1996 U.S. Tax Ct. LEXIS 42">*42 Orders will be issued denying petitioners' motions for partial summary judgment.
Ps had net operating losses for tax years 1989 to 1992 from deductible expenses they incurred to comply with various requirements of Federal law; i.e., the Internal Revenue Code, the 1934 Securities and Exchange Act, and the Employee Retirement Income Security Act of 1974.
Net operating losses generally may be carried back 3 years.
107 T.C. 177">*177 OPINION
COLVIN,
Respondent determined the following deficiencies in petitioners' Federal income tax:
| Petitioner | Year Ending | Deficiency |
| Sealy Corp. | Nov. 30, 1983 | $ 225,754.00 |
| Sealy Corp. | Nov. 30, 1984 | 648,717.48 |
| Ohio Mattress Co. | Dec. 30, 1984 | 3,630,737.24 |
| Sealy Corp. | Nov. 30, 1985 | 64,678.74 |
| Ohio Mattress Co. | Dec. 31, 1985 | 49,863.34 |
| Sealy Corp. | Nov. 30, 1986 | 6,816,632.00 |
| Ohio Mattress Co. | Dec. 30, 1986 | 447,617.00 |
| Sealy Corp. | Nov. 30, 1988 | 13,115,655.00 |
1996 U.S. Tax Ct. LEXIS 42">*45 Petitioners seek a partial summary judgment relating to their net operating loss carrybacks. They contend that $ 2,447,933 of expenses they incurred from 1989 to 1992 is specified liability losses under
A motion for summary judgment or partial summary judgment may be granted if there is no genuine issue of material fact and the decision can be rendered as a matter of law.
Unless otherwise indicated, section references are to the Internal Revenue Code in effect for the years at issue. Rule references are to the Tax Court Rules of Practice and Procedure.
A.
1996 U.S. Tax Ct. LEXIS 42">*46 Petitioners are corporations the principal places of business of which were in Seattle, Washington, when the petitions were filed.
Petitioners used the accrual method of accounting and reported their income on fiscal years ending November 30.
107 T.C. 177">*179 B.
Petitioners were privately owned before 1970 and thus were not subject to the reporting requirements of the Securities and Exchange Act of 1934 (the 1934 Act), ch. 404, 48 Stat. 881 (current version at
The 1934 Act requires petitioners to file quarterly and annual financial reports with the Securities and Exchange Commission (SEC). Petitioners incurred expenses of $ 1,808,309 in taxable years 1989 to 1992 for professional services to comply with reporting, filing, and disclosure requirements imposed by the 1934 Act. Petitioners paid auditing and professional fees to KPMG Peat Marwick, Ernst & Whinney, and Ernst & Young to represent petitioners before the SEC's chief accountant's1996 U.S. Tax Ct. LEXIS 42">*47 office and to prepare SEC registration statements S-1 and S-4 relating to public securities offerings. Petitioners incurred these expenses to comply with section 13(a)(2) of the 1934 Act,
C.
Before 1985, petitioners adopted various employee benefit plans for their employees. As employee benefit plan administrators, petitioners are subject to the Employee Retirement Income Security Act of 1974 (ERISA), Pub. L. 93-406, sec. 103(a)(1)(A), 88 Stat. 841,
107 T.C. 177">*180 D.
In December 1986, Sealy Mattress Co., formerly known as Ohio-Sealy Mattress Manufacturing Co., a subsidiary of the Ohio Mattress Co., bought the stock of Slumber Products Corp., Sealy Mattress Co. of Albany, Inc., Sealy Mattress Co. of Illinois, Inc., Sealy of Minnesota, Inc., Sealy of Connecticut, Inc., the Maryland Bedding Co., Sealy of Maryland and Virginia, Inc., the Metcalfe Brothers, Inc., and Sealy Mattress Co. of Kansas City, Inc. Sealy Mattress Co. bought Sealy of Michigan, Inc., in April 1987.
Each of these companies (the acquired companies) had license agreements with Sealy, Inc., which is now known as the Ohio Mattress Co. Licensing & Components Group. All but two of the acquired companies owned voting stock in Sealy, Inc. After the 1986 acquisitions, the Ohio Mattress Co. indirectly owned 77.49 percent of Sealy, Inc. In December 1986, Sealy Mattress Co. bought 4.37 percent of Sealy, Inc. from individual shareholders. Thereafter, the Ohio Mattress Co. indirectly owned 81.86 percent of Sealy, Inc.'s voting stock.
