92 T.C. 1116">*1116 OPINION

These cases were assigned to Special Trial Judge Carleton D. Powell pursuant to the provisions of section 7456(d)(4) of the Code (redesignated section 7443A(b)(4) by section 1556 of the Tax Reform Act of 1986, Pub. L. 99-514, 100 Stat. 2755) and Rule 180 et seq. of the Tax Court Rules of Practice and Procedure.¹ The Court agrees with and adopts the opinion of the Special Trial Judge, which is set forth below.

1989 U.S. Tax Ct. LEXIS 76">*77 92 T.C. 1116">*1117 OPINION OF THE SPECIAL TRIAL JUDGE

Powell, Special Trial Judge: Respondent determined deficiencies in petitioner's income taxes for the years and in the amounts as follows:

The primary issue in the notices of deficiency relates to valuing eligible timber for purposes of section 631(a). In addition, petitioner deducted $ 20 million on its return for the taxable year ended December 31, 1981, under section 461(f) for a contested liability. Respondent disallowed this deduction.

By order of this Court dated July 16, 1987, the issue under section 461(f) was severed and these cases were set for partial trial solely on that issue. The sole issue for decision now before us is the severed issue of whether petitioner, under the accrual method of tax accounting, may deduct in 1981, pursuant to section 461(f)(2), the amount of a letter of credit placed in trust to satisfy the estimated claims of a liability that was still being contested.

FINDINGS OF FACT

Some of the facts have been stipulated and are found accordingly. Petitioner had its principal office1989 U.S. Tax Ct. LEXIS 76">*78 in Portland, Oregon, when it filed the petitions in these cases.

Prior to 1964, almost all plywood was manufactured in the Pacific Northwest. Most producers quoted a purchase or "delivered" price which consisted of an individually negotiated "mill" price (also known as the "base" or "index" price) plus a freight charge based upon the rail freight rate from the West Coast to the geographic zone of delivery (West Coast Freight).

92 T.C. 1116">*1118 In 1964, a technology to make plywood from Southern pine was developed. Georgia-Pacific Corp. opened the first plywood mill in the South and other plywood producers (Southern producers), including petitioner, soon followed. Southern producers adopted the same price quotation as the Western producers, that is, individually negotiated mill prices plus West Coast freight calculated according to "standard weights," rather than actual weights.

The Federal Trade Commission brought an action in April 1974 against several Southern producers, including petitioner. The complaint charged these producers with violating section 5 of the Federal Trade Commission Act (15 U.S.C. Sec. 45 (1982)). 1989 U.S. Tax Ct. LEXIS 76">*79 Following extensive hearings, the Federal Trade Commission issued an opinion and order in January 1978, which directed the Southern producers to cease and desist from quoting prices based upon West Coast freight and from using standard weights. Boise Cascade Corp., 91 F.T.C. 1 (1978). Petitioner and the other Southern producers appealed the decision of the Federal Trade Commission to the Court of Appeals for the Ninth Circuit. On May 9, 1980, the Court of Appeals reversed the determination and denied enforcement of the Commission's order. Boise Cascade Corp. v. Federal Trade Commission, 637 F.2d 573">637 F.2d 573 (9th Cir. 1980).

Prior to the decision of the Ninth Circuit, numerous private actions were filed against petitioner and other Southern plywood producers pursuant to section 4 of the Clayton Act (15 U.S.C. Sec. 15 (1982)). The plaintiffs (antitrust plaintiffs) challenged the method of quoting plywood prices which was in dispute in the Federal Trade Commission proceeding. The various actions were consolidated as a multi-district case in the U.S. District Court for Eastern District of Louisiana1989 U.S. Tax Ct. LEXIS 76">*80 and were certified as a class action.

The trial commenced before a jury in October 1978. In November 1978, the jury returned a verdict against petitioner, Georgia-Pacific Corp., and Weyerhaeuser Co., finding that they had engaged in a conspiracy with all other Southern pine plywood manufacturers to use "West Coast freight" in plywood pricing. In addition, the jury found that defendants had engaged in a conspiracy with all other 92 T.C. 1116">*1119 softwood plywood manufacturers to use the "standard weight" system in the pricing of Western fir plywood. Although the jury did not determine the dollar amount of the liability, it did determine that the measure of damages should be the difference between West Coast freight and actual freight and between standard weights and actual weights.

