The Fact of the Liability Requirement in the All Events Test—Flying Lessons Over the Dark Clouds of General Dynamics from a Giant Eagle

THE FACT OF THE LIABILITY REQUIREMENT 635 The Fact of the Liability Requirement in the All Events Test—Flying Lessons over the Dark Clouds of General Dynamics from a Giant Eagle

PHILIP G. COHEN*

Abstract For taxpayers employing the accrual method of accounting, a liability is generally deductible for federal income tax purposes “in the taxable year in which all the events have occurred that establish the fact of the liability, the amount of the liability can be determined with reasonable accuracy, and economic performance has occurred with respect to the liability.” The first requirement of the all events test, establishing the fact of the liability, was the subject of a thought-provoking Third Circuit decision, Giant Eagle, Inc. v. Commissioner, a case in which the taxpayer prevailed. In Giant Eagle, the dissenting judge, Thomas M. Hardiman, determined that the majority’s reasoning contained a fatal flaw: it did not adequately address the fact that the rebate program established by the taxpayer included an expiration provision on claims not filed within a prescribed time frame. This Article utilizes Giant Eagle to analyze conditions precedent that are real versus those that are mere technicalities, the differences between conditions precedent and conditions subsequent, and the effect of waivers upon establishing the fact of the liability. Other important lessons are garnered from the examination of Giant Eagle, including overcoming the questionable decision of the Supreme Court in United States v. General Dynamics Corp.

* Associate Professor of Taxation, Pace University Lubin School of Business; Retired Vice President-Tax & General Tax Counsel, Unilever United States, Inc.; B.A. New York Univer- sity; J.D. Duke University School of Law; LL.M. (Labor Law & Taxation) New York Univer- sity School of Law; M.B.A. (Accounting) George Washington University. The author thanks Michael Schler and Professor Richard Kraus for their helpful comments on an earlier draft and his graduate teaching assistant, Huirong (Helena) Tang for her assistance with the Article, as well as Professors Cynthia Pittson and Gail Whittemore of the Pace University Elizabeth Haub School of Law Library. All errors, omissions and views, however, are his own.

Tax Lawyer, Vol. 71, No. 3 635 636 SECTION OF TAXATION Table of Contents I. Introduction...... 636 A. The All Events Test—Background and Overview...... 636 B. The Supreme Court’s Analysis of the Application of the First Prong of the All Events Test in United States v. Hughes Properties and United States v. General Dynamics...... 639 II. Giant Eagle v. Commissioner...... 646 A. The Tax Court Decision...... 646 B. The Third Circuit Decision...... 650 C. The Third Circuit Dissent...... 659 D. Condition Precedent, Condition Subsequent & Waivers...... 660 III. Further Observations...... 668 IV. Conclusion...... 671

I. Introduction

A. The All Events Test—Background and Overview For taxpayers utilizing the accrual method of accounting, a liability is generally deductible for federal income tax purposes “in the taxable year in which all the events have occurred that establish the fact of the liability, the amount of the liability can be determined with reasonable accuracy, and economic performance has occurred with respect to the liability.”1 The first requirement, establishing the fact of the liability, was the subject of a thought-provoking Third Circuit decision, Giant Eagle, Inc. v. Commissioner, albeit one with a fatal flaw.2 The decision, in which the taxpayer prevailed, provides important lessons for other taxpayers including overcoming a questionable decision of the Supreme Court in United States v. General Dynamics Corp.3 Despite the taxpayer win in Giant Eagle, Judge Thomas M. Hardiman’s dissent provides further instruction about program design to which similarly situated taxpayers should pay heed. Prior to the enactment of section 461(h) in 1984,4 which added the economic performance requirement, accrual method taxpayers needed to satisfy a two prong all events test, now codified in section 461(h)(4), requiring that “all events have occurred which determine the fact of liability and the amount

1 Reg. § 1.461-1(a)(2)(i). 2 Giant Eagle, Inc. v. Commissioner, 822 F.3d 666 (3d Cir. 2016), nonacq. A.O.D. 2016-03, 2016-40 I.R.B. 424, rev’g T.C. Memo 2014-146 (2014). 3 United States v. Gen. Dynamics Corp., 481 U.S. 239 (1987). 4 Deficit Reduction Act of 1984, Pub. L. No. 98-369, § 91(a), 98 Stat. 494, 598 (1984) (codified as amended at I.R.C. § 461).

