UNITED STATES COURT OF APPEALS FOR THE THIRD CIRCUIT
filed: December 2, 1994.
E.I. DU PONT DE NEMOURS & COMPANY, AND AFFILIATED CORPORATIONS, APPELLANT IN NO. 94-7242, REMINGTON ARMS COMPANY, INC., APPELLANT IN NO. 94-7243, E.I. DU PONT DE NEMOURS & COMPANY, SUCCESSOR TO NEW ENGLAND NUCLEAR CORPORATION, APPELLANT IN NO. 94-7244
COMMISSIONER OF INTERNAL REVENUE SERVICE
On Appeal from the United States Tax Court Washington, D.C. (Tax Court Nos. 91-19950, 91-19952 & 91-19953).
Before: Scirica, Nygaard and McKEE, Circuit Judges.
Opinion OF THE COURT
SCIRICA, Circuit Judge.
In this appeal, we must determine the validity of Treas. Reg. § 1.58-9 (1992). Specifically, the issue is whether the Department of the Treasury may implement a "suspended-tax" approach instead of a "suspended-preference" method in calculating minimum tax under the "tax benefit rule" of former I.R.C. § 58(h), 26 U.S.C. The first approach computes and suspends tax liability until a benefit results while the latter suspends items of tax preference. Because we find the suspended-tax approach to be a reasonable construction of § 58(h), in accord with its language and purpose, we will uphold the regulation.
E.I. du Pont de Nemours & Company, Conoco, Inc., Remington Arms Company, and New England Nuclear Corp.*fn1 filed federal income tax returns for 1979, 1980, and 1981,*fn2 claiming reductions in tax liability through the use of income tax credits carried back from the 1982 tax year. Subsequently, the Internal Revenue Service issued notices of deficiency to taxpayers for $25,633,133. Taxpayers responded by filing petitions in the Tax Court, contending the regulation on which the deficiencies were based exceeded the scope of the authorizing statute, I.R.C. § 58(h).*fn3 The Tax Court sustained the regulation, E.I. Du Pont De Nemours & Co. v. Commissioner, 102 T.C. 1 (T.C. 1994), and taxpayers appealed.*fn4 We will affirm.
In 1969, Congress enacted I.R.C. § 56(a) out of concern over the use of tax deductions and exemptions that enabled some high-income taxpayers to pay little or no income tax.*fn5 Section 56(a) imposed a minimum tax, apart from the regular income tax, on certain deductions and exemptions designated as "items of tax preference."*fn6 During the years relevant to this case, the statute levied a minimum tax of 15% of the amount by which the taxpayer's preferences exceeded its regular tax deduction*fn7 or $10,000, whichever was greater.
In some situations, however, tax preferences did not result in a current tax benefit for the taxpayer. For example, a taxpayer's tax liability could be completely offset by income tax credits, which were not designated as preferences. Yet, even in those cases in which tax preferences did not result in an actual benefit, such as when a taxpayer had enough tax credits to reduce its tax liability to zero, the minimum tax still was imposed. See Occidental Petroleum Corp. v. United States, 231 Ct. Cl. 334, 685 F.2d 1346 (Cl. Ct. 1982) (Occidental I).
To remedy this perceived unfairness, Congress enacted a new provision, I.R.C. § 58(h), in the Tax Reform Act of 1976, Pub. L. No. 94-455, § 301(d)(3), 90 Stat. 1520, 1553 (1976).*fn8 I.R.C. § 58(h) provided:
Regulations to include tax benefit rule
The Secretary shall prescribe regulations under which items of tax preference shall be properly adjusted where the tax treatment giving rise to such items will not result in the reduction of the taxpayer's tax under this subtitle for any taxable years.
Despite the express statutory directive, the Department of the Treasury failed to propose implementing regulations for thirteen years.*fn9 In the meantime, Congress repealed § 58(h) in 1986 and adopted an alternative minimum tax,*fn10 although it later noted that § 58(h) would continue to apply to tax years preceding the 1986 statutory change.*fn11
In 1989, the Treasury Department issued a temporary regulation to implement § 58(h).*fn12 Three years later, the department promulgated a final version of the regulation, 26 C.F.R. § 1.58-9, applicable only to preferences arising in taxable years from 1977 to 1986, when the statute was in effect. Id. § 1.58-9(b). Under the regulation, as specified by § 58(h), a taxpayer is not liable for the minimum tax on its preferences when they result in no current tax benefit, such as when the taxpayer has sufficient credits to offset tax liability for the year without deducting any available preferences.