The District Court denied a motion for a new trial and entered judgments based upon the jury's verdict. Following entry of the judgments, motions were filed for monetary judgments for treble damages based on the formulae contained in the jury verdict. The District Court granted these motions, ruled that no further trial would be necessary to determine the damages, and entered monetary judgments in favor of1989 U.S. Tax Ct. LEXIS 76">*81 four sample plaintiffs. Petitioner, Georgia-Pacific Corp., and Weyerhaeuser Co. filed appeals to the U.S. Court of Appeals for the Fifth Circuit. ²

On September 8, 1981, the Court of Appeals entered its opinion affirming the judgments based on the jury's verdict in all respects. In re Plywood Antitrust Litigation, 655 F.2d 627">655 F.2d 627 (5th Cir. 1981). Motions for rehearing and rehearing en banc were denied on November 3, 1981.

On December 28, 1981, petitioner applied to the Bank of America for a letter of credit in the amount of $ 20 million. The letter of credit was issued and transferred to a settlement trust on that date. The letter of credit and the trust became valid and enforceable on December 28, 1981. By its terms, the letter of credit was subject to the Uniform Customs and Practice for Documentary Credits (1974 revision).

The letter of credit required the Bank of1989 U.S. Tax Ct. LEXIS 76">*82 America to pay the amount of the letter to the trustee on December 31, 1986, if the letter was not drawn upon in full, prior to that date. The letter of credit also gave the Bank of America the discretion to pay the amount of the letter to the trustee at any time prior to the earlier of a draw or December 31, 1986.

92 T.C. 1116">*1120 A loan agreement appeared on the reverse side of the letter of credit. The agreement obligated petitioner to repay the bank within 90 days of withdrawal with interest at 103 percent of the prime rate. Petitioner paid the bank approximately $ 85,000 for the letter of credit and trustee fees.

By instrument dated December 28, 1981, petitioner also entered into a trust agreement with the Bank of America. The trust agreement obligated the trustee to draw on the letter of credit in the event of a final judgement against petitioner, whether that final judgment was entered as a result of a voluntary settlement agreement or the result of an adverse ruling.

In October 1982, petitioner entered into a reimbursement loan agreement with Bank of America, dated as of December 28, 1981, relating to the trust agreement and the letter of credit. The reimbursement loan agreement1989 U.S. Tax Ct. LEXIS 76">*83 replaced the loan agreement of December 29, 1981, signed by petitioner and the Bank of America, which appeared on the reverse side of the letter of credit. The reimbursement loan agreement permitted petitioner to repay any draws made on the letter of credit over a period of one year.

1983 Settlement of Litigation

On March 2, 1982, petitioner, Georgia-Pacific Corp., and Weyerhaeuser Co., filed petitions with the Supreme Court of the United States for a Writ of Certiorari to the U.S. Court of Appeals for the Fifth Circuit. On May 17, 1982, the petitions were granted. Weyerhaeuser Co. v. Lyman Lamb Co., 456 U.S. 971">456 U.S. 971 (1982).

While the case was pending in the Supreme Court, the parties renewed settlement negotiations. On December 13, 1982, counsel for the respective parties met and agreed to recommend to their clients an overall settlement in the amount of $ 165 million. Based upon the plywood sales of each of the trial defendants during the years covered by the antitrust litigation, petitioner would pay 17.5 percent, Georgia-Pacific would pay 60 percent, and Weyerhaeuser would pay 22.5 percent.

The settlement was contingent on approval by the 1989 U.S. Tax Ct. LEXIS 76">*84 antitrust plaintiffs, the execution of a definitive agreement, and compliance with Federal Rule of Civil Procedure 23(e) which 92 T.C. 1116">*1121 governs class actions. The antitrust plaintiffs signed the settlement agreement on January 13, 1983. Following a hearing on the proposed settlement, the U.S. District Court for the Eastern District of Louisiana entered its order of final approval of settlement and final dismissal with prejudice on April 29, 1983. On June 14, 1983, the Supreme Court dismissed the writs (462 U.S. 1125">462 U.S. 1125).

