19 T.C. 189">*189 The respondent determined deficiencies in income taxes as follows:

19 T.C. 189">*190 The petitions filed assigned a number of errors in the respondent's determinations. By stipulation the parties have settled all issues raised by the pleadings except one. That issue is whether a partnership, of which the three Patsch brothers were members, was entitled to accrue and deduct estimated costs of backfilling tracts of land on which it strip-mined coal in the taxable years. If accrual was proper, there is a further question as to whether the partnership is entitled to a greater deduction than it accrued and claimed for the year 1946.

Part of the facts were stipulated, and as stipulated are included herein by reference.

1952 U.S. Tax Ct. LEXIS 52">*55 FINDINGS OF FACT.

Ralph L. Patsch, J. Glenn Patsch, and C. W. Patsch are individuals residing in Houston, Pennsylvania. Eulala Patsch, Wilma Patsch, and Eva Patsch are, respectively, the wives of the petitioners named in the preceding sentence. For the years 1946 and 1947 the husbands filed individual income tax returns. For the year 1948 the husbands and wives filed joint income tax returns. The returns were all filed with the collector of internal revenue at Pittsburgh, Pennsylvania. All of the petitioners, either individually or as husband and wife, kept their books and filed their returns on a calendar year basis and on the cash receipts and disbursements method of accounting.

On January 10, 1946, the three individuals first above named formed a partnership, in which each had a one-third interest, under the name of Patsch Brothers Coal Company (hereinafter referred to as the mining partnership). The mining partnership was formed for the purpose of mining coal by the open pit or strip-mining method. During the calendar years 1946, 1947, and 1948 the mining partnership was actually engaged in such mining.

The mining partnership kept its books on the accrual method of accounting. 1952 U.S. Tax Ct. LEXIS 52">*56 It filed a partnership return of income on Form 1065 for each of the calendar years 1946, 1947, and 1948 with the collector of internal revenue at Pittsburgh, Pennsylvania.

Open pit or strip-mining is a process of mining whereby the strata or material which overlies or is above the coal deposit or seam in its natural condition is removed so that the coal can be mined with shovels.

In the years 1946 to 1948, inclusive, the mining partnership strip-mined from the several tracts on which it operated the following tonnages of coal from the number of acres indicated: 19 T.C. 189">*191

1952 U.S. Tax Ct. LEXIS 52">*57 As to some of the above tracts, the mining partnership owned the surface of the land and as to others it did not. In the case of one tract, it owned both the coal in place and the surface of the land.

Each of the lease agreements under which the mining partnership operated on the above tracts contained a provision whereby the mining partnership agreed with the lessor to obey and conform to the laws of the Commonwealth of Pennsylvania and of the United States concerning strip-mining operations. Leases on the Feist, McNary, Boon Terrace, and Gresko tracts contained specific provisions which required the operator, after removal of the coal, to backfill the mined land to as near the former contour of the ground as possible.

At the end of each of the years 1946, 1947, and 1948, the mining partnership made an estimate of the cost of backfilling the acreage from which coal had been mined by the strip-mining process during the year. The amounts of such estimates were entered as credit entries in two ledger accounts maintained by the partnership entitled "Back Fill Reserve," one of which accounts was a control account and the other a detail account. The amounts so credited at the close1952 U.S. Tax Ct. LEXIS 52">*58 of the several years involved were:

The amounts so credited by the partnership to the Black Fill Reserve were computed as follows:

19 T.C. 189">*192 Expenditures thereafter made by the partnership for backfilling were entered as debit entries in the reserve accounts.

During the year 1946, the partnership did no backfilling or other restoration work, and it did not enter into any contracts for such work except as provided for in the lease agreements under which it operated. In the years 1947 and 1948, the partnership performed backfilling and other restoration work on the tracts and at costs as follows:

1952 U.S. Tax Ct. LEXIS 52">*59 The costs of such backfilling and restoration work were allowed by the respondent as deductions in computing net distributable partnership income. In the years 1947 and 1948, the mining partnership did no other backfilling or restoration work, and entered into no contracts for such work, other than the lease agreements under which it operated.