Operation of the statute and regulation, however, results in an unavoidable secondary effect. When tax credits exceed regular tax liability for a year, the taxpayer is deemed to have received no current tax benefit and no minimum tax is imposed. Yet, the taxpayer still calculates regular tax liability by deducting its preferences. Because the resulting regular tax liability is lower than it otherwise would be without the inclusion of the preferences, fewer credits are necessary to offset the taxpayer's tax liability for the year. Because tax credits may be carried over from year to year, the need for fewer tax credits to offset tax liability in one year "frees up" additional credits for use in other years.
If the taxpayer does not use those "freed-up" tax credits to reduce regular tax liability in any year, then it never benefits from the preferences; thus, no minimum tax may be imposed. See Occidental Petroleum Corp. v. Commissioner, 82 T.C. 819 (T.C. 1984) (Occidental II). If the taxpayer later uses those freed-up credits, however, then it has benefitted from the preferences and must pay the minimum tax. Treas. Reg. § 1.58-9. All parties agree with this Conclusion. The dispute centers on the method by which the minimum tax is calculated.
For the 1982 tax year, DuPont filed a consolidated federal income tax return for itself and its affiliates -including Conoco, Remington, and NEN -- showing taxable income of $629,112,639. DuPont claimed tax preferences of $177,082,305, which reduced its tax liability to $256,844,566. Without the use of preferences to compute taxable income, DuPont's tax liability would have been $338,302,426.*fn13 Because DuPont had $469,997,179 in credits -- more than enough to offset the potential tax liability of $338,302,426 -- it was not subject to minimum tax for the year, pursuant to I.R.C. § 58(h). See First Chicago Corp. v. Commissioner, 842 F.2d 180 (7th Cir. 1988).
Nevertheless, because DuPont claimed the preferences in 1982 to reduce its taxable income and subsequent tax liability,*fn14 it saved $81,457,860*fn15 in credits for use in other years. DuPont carried back those freed-up credits and applied them to its own return for the 1979 tax year and to individual returns filed by Conoco, Remington, and NEN, which were not affiliated at the time with DuPont.*fn16
Under Treas. Reg. § 1.58-9, the minimum tax constitutes 15% of the difference between the taxpayer's tax preferences and its regular tax deduction for the year in which the preferences arose, here 1982. The regulation requires that credits freed up by the preferences in one year must be reduced by the amount of the minimum tax before being carried over to other tax years.
In this case, § 1.58-9 mandated that the freed-up DuPont credits of $81,457,860 be reduced by $25,633,133, which was 15% of the difference between the 1982 preferences of $177,082,305 and the 1982 regular tax deduction of $6,194,754.*fn17
Because DuPont had not reduced the credits pursuant to the regulation, the Commissioner assessed the following deficiencies:
Taxpayer Taxable Year Ended Deficiency
DuPont December 31, 1979 $13,010,040
Conoco December 31, 1980 12,436,199
Remington January 31, 1980 78,698
NEN February 28, 1981 108,196
In contrast to the system mandated by the regulation, which the Tax Court characterized as the "suspended-tax method," taxpayers advocate a "suspended-preference approach." Du Pont, 102 T.C. at 6. In essence, taxpayers' method would suspend the preferences -- not the minimum tax -- and treat them as if they had arisen during the carry-over year, i.e., the year the freed-up credits are used. Those suspended preferences would be aggregated with other preferences arising in the carry-over year. The minimum tax then would equal 15% of the difference between the aggregated preferences and the regular tax deduction for the carry-over year. Under taxpayer's method, DuPont, Remington, and NEN would have no minimum tax liability, and the deficiency against Conoco would be reduced to $10,551,956*fn18 -- instead of the $25,633,133 total deficiency assessed under Treas. Reg. § 1.58-9.
Accordingly, taxpayers filed petitions in the Tax Court claiming the deficiencies were based on an invalid regulation. The Commissioner of Internal Revenue disagreed, and all parties submitted a fully stipulated record to the Tax Court, which upheld Treas. Reg. § 1.58-9 as a reasonable interpretation of the statute. Du Pont, 102 T.C. at 20-21. Taxpayers then appealed.*fn19
The Tax Court had jurisdiction of the case under I.R.C. §§ 6214(a) and 7442 (1988). We have jurisdiction under I.R.C. § 7482 (1988), and our review is plenary. Pleasant Summit Land Corp. v. Commissioner, 863 F.2d 263, 268 (3d Cir. 1988), cert. denied, 493 U.S. 901 (1989).