On its 1981 tax return, petitioner claimed, under section 461(f), a deduction in the amount of $ 20 million for the liability.

Payments made to the antitrust plaintiffs by the Bank of America and petitioner were as follows:

The funds for the 1983 and the $ 3,388,750 1985 disbursements came directly from petitioner. The bank's 1984 and the $ 9,605,000 1985 disbursements resulted from draws against the letter of credit. Petitioner, however, on the same day as the draws paid the bank the amount of the payment.

OPINION

Generally, an accrual1989 U.S. Tax Ct. LEXIS 76">*85 basis taxpayer may deduct a liability expense only in the taxable year in which all events have occurred that determine the fact of the liability and only when the amount can be determined with reasonable accuracy. Sec. 1.461-1(a)(2), Income Tax Regs. Where a liability is contingent on the outcome of a contested lawsuit, then neither the fact nor amount of the expense can be reasonably ascertained, and, generally, the expense is not deductible. See Dixie Pine Products Co. v. Commissioner, 320 U.S. 516">320 U.S. 516 (1944); Lucas v. American Code Co. 280 U.S. 445">280 U.S. 445 (1930). After the decision in Chestnut Securities Co. v. United States, (104, Ct.Cl. 489, 62 F. Supp. 574">62 F. Supp. 574, 62 F. Supp. 574">1945) and prior to 1961, however, the Internal Revenue Service generally took the position that contested tax liabilities actually paid in a year constituted a narrow exception to this general rule.

92 T.C. 1116">*1122 In 1961, the Supreme Court eliminated this narrow exception to the general tax accounting rules. United States v. Consolidated Edison Co., 366 U.S. 380">366 U.S. 380 (1961). The facts in Consolidated Edison1989 U.S. Tax Ct. LEXIS 76">*86 may be summarized as follows: During 1946 through 1950, an accrual basis taxpayer paid an asserted real estate tax under protest to avoid seizure and sale of its property. The corporation, however, continued to challenge a portion of the liability in court. In 1951, the litigation terminated and the taxpayer deducted that portion of the contested liability for which it was held liable. The Supreme Court held that all events determining the fact and amount of the obligation had not occurred until 1951.

Legislative relief was sought. Congress recognized that it was "unfortunate to deny taxpayers a deduction with respect to an item where the payment has actually been made, even though the liability is still being contested either as to amount or as to the item itself." S. Rept. 830, 88th Cong., 2d Sess. (1964), 1964-1 C.B. (Part 2) 505, 604. The Committee felt that "allowing the deduction of items in the year paid, even though they are still being contested in the courts or otherwise, more realistically matches these deductions up with the income to which they relate than would the postponement of the deduction * * * until the contest is settled." S. Rept. 1989 U.S. Tax Ct. LEXIS 76">*87 830, supra, 1964-1 C.B. (Part 2) at 100.

In 1964, Congress enacted section 461(f). Sec. 223(a)(1), Revenue Act of 1964, Pub. L. 88-272, 78 Stat. 19, 76. Generally, section 461(f) permits both cash and accrual taxpayers to deduct a liability, even if contested, provided a transfer is made in that tax year to satisfy the claimed liability. See Consolidated Freightways, Inc. v. Commissioner, 74 T.C. 768">74 T.C. 768 (1980), affd. on this point, revd. on other issues 708 F.2d 1385">708 F.2d 1385 (9th Cir. 1983). Section 461(f) provides:

Sec. 461 (f). Contested Liabilities. -- If --

(1) the taxpayer contests an asserted liability,

(2) the taxpayer transfers money or other property to provide for the satisfaction of the asserted liability,

(3) the contest with respect to the asserted liability exists after the time of the transfer, and

92 T.C. 1116">*1123 (4) but for the fact that the asserted liability is contested, a deduction would be allowed for the taxable year of the transfer (or for an earlier taxable year),