On September 15, 1987, petitioners timely elected to treat the stock purchases (except Sealy, Inc., and Sealy of Michigan) 1996 U.S. Tax Ct. LEXIS 42">*49 as asset acquisitions under section 338.
E.
The Internal Revenue Service (IRS) audited petitioners' tax returns for the years ending November 30, 1987, November 30, 1988, April 24, 1989, November 30, 1989, November 30, 1990, November 30, 1991, and November 30, 1992. The IRS examined petitioners' books, records, and tax filings relating to the acquisitions. Petitioners paid Ernst & Young, American Appraisal Associates, and other accounting and law firms for services relating to the 1991 and 1992 IRS audits of petitioners' 1987, 1988, and 1989 tax years.
Most of petitioners' IRS examination expenses related to the IRS audit of the acquisitions, the section 338 elections, and petitioners' return for the tax year ending November 30, 1987.
Petitioners paid $ 567,974 in 1991 and 1992 for accounting and legal services relating to IRS audits of petitioners' 1987 tax year. Petitioners incurred the expenses to comply with 107 T.C. 177">*181 section 7602, which allows the IRS to examine taxpayers' books and records to ascertain whether a return is correct.
Petitioners reported that they had losses of $ 26,441,402 for 1989, $ 60,447,014 for 1990, $ 35,262,161 for 1991, and $ 11,772,3841996 U.S. Tax Ct. LEXIS 42">*50 for 1992 before taking into account net operating loss carrybacks or carryforwards.
On April 29, 1994, petitioners filed amended returns for their tax years ending November 30, 1989, 1990, 1991, and 1992. Petitioners filed an amended return for their tax year ending November 30, 1985, on April 29, 1994. On it, petitioners claimed a carryback of $ 6,484,484 for specified liability losses under
Respondent determined that petitioners may deduct $ 4,007,551 as specified liability losses and $ 2,476,933 2 as a loss subject to the general 3-year carryback and 15-year carryforward under
The following losses are in dispute:
| Acctg fees re: | Acctg fees re: | Prof. | |
| Tax | audited financial | employee benefits | fees |
| year | statements and SEC | financial | Re: IRS |
| ending | regis. statements | statements | audit |
| 11/30/89 | $ 631,109 | $ 34,450 | -- |
| 11/30/90 | 552,000 | 24,500 | -- |
| 11/30/91 | 337,700 | 24,500 | $ 140,186.50 |
| 11/30/92 | 287,500 | 17,200 | 427,787.50 |
1996 U.S. Tax Ct. LEXIS 42">*51 Petitioners reported that they had losses on their 1989, 1990, 1991, and 1992 returns, part of which petitioners carried back as specified liability losses under
107 T.C. 177">*182 The parties agree that the SEC and ERISA professional fees and the IRS examination expenses described above are deductible under chapter 1.
The parties have stipulated the amount of petitioners' net operating losses. The only issue for us to decide is whether petitioners may carry those losses back 10 years or 3 years.
A.
1.
Generally, a taxpayer may carry a net operating loss back 3 years before the loss year and forward 15 years after the loss year.
This 10-year carryback includes product liability and tort losses and nuclear decommissioning expenses.
1996 U.S. Tax Ct. LEXIS 42">*53 2.
(1) In general.--The term "specified liability loss" means the sum of the following amounts to the extent taken into account in computing the net operating loss for the taxable year: * * * * 107 T.C. 177">*183 (B) Any amount (not described in subparagraph (A)) allowable as a deduction under this chapter with respect to a liability which arises under a Federal or State law * * * if-- (i) * * * the act (or failure to act) giving rise to such liability occurs at least 3 years before the beginning of the taxable year, * * * * A liability shall not be taken into account under subparagraph (B) unless the taxpayer used an accrual method of accounting throughout the period or periods during which the acts or failures to act giving rise to such liability occurred. (2) Limitation.--The amount of the specified liability loss for any taxable year shall not exceed the amount of the net operating loss for such taxable year.
The 10-year carryback for specified liability losses described in
(1) The taxpayer took the specified liability loss into account1996 U.S. Tax Ct. LEXIS 42">*54 in computing its net operating loss for the taxable year;
(2) the expense resulting in the specified liability loss is deductible under chapter 1 of the Internal Revenue Code;
(3) the liability with respect to which the taxpayer incurred the expense arose under a Federal or State law;
(4) the act or failure to act which gave rise to the liability occurred at least 3 years before the taxable year at issue;
(5) the taxpayer used the accrual method of accounting throughout the period in which the acts or failures to act giving rise to the liability occurred; and
(6) the specified liability loss for any taxable year does not exceed the net operating loss for that year.