In the years 1949, 1950, and in 1951 up to October 1 of 1951, the partnership did backfilling on tracts, and at costs, as follows:

In 1949 the mining partnership paid $ 1,250 to the owner of the McNary tract in full settlement of all of his backfilling claims.

Strip-mining operations were conducted on the Allison Farms tract in 1946 and 1947 and were completed on that tract in 1947. They were completed on the other tracts above mentioned on various dates in 1947 and 1948 except on the Feist, Boon Terrace, and Montour tracts. They were completed on the Feist and Boon Terrace tracts in 1949, and on the Montour tract in 1950.

The coal on the Feist, McNary, and Gresko leases was 1952 U.S. Tax Ct. LEXIS 52">*60 stripped by independent contractors who agreed as part of the contract price to do some of the backfilling. The contract stripper did no backfilling on the Allison Farms tract.

The cost of backfilling and restoring strip-mined areas varies from tract to tract, dependent on the existence of a number of factors. Among such factors are the depth of the overburden that must be moved, the distance that the overburden must be moved, drainage conditions, the shape of the cut and the thickness of the coal seam. The Allison Farms tract had a greater depth of overburden than the 19 T.C. 189">*193 other tracts mined by the partnership. Its coal seam averaged a foot less in thickness, drainage problems were encountered which were not met on the other tracts, and the curved shape of the cut required moving the overburden and backfill a greater distance than on the other tracts where the cuts were straight.

In mining coal by the strip-mining method, it is not feasible or economically practical to backfill as mining progresses. It is the general practice in strip-mining operations to backfill only after all of the coal has been removed from the particular tract. In the taxable years, mining machinery1952 U.S. Tax Ct. LEXIS 52">*61 and equipment were scarce. What was available was used to mine coal.

On April 23, 1948, the mining partnership filed a registration certificate, operation report, and surety bond with the Department of Mines of the Commonwealth of Pennsylvania, covering strip-mining operations on owned and leased premises on and after January 10, 1946. The surety bond was in the amount of $ 3,000 and was conditioned on the performance of the requirements of the Bituminous Coal Open Pit Mining Conservation Act.

At the time of the hearing of these proceedings, backfilling and restoration operations had been completed on all of the tracts above mentioned except on the Allison Farms, Hitchman Berry, and Montour Land Co. tracts. On the Allison Farms tract, backfilling had been completed on 10 acres out of a total of 28.6 acres that were strip-mined.

OPINION.

The primary question for decision in these proceedings is whether Patsch Brothers Coal Company is entitled to deduct as an accrued expense for the years 1946, 1947, and 1948 the estimated cost of backfilling lands from which it stripped coal in those years. If it is entitled to the deduction, there is a further question of whether it may deduct1952 U.S. Tax Ct. LEXIS 52">*62 an additional amount for the year 1946 by reason of having underestimated for that year the cost of backfilling the Allison Farms tract. Other issues raised by the pleadings have been settled by stipulation.

Patsch Brothers Coal Company was a partnership which was engaged in the business of mining coal in Pennsylvania by the open pit or strip-mining method. Its books were kept and returns filed on the accrual method of accounting. It accrued on its books reserves, computed on the basis of tonnages of coal mined, which were intended to cover the cost of backfilling the areas from which coal was mined in each year. The amounts of such reserves were claimed as deductions from gross income in the partnership returns of income. The respondent disallowed such deductions, but he allowed deductions for 19 T.C. 189">*194 the amounts actually expended for backfilling in the years 1947 and 1948.

The partnership conducted mining operations under leases which required it to conform to the laws of the Commonwealth of Pennsylvania concerning strip-mining operations. Under four of the leases the partnership was further required to backfill so as to restore the original contour of the mined areas as1952 U.S. Tax Ct. LEXIS 52">*63 nearly as possible.