As an initial matter, we consider the judicial deference to which the regulation is entitled. Under Chevron U.S.A. Inc. v. Natural Resources Defense Council, Inc., 467 U.S. 837, 844, 81 L. Ed. 2d 694, 104 S. Ct. 2778 (1984), "legislative regulations are given controlling weight unless they are arbitrary, capricious, or manifestly contrary to the statute." Taxpayers, however, contend that § 1.58-9 is not a "legislative" regulation entitled to deference under Chevron.
Because the Treasury proposed the regulation thirteen years after the statute's enactment and three years after its repeal, taxpayers argue that § 1.58-9 is not a "legislative" regulation issued under I.R.C. § 58(h), but merely an "interpretative" one*fn20 under the department's general rule-making authority. See I.R.C. § 7805(a) (1988) ("the Secretary shall prescribe all needful rules and regulations for the enforcement of this title").*fn21 We cannot agree. I.R.C. § 58(h) provided that the "Secretary shall prescribe regulations . . .," which appears to be precisely the type of "express delegation of authority to the agency" that Chevron contemplates. 467 U.S. at 843-44. Although there may be situations in which substantial and prejudicial delay in exercising rule-making authority might alter the degree of deference accorded a regulation, we see no express prejudice here nor do we discern any other factors that would change the nature of our review. In addition, even after the repeal of § 58(h), Congress expressly stated that the statute would remain effective for preferences arising in taxable years before 1987.*fn22 Therefore, the congressional directive for the Treasury to "prescribe regulations" under § 58(h) remained in force as to those taxable years.
Furthermore, in the tax area, we are still required to treat regulations issued under a general grant of authority with broad deference, although to a somewhat lesser degree than when Congress has made a specific delegation of authority in a specific statute.*fn23 As the Supreme Court has explained: "Because Congress has delegated to the Commissioner the power to promulgate 'all needful rules and regulations for the enforcement of [the Internal Revenue Code],' 26 U.S.C. § 7805(a), we must defer to his regulatory interpretations of the Code so long as they are reasonable." Cottage Sav. Ass'n v. Commissioner, 499 U.S. 554, 560-61, 113 L. Ed. 2d 589, 111 S. Ct. 1503 (1991) (quoting National Muffler Dealers Ass'n v. United States, 440 U.S. 472, 476-77, 59 L. Ed. 2d 519, 99 S. Ct. 1304 (1979)).*fn24
I.R.C. § 58(h) directs the Treasury to enact regulations "under which items of tax preference shall be properly adjusted where the tax treatment giving rise to such items will not result in the reduction of the taxpayer's tax under this subtitle for any taxable years." On appeal, taxpayers' principal contention is that the regulation adjusts tax credits, not items of tax preference.
Although § 58(h) requires that taxpayers be exempt from the minimum tax for any year in which their preferences do not result in a tax benefit, the regulation nevertheless computes the minimum tax that otherwise would be due on those preferences for the year. The regulation then reduces the taxpayers' tax credits by the amount of the minimum tax. It is only when taxpayers attempt to benefit from their preferences -- by using the freed-up credits -- that they become subject to the tax.
Taxpayers complain that the operation of § 1.58-9 results in adjustments to their tax credits, contrary to the language of the statute. Instead, taxpayers claim the tax should be assessed by carrying the preference items from the "non-benefit" year over to the "benefit" year and combining them with the preferences that arose during the latter year. The minimum tax then would equal 15% of the total number of preferences from both years subtracted by the benefit year's regular tax deduction. Taxpayers contend this method would adjust actual "items of tax preference," as the statute required.
Although taxpayers' proposal appears to be reasonable, it is not the only permissible construction of the statute, nor is it necessarily the most reasonable one.*fn25 We believe Treas. Reg. § 1.58-9 adjusts "items of tax preference" simply by ignoring them -- for minimum tax purposes -- during the year when no tax benefit is realized. As we have noted, the purpose of the statute was to ensure that no minimum tax be assessed on preferences when they did not result in a tax benefit;*fn26 Treas. Reg. § 1.58-9 accomplishes this result.