The parties agree that petitioners meet requirements (1), (2), (5), and (6). To prevail, petitioners must also meet requirements (3) and (4).
Deductions are a matter of legislative grace, and petitioners bear the burden of proving that they are entitled to any deductions they claimed on their returns.
1996 U.S. Tax Ct. LEXIS 42">*55 107 T.C. 177">*184 B.
1.
To be a specified liability loss, the liability with respect to which petitioners incurred the expense must have arisen under a Federal or State law.
We disagree. It is true that the 1934 Act, ERISA, and the Internal Revenue Code require petitioners to file financial reports and disclosure statements, maintain and provide books and records, and cooperate with IRS audits. However, those provisions do not establish petitioners' liability to pay the amounts at issue. Petitioners' liability to pay those amounts did not arise until petitioners contracted for and received the services. Petitioners' choice of the means of compliance, and not the regulatory provisions, determined the nature and amount of their costs. If, on the other hand, petitioners had failed to comply with the auditing and reporting requirements or had not obtained the particular services in issue1996 U.S. Tax Ct. LEXIS 42">*56 here, their liability would have been in amounts not measured by the value of services. Thus, petitioners' liability did not arise under Federal law.
2.
Our interpretation is entirely consistent with the legislative history which accompanied enactment of the predecessor of the specified liability loss provision. Before 1984, an accural basis taxpayer generally could deduct an expense for the tax year in which (a) all events had occurred which determined the fact of the liability and (b) the amount of the liability could be determined with reasonable accuracy.
107 T.C. 177">*185 In the legislative history accompanying enactment of the economic performance rules, Congress described the pre-DEFRA law, 1996 U.S. Tax Ct. LEXIS 42">*57 gave an overview of the House bill, discussed the economic performance rules added by DEFRA, and described the predecessor of the specified liability loss rule. The conference report for DEFRA states in pertinent part:
1. Premature accruals
* * * * * * * * The House bill provides a 10-year carryback for net operating losses attributable to certain liabilities deferred under these provisions. The bill also provides a special carryback rule for losses incurred in connection with the decommissioning of a nuclear power plant. Such losses may be carried back to each of the taxable years during the period beginning with the taxable year in which the plant was placed in service. No loss, however, may be carried back to a taxable year beginning before January 1, 1984, unless it may be carried back without regard to these rules. The provisions of the bill apply generally to expenses incurred (without regard to the economic performance requirement) after the date of enactment. * * * * The Conference Agreement generally follows the House bill, with modifications. * * 1996 U.S. Tax Ct. LEXIS 42">*58 * *
The conference report states that the 10-year carryback of specified liability losses applies to "net operating losses attributable to certain liabilities deferred under these provisions." "These" provisions are the limits on premature accruals; i.e., the economic performance rules of
3.
Petitioners argue that according to the plain language of
We conclude1996 U.S. Tax Ct. LEXIS 42">*60 that petitioners' compliance costs and other accounting expenses were not liabilities that arose under Federal or State law.
C.
To be a specified liability loss under
D.
We hold that petitioners' professional fees and IRS examination expenses are not specified liability losses under
To reflect the foregoing1996 U.S. Tax Ct. LEXIS 42">*61 and concessions,
1. Cases of the following petitioners are consolidated herewith: Sealy Corp. & Subsidiaries, f.k.a. The Ohio Mattress Co. & Subsidiaries, docket nos. 3028-93 and 6266-93; The Ohio Mattress Co. Licensing and Components Group & Subsidiaries, f.k.a. Sealy, Inc. & Subsidiaries, docket nos. 3029-93, 6267-93, and 6268-93; and Sealy Mattress Co. & Subsidiaries, f.k.a. Ohio-Sealy Mattress and Manufacturing Co. & Subsidiaries, docket nos. 3030-93 and 6269-93.↩
2. Petitioners concede that they may not deduct $ 29,000 of this amount. Thus, the amount in dispute is $ 2,447,933.↩
3. The Revenue Reconciliation Act of 1990, Pub. L. 101-508, sec. 11811(b)(1), 104 Stat. 1388-532, combined