Tax Lawyer, Vol. 71, No. 3 THE FACT OF THE LIABILITY REQUIREMENT 637 of such liability can be determined with reasonable accuracy.”5 Section 461(h) (1) added a third requirement relating to timing of the deduction by providing that “the all events test shall not be treated as met any earlier than when economic performance with respect to such item occurs.”6 As the Tax Court observed in VECO Corp. v. Commissioner, “An accrual basis taxpayer claiming that it incurred a liability for Federal income tax purposes must satisfy each of the three requirements under the all events test in order to claim a deduction for the liability.”7 A liability is considered to be “fixed when payment is unconditionally due or when the required performance occurs on the part of the other party.”8 The Tax Court has indicated that “[t]he purpose of . . . [requiring that the fact of liability be established] is to protect tax revenues by insuring that a taxpayer will not take deductions for expenditures that might never occur.”9 In determining whether this first prong of the all events test is met, generally “‘conditions precedent’ (contingencies) will prevent accrual, but ‘conditions subsequent’ will not.”10 “The [first prong of the] all-events test is not satisfied, and a liability not established, by a statistical probability—however high—that the taxpayer will ultimately pay the expense.”11 In their leading treatise, Federal Taxation of Income, Estates and Gifts, Professors Boris T. Bittker and Lawrence Lokken observed, however, that “[t]he all events standard for deductions does not make complete certainty a prerequisite to the accrual of expenses.”12 They further noted that: In commercial practice, many expenses are accrued or paid in circumstances entailing a residual possibility that the liability will be cancelled or the payment refunded because, for example, the goods or services do not meet specifications or the supplier made a misrepresentation or breached a war- ranty. If accrual were postponed until these dormant possibilities evaporat- ed, any hope of matching expenses against revenues would also disappear.13

5 I.R.C. § 461(h)(4). The original all events test became part of the regulations in 1957 upon the adoption of Regulation section 1.461-1 in 1957, T.D. 6282, 1958-1 C.B. 215, 228. 6 Deficit Reduction Act of 1984, Pub. L. No. 98-369, § 91(a), 98 Stat. 494, 598 (1984) (codified as amended at I.R.C. § 461). 7 VECO Corp. v. Commissioner, 141 T.C. 440, 460 (2013). 8 George White, Accounting Methods-General Principles, 570 Tax Mgmt. Port. (BNA) § V.C.1.a (2010) (citing Rev. Rul. 80-230, 1980-2 C.B. 169; Rev. Rul. 79-410, 1979-2 C.B. 213). 9 World Airways, Inc. v. Commissioner, 62 T.C. 786, 802 (1974) (citing Mooney Aircraft, Inc. v. United States, 420 F.2d 400 (5th Cir. 1969)). 10 White, supra note 8, § V.C.1. 11 N.Y. Life Ins. Co. v. United States, 724. F.3d 256, 263 (2d Cir. 2013). 12 Boris T. Bittker & Lawrence Lokken, Federal Taxation of Income, Estates & Gifts ¶ 105.6.3 (3d ed. 2017) (citing Reg. § 1.461-1(a)(2)(ii)). 13 See Bittker & Lokken, supra note 12, ¶ 105.6.3.