Taxpayers contend Congress intended a "suspended-preference approach" be promulgated to implement I.R.C. § 58(h) and claim the legislative history of the 1976 Tax Reform Act, which adopted § 58(h), supports their construction of the statute. But none of the congressional committee reports on § 58(h) indicates the method by which the preferences were to be adjusted.*fn27 Nevertheless, taxpayers point to one committee report discussing other provisions of the Code that specify a type of suspension and reactivation of preferences somewhat similar to the system they advocate.*fn28 That committee report, however, does not explicitly support taxpayers' method of tax computation. Furthermore, as the Commissioner contends, the cited Code provisions are not analogous because they suspend tax deductions for other purposes,*fn29 not just for minimum tax purposes, as does § 58(h).*fn30
Taxpayers also assert that Treas. Reg. § 1.58-9 distorts congressional will by interfering with the operation of other provisions of the Internal Revenue Code. First, taxpayers claim the regulation disregards the import of the regular tax deduction in calculating and reducing minimum tax liability under I.R.C. § 56(a), (c). Because Treas. Reg. § 1.58-9 "transforms a suspended minimum tax in the year the nonbeneficial preferences arise into regular tax liability in the benefit year," Du Pont, 102 T.C. at 15-16, the preferences from the non-benefit year are not being weighed against the regular tax deduction in the year they result in a benefit. Yet, under the regulation, the preferences from the non-benefit year continue to be weighed against the regular tax deduction in the non-benefit year in calculating the amount of the suspended tax. Furthermore, while the regular tax deduction appears to be an integral part of the minimum tax computation system of § 56, we can discern no authority or evidence the regular tax deduction was meant to play a crucial role in the tax benefit rule of § 58(h).
Second, because Treas. Reg. § 1.58-9 operates to reduce tax credits available for use in other years, taxpayers contend the regulation improperly interferes with Code provisions governing tax credits and the regular income tax. Although the regulation does affect tax credits, it does so only in limited circumstances to certain taxpayers, as the Tax Court noted. Du Pont, 102 T.C. at 19. There is no authority suggesting the minimal effects of the regulation will disrupt the entire system of tax credits crafted by Congress or that Congress intended to forbid all regulations that affect tax credits in any manner.*fn31
Taxpayers urge us to look to other provisions of the Internal Revenue Code for guidance in considering the validity of Treas. Reg. § 1.58-9. Accordingly, we have examined I.R.C. § 56(b), which until 1987 provided for deferral of minimum tax liability in situations involving net operating losses affected by preferences. Under § 56(b), if preferences served to increase a net operating loss in one year, the minimum tax otherwise due on the preferences under § 56(a) was suspended until the year the preferences provided a tax benefit. The amount of the minimum tax imposed on the preferences in this situation was calculated with reference to the minimum tax rate and the regular tax deduction for the year in which the preferences originated -similar to the manner in which § 1.58-9 operates. Du Pont, 102 T.C. at 17-18. We agree with the Tax Court that § 56(b) generally supports the rationale of Treas. Reg. § 1.58-9. Id. at 18.
Therefore, we find nothing in the legislative history or inferentially from other sections of the Internal Revenue Code that would indicate the Treasury deviated from the language or purpose of the statute. What is clear is the language of § 58(h) that directs the Secretary to "prescribe regulations under which items of tax preference shall be properly adjusted." Congress made a specific delegation of authority to the Secretary to promulgate regulations, and we may not substitute an alternative construction of the statute unless the regulation contravenes the language or purpose of the statute,*fn32 which this regulation does not do.
Since 1976, when I.R.C. § 58(h) was enacted, other courts have considered its meaning and scope.*fn33 Although no prior cases directly confronted the validity of Treas. Reg. § 1.58-9, taxpayers contend their position here is bolstered by the reasoning of First Chicago Corp. v. Commissioner, 842 F.2d 180 (7th Cir. 1988). In First Chicago, the taxpayer had credits exceeding its tax liability for the 1980 and 1981 tax years. The Internal Revenue Service, however, decreed First Chicago should pay the minimum tax for those years on the preferences it used to reduce its tax liability, because those preferences freed up tax credits that might have been used to reduce First Chicago's future tax liability. The Court of Appeals for the Seventh Circuit disagreed, affirming the Tax Court's holding that "there is no minimum tax on tax-preference items until the items confer an actual benefit on the taxpayer." Id. at 180.*fn34
In the course of its Discussion, the Seventh Circuit noted:
It is true that, as a result of Congress's extreme restlessness in the area of tax law, by the time the benefit is obtained the structure of taxation may have changed and the taxpayer may escape part or even all of the tax. But this instability is built into tax law. If a taxpayer is able to defer income to a year when tax rates are lower, he obtains a tax savings analogous to what First Chicago may someday obtain if its tax-preference items yield a tax benefit which gives rise to a minimum-tax liability that it can offset with foreign or investment tax credits, thanks to the new alternative minimum tax. But the deferral may backfire, if the structure of taxation changes against the taxpayer.