Both parties assume that the partnership in its operations was subject to the provisions of the Bituminous Coal Open Pit Mining Conservation Act ⁴ of the Commonwealth of Pennsylvania. That statute requires the operator of a strip-mine to file with the Department of Mines a certificate giving certain information as to its operations and also to file a bond conditioned on performance of all of the requirements of the act. (Sec. 1396.4.) ⁵ Operation and completion reports are required to be filed, and if operations are not completed within a year after registration, annual reports must be filed. (Secs. 1396.5, 1396.6, 1396.7.) Section 1396.10 provides that within one year after completion of an operation "the operator shall place sufficient overburden or earth not containing reject coal or combustible material in the open cut to cover the exposed face of the unmined coal" and specifies how the covering shall be done. That section also requires that the peaks and ridges of spoilbanks be leveled and rounded off to an extent to permit the planting of trees, grasses, or shrubs, except where it is proposed to conduct drift mining operations. Other sections provide1952 U.S. Tax Ct. LEXIS 52">*64 for the planting of trees, shrubs, or grasses under supervision of the Secretary of Forests and Waters, release of performance bond, and forfeiture of the bond or deposit in the event of default in compliance with the statute. Mining without registration is a misdemeanor and punishable by a fine. (Secs. 1396.11-16.)

The petitioners contend that the removal of the coal by the partnership was an event which created a liability to backfill under the provisions of the leases under which it operated, its performance bond, and the laws of1952 U.S. Tax Ct. LEXIS 52">*65 Pennsylvania. They argue that as soon as any overburden was removed there was a definite, fixed, and existent obligation to backfill, though as a practical mining procedure backfilling is not done until the particular tract involved is completely mined.

For statutory support for their position the petitioners cite Internal Revenue Code sections 41 and 43 which provide that "The net income shall be computed * * * in accordance with the method of accounting 19 T.C. 189">*195 regularly employed in keeping the books * * *" and that "* * * deductions and credits * * * shall be taken for the taxable year in which 'paid or accrued' or 'paid or incurred', dependent upon the method of accounting upon the basis of which the net income is computed, unless in order to clearly reflect the income the deductions or credits should be taken as of a different period." Their view is that under these provisions of the Code, and sound accounting practice, accrual of estimated costs of backfilling was proper for the years in which coal was removed.

The respondent's position is that neither the fact nor the amount of liability had been fixed by events that occurred during the taxable years. He argues that the1952 U.S. Tax Ct. LEXIS 52">*66 requirements of the existence of a liability and its amount will be met in these cases only when the backfilling work has actually been performed.

It is our conclusion that the respondent properly disallowed the claimed deductions for the reserves for backfilling. The mining of the coal by the partnership was not an event which fixed within the year the partnership's liability to pay. Further, the amount of the partnership's liability, if any, has not been established with sufficient certainty to support an accrual.

The factual situations under which deductions are permissible in advance of payment for items allowable by statute, such as taxes, expenses, losses, and interest, have often been stated. Such deductions are allowable to a taxpayer who accounts on the accrual method where, within the taxable year, all events have occurred which (a) establish the existence of a definite liability of the taxpayer to pay and (b) fix the amount of such liability. ⁶ On the other hand, no deduction is allowable in a year where not all events have occurred which establish a liability to pay, or where the amount of the liability is uncertain because of an existent contingency. 1952 U.S. Tax Ct. LEXIS 52">*67 ⁷

Among the cases in the latter category, and closely in point factually with those before us, is Spencer, White & Prentis v. Commissioner, 144 F.2d 45,1952 U.S. Tax Ct. LEXIS 52">*68 affirming a Memorandum Opinion of this Court in which we disallowed a deduction for a reserve for the estimated cost of restoration of property in connection with the construction of a subway. The restoration work was not performed in the year of the creation of the reserve and the claim for deduction, but was 19 T.C. 189">*196 performed in the following year at a cost within four per cent of the amount of the estimate. In holding that the claimed deduction was not allowable, the Circuit Court said:

The liability for the estimated deduction clearly had not accrued during the year in which deduction was sought. The only thing which had accrued was the obligation to do the work which might result in the estimated indebtedness after the work was performed.

It is well settled that deductions may only be taken for the year in which the taxpayer's liability to pay becomes definite and certain, even though the transactions (such as the contract in the present case) which occasioned the liability, may have taken place in an earlier year. * * * Here liability for the work done after July 1, 1938 had not been incurred for the work had not been performed. [Emphasis added.]