Tax Lawyer, Vol. 71, No. 3 638 SECTION OF TAXATION The all events test can be traced to the seminal Supreme Court case, United States v. Anderson.14 In Anderson, corporate taxpayers, both munitions manu- facturers, kept their books using the accrual method of accounting.15 The taxpayers incurred a special profits tax on munitions manufactured by it in 1916 but not assessed and payable until 1917.16 Because income tax rates were higher in 1917 than 1916, the taxpayers wanted to deduct the tax in 1917. The Court held that the tax was deductible in 1916, not 1917, because: In a technical legal sense it may be argued that a tax does not accrue until it has been assessed and becomes due; but it is also true that in advance of the assessment of a tax, all the events may occur which fix the amount of the tax and determine the liability of the taxpayer to pay it. In this respect, for purposes of accounting and of ascertaining true income for a given accounting period, the munitions tax here in question did not stand on any different footing than other accrued expenses appearing on appellee’s books. In the economic and bookkeeping sense with which the statute and Treasury decision were concerned, the taxes had accrued.17 In Brown v. Helvering, the taxpayer was a general agent for fire insurance companies.18 He deducted on his tax return a reserve amount that he had calculated from his prior experience to be a solid estimate of the cost he expected to incur from insurance policy cancellations.19 In sustaining the disallowance of the deductions for the tax years in dispute, the Supreme Court stated that “no liability accrues during the taxable year on account of cancellations which it is expected may occur in future years, since the events necessary to create the liability do not occur during the taxable year.”20 The Court observed that “[e]xcept as otherwise specifically provided by statute, a liability does not accrue as long as it remains contingent.”21 The Supreme Court further noted that “[e]xperience taught that there is a strong probability that many of the policies written during the taxable year will be so cancelled. But experience taught also that we are not dealing here with certainties.”22 Ohmer Register Co. v. Commissioner was decided a few years after Brown and in effect distinguished a contingency or condition precedent from a condition subsequent.23 The taxpayer in Ohmer Register was computing its

14 United States v. Anderson, 269 U.S. 422 (1926). 15 Id. at 435. 16 Id. at 436. 17 Id. at 441. 18 Brown v. Helvering, 291 U.S. 193, 195 (1934). 19 Id. at 197. In court, Brown testified that “[f]rom my experience in the insurance business, I would say that approximately the general ratio of cancellations to business written, depend- ing on the year, runs between 20% and 25%.” Id. at 201 n.7. 20 Id. at 200. 21 Id. 22 Id. at 201. 23 Ohmer Register Co. v. Commissioner, 131 F.2d 682, 686 (6th Cir. 1942).

Tax Lawyer, Vol. 71, No. 3 THE FACT OF THE LIABILITY REQUIREMENT 639 taxable income on an accrual basis.24 It deducted commissions credited to its sales agents at the time the goods it manufactured were shipped.25 The Sixth Circuit upheld the deduction even though the commission could be nullified or reduced by later events such as a customer’s refusal to accept the shipment, “or tender a dishonored check.”26 While the Sixth Circuit cited both Anderson and Brown, it found neither case precedent for the denial of the deduction. Instead, the court stated, “[T]he right to deduct an expense item accrues when the fixed obligation is incurred, even though the amount may be diminished by subsequent events.”27 B. The Supreme Court’s Analysis of the Application of the First Prong of the All Events Test in United States v. Hughes Properties and United States v. General Dynamics The first prong of the all events test has been subject to extensive litiga- tion, including two 1980’s Supreme Court cases decided within a span of less than one year, United States v. Hughes Properties, Inc.28 and United States v. General Dynamics Corp.29 Professor Erik Jensen said of United States v. Hughes Properties and United States v. General Dynamics that “the cases fit together poorly, if at all, and the Court’s attempted reconciliation reflects an analysis made at the most mundane conceptual level.”30 In Hughes Properties, an accrual basis taxpayer owned a gambling casino in Reno, Nevada, which operated slot machines including what are called “progressive” machines.31 The Court, in an opinion authored by Justice Blackmun, explained that “[a] progressive machine, like a regular one, pays fixed amounts when certain symbol combinations appear on its reels . . . [however it also] has an additional ‘progressive’ jackpot, which is won only when a different specified combination appears.”32 With the “progressive” jackpot, the payment builds “according to a ratio determined by the casino, as money is gambled on the machine.”33 The machine’s façade listed the jackpot amount and this payout “continues to increase as patrons play the machine until the jackpot is won or until a maximum, also determined by the casino, is reached.”34 Furthermore, the Nevada Gaming Commission regulations require that the indicated payoff not be reduced without paying the jackpot.35

24 Id. at 683. 25 Id. at 684. 26 Id. at 683. 27 Id. at 686. 28 United States v. Hughes Props., Inc., 476 U.S. 593 (1986). 29 United States v. Gen. Dynamics Corp., 481 U.S. 239 (1987). 30 Erik M. Jensen, The Supreme Court and the Timing of Deductions for Accrual-Basis Taxpay- ers, 22 Ga. L. Rev. 229, 230 (1988). 31 Hughes Props., Inc., 476 U.S. at 595. 32 Id. 33 Id. 34 Id. 35 Id. at 596.