Id. at 183. This language suggests the court may have assumed that if the 1980-81 preferences generated a tax benefit after the 1986 statutory changes, then they would be treated as preferences in that later year and be subject to the new alternative minimum tax, a view of § 58(h) advocated by taxpayers here.
But such assumptions, even if indicative of the court's view, cannot be persuasive here. At the time of the decision in First Chicago, § 1.58-9 had not been promulgated. In fact, the court decried the absence of a regulation as contributing to the difficulties in interpreting § 58(h).*fn35 Once the Treasury Department adopted the regulation pursuant to § 58(h), the landscape changed. Instead of choosing among alternative methods of interpreting the statute, we must inquire whether the Treasury regulation reasonably implements the statute.*fn36 As we have noted, we believe it does.
Besides challenging the substance of Treas. Reg. § 1.58-9, taxpayers assert the regulation was enacted in "bad faith" and thus not entitled to judicial deference. In support, taxpayers cite National Muffler Dealers Ass'n v. United States, 440 U.S. 472, 59 L. Ed. 2d 519, 99 S. Ct. 1304 (1979). In National Muffler, the Supreme Court stated, in assessing the validity of regulations, courts should consider factors such as whether the regulation was issued contemporaneously with the statute, the manner in which it evolved, "the length of time the regulation has been in effect, the reliance placed on it, the consistency of the Commissioner's interpretation, and the degree of scrutiny Congress has devoted to the regulation during subsequent re-enactments of the statute." Id. at 477. Taxpayers argue the National Muffler factors demonstrate the regulation should be set aside. Although application of the National Muffler factors may not explicitly validate § 1.58-9, we do not find that sufficient to warrant striking down the regulation.*fn37 In fact, we already have determined the regulation implements the statute in a "reasonable manner," which is all National Muffler ultimately requires and which is what its factors were intended to ascertain. Id. at 476-77 (noting that courts should defer to regulations that "implement the congressional mandate in some reasonable manner" and listing factors to "determine whether a particular regulation carries out the congressional mandate in a proper manner").
Taxpayers also assert the regulation is not entitled to deference because the Treasury Department promulgated it in an attempt to circumvent the 1986 change in the revenue statutes that permitted up to 90% of the minimum tax to be offset by foreign tax credits.*fn38 In addition, taxpayers claim the Treasury adopted § 1.58-9 merely to enhance its litigating stance in cases like this.
As to the claim the regulation was enacted merely to bolster the Treasury's litigating position, one court has ruled that "the Commissioner may not take advantage of his power to promulgate retroactive regulations during the course of a litigation for the purpose of providing himself with a defense based on the presumption of validity accorded to such regulations." Chock Full O' Nuts Corp. v. United States, 453 F.2d 300, 303 (2d Cir. 1971). Yet, as the Court of Appeals for the Fifth Circuit noted, "no case has held that the Secretary abused his discretion to promulgate retroactive regulations merely because the regulation at issue affected a legal matter pending before a court at the time the regulation was adopted." Anderson, Clayton & Co. v. United States, 562 F.2d 972, 980 (5th Cir. 1977), cert. denied, 436 U.S. 944, 56 L. Ed. 2d 785, 98 S. Ct. 2845 (1978). In the present case, there is no claim that any specific case was pending at the time the regulation was proposed. Furthermore, taxpayers cite to nothing in the record to support any of their suspicions regarding the Treasury Department's motives in promulgating the regulation, and the case was submitted to the Tax Court fully stipulated. DuPont, 102 T.C. at 2.
In evaluating Treas. Reg. § 1.58-9, we are mindful of the Supreme Court's admonition: "The choice among reasonable interpretations [of the Internal Revenue Code] is for the Commissioner, not the courts." Skinner v. Mid-America Pipeline, 490 U.S. 212, 222, 104 L. Ed. 2d 250, 109 S. Ct. 1726 (1989) (quoting National Muffler Dealers Ass'n v. United States, 440 U.S. 472, 488, 59 L. Ed. 2d 519, 99 S. Ct. 1304 (1979)). After considering the regulation in light of the language of I.R.C. § 58(h), and the purpose behind it, we are satisfied § 1.58-9 constitutes a reasonable interpretation of the statute. Accordingly, we will affirm the judgment of the Tax Court.