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Callanan Road Improvement Co. v. United States

decided: December 11, 1968.


Friendly, Anderson and Feinberg, Circuit Judges.

Author: Feinberg

FEINBERG, Circuit Judge:

This case involves the interaction of various provisions of the Internal Revenue Codes of 1939 and 1954 which govern loss carryover deductions. In 1958, taxpayer Callanan Road Improvement Company sued in the United States District Court for the Northern District of New York for a refund of income taxes paid in the years 1951 through 1954. Over time, every issue in suit was settled except one: whether taxpayer could properly apply $158,000 of a loss carry-over deduction to the taxable year 1954. Chief Judge James T. Foley held that it could not and granted summary judgment for the United States. 279 F. Supp. 481 (N.D.N.Y.1968). For reasons given below, we affirm.

The relevant facts are not in dispute. In a short taxable year in 1955, taxpayer claimed a net operating loss of approximately $309,000. Under section 172 of the Internal Revenue Code of 1954 that loss could be used as a deduction against income in other years. As required, taxpayer first carried the loss back to 1953 to obtain a refund of taxes paid on its $48,000 taxable income for that year. Applying section 172, taxpayer then computed its loss carryover to 1954 by subtracting its 1953 taxable income from the 1955 loss, leaving it with $261,000 to use as a deduction from its 1954 taxable income.*fn1 The Government, however, did not accept these figures. It maintained that the amount of the loss carried forward from 1953 to 1954 had to be computed under the Internal Revenue Code of 1939, which would further reduce the loss carryover by $158,000 -- the excess of taxpayer's 1953 percentage depletion over its actual cost depletion.*fn2

Underlying the controversy is a fundamental change in the treatment of loss carryovers between the 1939 and 1954 Codes. Loss carryovers are designed to enable a taxpayer with fluctuating gains and losses to achieve a rough average of income and resulting taxes by deducting losses sustained in loss years from income in gain years. Under the 1939 Code, however, the loss carryover provisions embodied the concept of "economic income" -- a principle largely discarded by the 1954 Code.*fn3 Economic income took into account whether a taxpayer's actual income contained nontaxable items or had been artificially reduced. For example, because a percentage depletion is not an actual economic expenditure, the excess of a percentage depletion deduction over cost or actual depletion, such as the $158,000 in this case, was considered to be economic income. To appreciate the impact of the change in philosophy between the 1939 and 1954 Codes, it is necessary to understand that use of a loss carryover may involve the determination of income (or loss) in a number of years; e. g., there must be calculation of the loss in a particular year, application of that loss to the income of another year, and then, if any loss remains, determination of how much of it can be applied in still another year. Under the economic income concept of the 1939 Code, a taxpayer's economic (or real) income was relevant at each of these steps. Thus, before a loss from one year could be applied beneficially to taxable income of another year, it first had to be set off against such nontaxable items of economic income in the second year as the $158,000 at issue here. Under the 1954 Code, however, this is not necessary. Since this case involves carryback to 1953 of a loss incurred in 1955, and then a carry forward to 1954, it highlights the change in the loss carry-over rules. 1953 is a 1939 Code year; 1954 and 1955 are 1954 Code years. The question is whether on these facts the amount of loss absorbed in 1953 is governed by 1939 Code principles or by those of the 1954 Code. If the former apply, then no part of the $158,000 of loss in dispute remains to be used.

As so often occurs in tax cases, the question is narrow and close, and the relevant sections of the Code seem designed, like a doctor's prescription, to be read only by the initiated. The Government relies heavily on section 172(e) of the 1954 Code, quoted in full in the margin,*fn4 which states that in determining a loss carryover "to any taxable year, the necessary computations involving any other taxable year shall be made under the law applicable to such other taxable year." According to the Government, taxpayer's challenged loss carryover to "any taxable year" is to 1954, the "other taxable year" involved is 1953, and the "necessary computations" involving 1953 must be made under the 1939 Code,*fn5 the law ordinarily "applicable" to that year. And the force of section 172(e) is emphasized by the command that its general formula be followed whether the taxable years "begin before, on, or after January 1, 1954." The argument is strong, particularly since taxpayer recognizes that the principles of section 172(e) are relevant here. For example, taxpayer's 1955 loss is determined under the 1954 Code, even though it is then carried back to 1953, a 1939 Code year. In addition, taxpayer agrees that the amount of its loss carryover deduction in the year 1953 is determined by the economic income concepts of the 1939 Code. See, e. g., American Bank & Trust Co. v. United States, 333 F.2d 416 (5th Cir. 1964); Herbert J. Kent, 35 T.C. 30 (1960). However, taxpayer urges that whatever section 172(e) tells us about use of the loss in 1953, it does not instruct us on how much loss remains for application in 1954.

It is also persuasive for the Government that taxpayer in essence seeks a double deduction. Because loss carrybacks under the 1939 Code are first set off against economic but untaxed income, taxpayer would not be entitled to a deduction for 1953 (and consequent refund for taxes already paid) had the loss carryback from 1955 not exceeded taxpayer's 1953 excess of percentage over cost depletion allowance ($158,000). Thus, in 1953, taxpayer had to utilize $158,000 of the 1955 loss to get a refund for 1953 on the taxes paid on its $48,000 income for that year. If taxpayer can again apply that $158,000 of the 1955 loss to 1954, it is using the same loss twice. Finally, the Government relies upon long standing administrative regulations supporting its view,*fn6 which are, of course, entitled to weight. See, e.g., United States v. Correll, 389 U.S. 299, 305-306, 88 S. Ct. 445, 19 L. Ed. 2d 537 (1967).

For its part, taxpayer argues that use of a loss incurred in 1955, a 1954 Code year, in another 1954 Code year (1954) should not be affected by the 1939 Code economic income concept merely because the loss first had to be carried back to 1953, a 1939 Code year. Taxpayer relies on section 172(b) (2) of the 1954 Code which provides (with explanatory material inserted) that

the entire amount of the net operating loss [$309,000] for any taxable year [1955] * * * shall be carried to the earliest of the 7 taxable years [1953] to which * * * such loss may be carried. The portion of such loss which shall be carried to each of the other 6 taxable years [here only 1954] shall be the excess [$261,000], if any, of the amount of such loss [$309,000] over the sum of the taxable income [$48,000] for each of the prior taxable years [1953] to which such loss may be carried. [Emphasis added.]*fn7

There is no doubt that if section 172(b) (2) stood alone, its specific direction to look only to the "taxable income," rather than the economic income, of the prior year in which the loss was used would carry the day. But taxpayer is not in that happy position. Section 172(b) (2) does not stand isolated; it is part of a complete section which is headed "Net Operating Loss Deduction" and contains other provisions, including section 172 (e), quoted and discussed above. To this, taxpayer has a double response: Section 172(e) is ambiguous and therefore overborne by the specifics of section 172(b) (2); and, in any event, Congress did not intend section 172(e) to modify section 172(b) (2).

In support of the former argument, taxpayer cites United States v. Whitney Land Co., 324 F.2d 33 (8th Cir. 1963), which did adopt the position taxpayer urges. Indeed, the court there went further and found, id. at 37, that

the clause "the necessary computations involving any other taxable year shall be made under the law applicable to such other taxable year" means only that the net operating loss shall be determined under the law applicable to the loss year, * * *

and concluded that section 172(e) was

not intended to deal with the absorption of losses that may be ...

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