Tax Lawyer, Vol. 71, No. 3 640 SECTION OF TAXATION On its tax return for the years in question, the taxpayer deducted the excess of the “progressive” jackpot sums shown as of the end of its tax year over the prior year’s equivalent figure.36 The Service disallowed these deductions, reasoning that the taxpayer’s “obligation to pay a particular progressive jackpot matures only upon a winning patron’s pull of the handle in the future.”37 The Service’s view was that “until that event occurs [i.e., the winning patron’s pull of the machine’s handle], respondent’s liability to pay the jackpot is contingent and therefore gives rise to no deductible expense.”38 The taxpayer paid the deficiencies, filed claims for refund, and prevailed in both the Claims Court and the Court of Appeals for the Federal Circuit.39 Because of a con- flict between the Federal Circuit Court of Appeals and the Ninth Circuit Court of Appeals,40 the Court granted certiorari.41 The Court noted that the second prong of the all events test, that the amount of the deduction can be reasonably determined, was not an issue in Hughes Properties, because the parties agreed that this requirement was met.42 The Court rejected the government’s assertion that the fact of liability is not satisfied until the lucky gambler wins because, inter alia, “by setting very high odds respondent can defer indefinitely into the future the time when it actually will have to pay off the jackpot.”43 Furthermore, the government contended that the casino could never be subject to payment of the accrued liability if it were to shut down, “sell its business, . . . cease its gaming opera- tions, . . . go into bankruptcy, . . . or . . . patrons stop[ped] playing its slot machines.”44 The Court responded that “this potential nonpayment of an incurred liability exists for every business that uses an accrual method, and it does not prevent accrual.”45 According to the Supreme Court, the taxpayer’s “obligation to pay the indicated amount . . . was not contingent.”46 The Court reasoned “[t]hat an extremely remote and speculative possibility existed that the jackpot might never be won, did not change the fact that, as a matter of state law, respondent had a fixed liability for the jackpot which it could not escape.”47

36 Id. at 597. 37 Id. 38 Id. 39 Id. at 598-99. 40 Id. (citing Nightingale v. United States, 684 F.2d 611 (9th Cir. 1982)). 41 Id. at 599. 42 Id. at 600. Economic performance was similarly not an issue because the tax years in question were prior to section 461(h) becoming effective. See supra notes 4-5. 43 Hughes Props., Inc., 476 U.S. at 601. 44 Id. Professor Erik M. Jensen suggested other events for non-payment including the casino losing its license, or the lucky winner abandoning his jackpot because he wants to protect his identity from the government or his spouse; for example, the lucky winner’s spouse thinks he is elsewhere rather than risking the family savings at a casino. Jensen, supra note 30, at 243-44. 45 Hughes Props., Inc., 476 U.S. at 606. 46 Id. at 601. 47 Id. at 601-02 (footnote omitted).