Similarly, 1952 U.S. Tax Ct. LEXIS 52">*69 in Amalgamated Housing Corporation, 37 B. T. A. 817, affd. per curiam, 108 F.2d 1010, it was held that deductions for reserves for the anticipated cost of renovating apartments were not allowable. In that case the operations of the taxpayers were supervised by a state agency, and it was required to renovate its apartments periodically, and to set aside a reserve for that purpose out of rents received. It knew what its costs would be, as it had a contract for the repainting of the rooms at a fixed amount. We said in part:

Although the petitioners were obligated to renovate, they had no liability to pay anyone anything until someone had performed some services. The accrual is for services in renovating, not of the duty to renovate. The accrual method does not permit the anticipation of future expenses prior to the rendition of the services for which the payment is due.

In Atlas Mixed Mortar Co., 23 B. T. A. 245, the taxpayer was required by city ordinance to refill a pit from which it excavated sand and gravel, and it was required to file a performance bond. In the years that were before1952 U.S. Tax Ct. LEXIS 52">*70 us, the taxpayer did not do any refilling. It set up reserves for the estimated cost of refilling and claimed deductions therefor. In holding that the claimed deductions were not allowable we quoted from an earlier case ( William J. Ostheimer, 1 B. T. A. 18) that the liability for restoration of property "at some indefinite or indeterminate time in the future is not a present actual liability, and is not the actual incurring of an expense or liability."

In this group of cases, something further remained to be done before any liability to pay any amount had been incurred by the taxpayer. ⁸ Consequently in those cases, as here, the liability in the taxable year was contingent and not accruable as a deduction. 291 U.S. 193">Brown v. Helvering, supra.

To support the deductions here claimed the petitioners rely heavily on the case of Harrold v. Commissioner, 192 F.2d 1002,1952 U.S. Tax Ct. LEXIS 52">*71 which reversed 19 T.C. 189">*197 the decision of this Court in the case of Paul Harrold, 16 T.C. 134. That case, in its general aspects, resembles those before us. There the taxpayers were members of a partnership that was engaged in strip-mining operations under leases on lands in West Virginia. Under state law and the leases the partnership was required to backfill mined areas, and it posted a performance bond to insure compliance with its statutory obligations. By the end of 1945 operations had been completed on a tract of 31.09 acres. One of the partners had been engaged in strip-mining and backfilling for 16 years. Based on his experience, the partnership estimated the cost of backfilling at $ 1,000 per acre. It accrued $ 31,090 on its books as a reserve for backfilling and deducted that amount on its 1945 return. In 1945 the partnership was using its equipment in stripping operations and it postponed backfilling until 1946. Backfilling operations were commenced in the spring of 1946 when the weather became favorable, and were completed in that year at a cost of $ 25,210.18. The partnership then reduced the estimated cost shown on its books, and1952 U.S. Tax Ct. LEXIS 52">*72 filed an amended return for 1945 in which it reduced the claimed deduction to the amount of the actual cost of backfilling.

The Circuit Court held in the Harrold case that a deduction was allowable to the extent of the $ 25,210.18 expended in 1946 in backfilling. It cited and discussed the cases that we have mentioned above, and others, and expressed agreement with the general rule as to the need for the existence of a fixed liability and the certainty of the amount of the liability. ⁹ The Circuit Court stated its conclusion as follows:

We conclude that when all the facts have occurred which determine that the taxpayer has incurred a liability in the tax year, and neither the fact nor the amount of the liability is contested, and the amount, although not definitely ascertained, is susceptible of estimate with reasonable accuracy in the tax year, deduction thereof from income may be taken by a taxpayer on an accrual basis. This procedure does not violate the principle that income taxes must be calculated on an annual basis, but, on the contrary, allocates to each year the proper income and expense, and prevents distortion of the taxpayer's 19 T.C. 189">*198 financial condition in the1952 U.S. Tax Ct. LEXIS 52">*73 tax year. * * * We think the proper approach to the problem before us should be realistic and one that accords with good business practice, rather than an approach based upon subtle technicalities.