as earlier described, they would take into income in the year of sale any amounts previously deducted.
We tried to refute that argument--
Unidentified Justice: Well, what if a casino buys a bunch of slot machines and they don't pay for them.
They're going to... they have an installment payment contract and they default, and then purchaser... or the seller just comes along and repossesses them?
Mr. Lilienstern: --So that you can no longer have them in play?
Unidentified Justice: Yes.
Mr. Lilienstern: Well, there's no remedy available.
Unidentified Justice: Well, there's no... there's certainly... why should you accrue in those situations?
Mr. Lilienstern: Because, Justice White--
Unidentified Justice: I mean, just--
Mr. Lilienstern: --The all events test and the fixing of liability is not dependent on the kind of remote contingency you just described.
Unidentified Justice: --Well, the liability, as Justice Stevens pointed out to you, what's really contingent is the liability.
Mr. Lilienstern: Well, Your Honor, the liability is fixed.
Now, it may be avoided.
You may avoid paying the liability.
That is my analysis.
The liability is fixed but payment for that liability--
Unidentified Justice: You think it's fixed because the state law says that, look, George, you must accrue this money and pay it out if and when somebody ever wins it?
Mr. Lilienstern: --And you may not remove your machines and you may not sell your casino and avoid the liabilities.
Unidentified Justice: If certain events happen, nobody is ever going to win it.
Mr. Lilienstern: That's right, but that affects the payment rather than the imposition of the liability, under our view of the case.
Unidentified Justice: Well, it affects... surely it affects both?
Mr. Lilienstern: Well, again, if a company goes into bankruptcy and has insufficient assets to pay its liabilities, it's in no different situation than we are there.
Unidentified Justice: Well, except that you... except your statement shows that it is.
You say, pay your liabilities.
Mr. Lilienstern: It they can't pay them.
We... in your example the jackpots are not paid to people who win them.
In the situation in which the company goes into bankruptcy and doesn't have the money, these are not paid to the persons to whom they--
Unidentified Justice: But everybody agrees there was a liability?
Mr. Lilienstern: --But everybody agrees there's a liability.
Unidentified Justice: Well, not here.
Mr. Lilienstern: Well, no.
Unidentified Justice: That's the question in the case.
Mr. Lilienstern: I understand, Your Honor.
There are other cases in which state law applies liabilities.
There's a whole series of coal mining, strip mining cases.
The liability there is imposed not by bilateral contract, but it's imposed by state law which requires that once strip mining has occurred, the mined area must be backfilled.
That's exactly what we have here, it's imposed by state law.
If the coal companies... and there's a whole line of cases that supports our view on that... if the coal companies go out of business before backfilling those, there's no--
Unidentified Justice: So, a casino operator could say,
"I'm just dissatisfied with these newfangled progressive slot machines. "
"I just want to get rid of them and go back to the old style. "
And he goes to his next-door neighbor,
"Would you like to buy my progressive slot machines? "
And the fellow says,
"Yes, I like these devices. "
And so they just sell them.
Mr. Lilienstern: --A casino operator will probably lose his license and be fined up to $250,000.
Unidentified Justice: I know, but he wouldn't be liable.
He wouldn't have to pay that.
Mr. Lilienstern: Well--
Unidentified Justice: He wouldn't have to pay the accrual.
Mr. Lilienstern: --We have addressed that, Your Honor, by showing how the progressive slot machine productions are immaterial compared to the total wealth of... and revenues of the casino.
They're not going to shut down their casinos in order to save $433,000 over four years.
Unidentified Justice: I agree with that, but I can imagine that they'd want to sell their slot machines.
If they sold them to an operator in New Jersey, what liability would remain if they took their--
Mr. Lilienstern: Before they take the machines off the floor, they must address the issue of payment.
They must have a free-for all one day and insure that all those progressive slot machine jackpots are paid prior to disposing of them, Justice Stevens.
Unidentified Justice: --They couldn't sell them to a casino in New Jersey?
Mr. Lilienstern: Not without first discharging the jackpot liability.
Unidentified Justice: Well, how would you find out who's going to win?
Mr. Lilienstern: I beg your pardon, Justice Marshall?
Unidentified Justice: How are you going to find out who's going to win?
You said you have to pay off.
Who do you pay it to?
Mr. Lilienstern: You mean, once someone has won it?
You know that--
Unidentified Justice: No, nobody has won.
Mr. Lilienstern: --Oh, you have to keep them in play until they're won.
Unidentified Justice: I thought you said that they can sell them to Atlantic City?
Mr. Lilienstern: That's correct, Justice Marshall, but--
Unidentified Justice: What do they do then on their federal taxes?
Mr. Lilienstern: --If they sell them to Atlantic City before delivering them to Atlantic City, they must first make provision for paying those progressive jackpots to their customers in Las Vegas.
Unidentified Justice: How are they going to do that?
Mr. Lilienstern: Keep them in play until they're won, Justice Marshall.
You can't... in other words, you cannot sell them and deliver them tomorrow.
You must discharge that liability first.
Chief Justice Burger: Thank you, gentlemen.
The case is submitted.