Tax Lawyer, Vol. 71, No. 3 THE FACT OF THE LIABILITY REQUIREMENT 641 Furthermore, a liability can be fixed, without “the need for identification of the winning player.”48 The Court noted that “[a] part of the machine’s intake was to be paid out, that amount was known, and only the exact time of payment and the identity of the winner remained for the future.”49 Quoting the Second Circuit, the Court opined, “The existence of an absolute liability is necessary [for a liability to be considered fixed]; absolute certainty that it will be discharged by payment is not.”50 The Court distinguished Brown v. Helvering, which the government had heavily relied upon in support of its position. The Court equated the time of the policy cancellation in Brown, not with the jackpot payout, but “the last play of the machine before the end of the fiscal year, since that play fixed the jackpot amount irrevocably.”51 It also indicated that contrary to the government’s contention, Anderson was consistent with the Court’s reasoning. In this regard, the Court analogized the “reserve for munitions taxes”52 in Anderson,53 with “the commitment of a particular portion of the revenue generated to an irrevocable jackpot.”54 The Court similarly rejected the government’s assertion that holding for the taxpayer opened the proverbial floodgates to taxpayer avoidance (e.g., by ratcheting up the odds and placing “extra machines on the floor on the last day of the tax year”).55 The Court responded that first “[n]othing in this record even intimates that respondent used its progressive machines for tax- avoidance purposes.”56 Furthermore, “[i]f a casino manipulates its use of progressive slot machines to avoid taxes, the Commissioner has the power [pursuant to section 446(b)] to find that its accounting does not accurately

48 Id. at 602. 49 Id. at 604. 50 Id. at 606 (quoting Helvering v. Russian Fin. & Constr. Corp., 77 F.2d 324, 327 (2d Cir. 1935)). 51 Id. at 602-03 (citing the Claims Court decision in this case). 52 Id. at 606. 53 Id. 54 Id. 55 Id. at 604. 56 Id. at 605.

Tax Lawyer, Vol. 71, No. 3 642 SECTION OF TAXATION reflect its income and to require it to use a more appropriate accounting method.”57 The Court’s reasoning in Hughes Properties appears sound. There was, however, a dissent in Hughes Properties written by Justice Stevens and joined by Chief Justice Burger, which challenged whether nonpayment of the progressive jackpot was, in fact, remote. The dissent stated, “If the gross amount of the accruals on these machines should ever exceed the net value of the business—perhaps as a result of shrewd management—it could liquidate at a profit without having any liability to anyone for what the Court mistak- enly describes as a ‘fixed liability’. . . .”58 The casino operator could “simply tender . . . its gaming license.”59 The dissent was also troubled by the fact that “the taxpayer has no obligation that could be discharged in a bankruptcy court—a fact that confirms that it has no present liability to pay the jackpots on its progressive slot machines.”60 Finally, the dissent professed that in “no other instance [has] the Commissioner . . . been forced to allow accrual of a deduction when the expense deducted may be avoided entirely at the election of the taxpayer.”61 Coming so soon after Hughes Properties, one might have thought United States v. General Dynamics would be decided for the taxpayer. Instead, by a 5–4 vote in which both Justice Blackmun, who authored the opinion in Hughes Properties, and Justice Stevens, who wrote the Hughes Properties dissent, both dissented, the Court held the first prong of the all events test was not met.62 The Court in General Dynamics, without overruling Hughes Properties, held that an accrual-basis taxpayer that self-insured medical benefits for its employees was not permitted to deduct at the end of the tax year “an estimate of its obligation to pay for medical care obtained by employees

57 Id. In general, a more robust defense to abuses in this area has resulted from Congress’ enactment of the third prong of the “all events” test, economic performance, Pub. L. No. 98-369, § 91(a), 98 Stat. 494, 598 (1984) (codified as amended at I.R.C. § 461). Section 461(h) was not effective for the tax years at issue in both Hughes Properties and General Dynam- ics. Pursuant to section 461(h) and the regulations promulgated thereunder, absent application of the recurring item exception, the deduction for jackpot payouts now does not occur now until the prize is won. See Reg. § 1.461-4(g)(8), Ex. 4. With respect to the recurring item exception, section 461(h)(3) provides an exception from the economic performance limitation for certain recurring liabilities in which “the all events test with respect to such item is met during such taxable year (determined without regard to paragraph [I.R.C. §461(h)](1))” if (1) the taxpayer makes payment within the shorter of “a reasonable period after the close of . . . the taxable year” or “8 1/2 months after the close of such taxable year” and (2) “such item is recurring in nature and the taxpayer consistently treats items of such kind as incurred in the taxable year in which the requirements . . . [for such treatment] are met” and (3) “such item is not a material item, or . . . [this treatment] results in a more proper match against income.” The recurring item exception can apply to jackpot winnings. See Reg. § 1.461-5(b)(5)(ii). 58 Hughes Props., Inc., 476 U.S. at 608-09. 59 Id. at 609. 60 Id. at 608. 61 Id. at 609. 62 United States v. Gen. Dynamics Corp., 481 U.S. 239, 240 (1987).

Tax Lawyer, Vol. 71, No. 3 THE FACT OF THE LIABILITY REQUIREMENT 643 or their qualified dependents during the final quarter of the year, claims for which have not been reported to the employer.”63 Under the General Dynamics plan, employees were required to “submit claims forms to employee benefits personnel, who verify that the treated persons were eligible under the applicable plan as of the time of treatment.”64 The claims were then reviewed and where valid approved for payment, but because of the evaluation process, “there . . . [was] a delay between the provision of medical services and payment by General Dynamics.”65 The taxpayer “established reserve accounts to reflect its liability for medical care received, but still not paid for as of [the end of its tax year] December 31, 1972” which it attempted to deduct in an amended return.66 The Service denied the refund claim, but the taxpayer prevailed in both Claims Court and at the Court of Appeals for the Federal Circuit.67 Unlike Hughes Properties, the Court in General Dynamics found Brown to be persuasive, stating that “[w]e think that this case, like Brown, involves a mere estimate of liability based on events that had not occurred before the close of the taxable year, and therefore the proposed deduction does not pass the ‘all events’ test.”68 Furthermore, as in Brown, the Court expressed the view that satisfaction of the second prong of the all events test (determination of the amount of the liability with reasonable accuracy) does not by itself fix the liability. In other words, the fact that General Dynamics made a “reasonable

63 Id. at 240. 64 Id. at 241. 65 Id. 66 Id. at 241-42. 67 Id. at 242. 68 Id. at 244.

Tax Lawyer, Vol. 71, No. 3 644 SECTION OF TAXATION estimate of how many claims would be filed for the last quarter of 1972 . . . alone does not justify a deduction.”69 According to the Court, in an opinion written by Justice Marshall, the claim’s “filing is not a mere technicality.”70 Instead, the Court maintained that the filing of the claim was “a true condition precedent to liability.”71 The Court observed that “[s]ome covered individuals, through oversight, procrastination, confusion over the coverage provided, or fear of disclosure to the employer of the extent or nature of the services received, might not file claims.”72 The Court opined that “[m]ere receipt of services for which, in some instances, claims will not be submitted does not, in our judgment, constitute the last link in the chain of events creating liability for purposes of the ‘all events’ test.”73 As to why this was different from the fact pattern in Hughes Properties, the Court stated, “Nor does the failure to file a claim represent the type of ‘extremely remote and speculative possibility’ that we held in Hughes.”74 This conclusion appears to be somewhat questionable. Is the likelihood of not filing a medical claim really that much greater than the casino being absolved of its accrued liability from its “progressive” slot machines? This aspect was seized upon by Justice O’Connor in her dissent discussed below.

69 Id. at 245. Interestingly, the second prong of the all events test, which was not an issue in General Dynamics, appeared to be stronger grounds for holding for the government than that the first prong had not been satisfied. Professor Erik M. Jensen commented on this as follows: The General Dynamics Court faced one insuperable problem in denying GD a deduction in 1972, while fitting the analysis comfortably within the traditional cases governing the all events test. The Court was presented with only the fact of liability issue. Because GD’s claimed deduction greatly exceeded its ultimate reimbursement obligation, however, the case is more easily seen as involving the second prong of the test, the amount of the claimed liability. As of the end of taxable year 1972, a year in which medical services had unquestionably been provided to GD employees, all events had occurred to fix the fact of some liability. GD did not know the precise extent of the obligation at that time. Because not all medical costs were eligible for reimbursement, some claims might have been denied in whole or in part. Furthermore, the plan administrator might later have challenged the legitimacy of some claimed expenses. But an obligation existed with respect to any covered and uncontested claims. What was uncertain was the amount of that obligation, and that question had been removed from the Court’s scrutiny. Jensen, supra note 30, at 246-48 (footnotes omitted). 70 Gen. Dynamics, 481 U.S. at 244. It is important to note that the Service has acknowledged that “the establishment of the fact of liability under the all events test is not delayed by an additional requirement in the agreement that a claim or documentation be submitted to obtain payment, if such act is ministerial.” Rev. Rul. 98-39, 1998-2 C.B. 198-99. 71 Gen. Dynamics, 481 U.S. at 244 n.5. 72 Id. at 244. 73 Id. at 245. 74 Id. at 244-45.

Tax Lawyer, Vol. 71, No. 3 THE FACT OF THE LIABILITY REQUIREMENT 645 While of only academic interest, as noted by Professor Erik M. Jensen, the Court “stopped short of fully accepting the government’s proffered theory that both filing and approval of a claim should be necessary to satisfy the all events test.”75 Professors Marvin A. Chirelstein and Lawrence Zelenak in their text were critical of the Court’s reasoning on this facet of the decision. First, they believed that the possibility of not filing a medical claim for reimbursement an employee is entitled to is “pretty remote.”76 Second, they assert that: Rejection of a doubtful claim by the benefit staff following review seems a good deal more likely in a given instance, and one might have thought that if anything qualified as a “last link” it would be the stamp of approval that turned a pending claim into a right to payment.77 Finally, the Court pointed out that the Code “permits insurance companies to deduct additions to reserves for such ‘incurred but not reported claims.’”78 According to the Court, “If the ‘all events’ test permitted the deduction of an estimated reserve representing claims that were actuarially likely but not yet reported, Congress would not have needed to maintain an explicit provision [for] insurance companies . . . .”79 In her well-reasoned dissent80 in General Dynamics, Justice O’Connor, joined by Justices Blackmun and Stevens, stated that “the circumstances of this case differ little from those in Hughes Properties.”81 Justice O’Connor reasoned:

75 Jensen, supra note 30, at 241 (citing Brief for Petitioner, United States v. Gen. Dynamics Corp., 481 U.S. 239 (1987) (No. 85-1385), 1986 WL 727474). 76 Marvin A. Chirelstein & Lawrence Zelenak, Federal Income Taxation: A Law Student’s Guide to the Leading Cases and Concepts 332 (13th ed. 2015). 77 Chirelstein & Zelenak, supra note 76, at 332-33. 78 Gen. Dynamics, 481 U.S. at 246 (citing I.R.C. §§ 832(b)(5), (c)(4)). 79 Id. at 246-47. 80 Professor Deborah A. Geier, for one, did not share this writer’s views on Justice O’Connor’s dissenting opinion, pointing out that it was “too narrow in its approach, focusing on the language of the all events test, wholly detached from the underlying tax values at stake.” Deborah A. Geier, The Myth of the Matching Principle as a Tax Value,15 Am. J. Tax Pol’y 17, 109 (1997). Her criticism was not limited to Justice O’Connor’s decision but embraced both the majority and dissenting opinions in Hughes Properties as well as the majority opinion in General Dynamics. Professor Geier wrote In short, none of the four opinions in Hughes Properties and General Dynamics is commendable in its form and approach to the real tax values at stake and to the history of thought in this area. Through its example, the Court’s opinions cemented a narrow focus on the language of the all events test, though with the economic performance requirement that test becomes less important. It encouraged taxpayers and lower courts to engage in constructing “imagined contingencies” and their likelihood of actual occurrence in determining whether the test was satisfied or whether the contingent liability cases should be deemed to control instead of focusing on the underlying tax values at stake. Geier, supra, at 110 (footnotes omitted). 81 Gen. Dynamics, 481 U.S. at 248 (O’Connor, J., dissenting).

Tax Lawyer, Vol. 71, No. 3 646 SECTION OF TAXATION Once the medical services were rendered to an employee while the relevant benefit plan was in effect, General Dynamics could not avoid liability by terminating the plan prior to the filing of a claim. Neither could General Dynamics extinguish its liability by firing an employee before the employee filed a claim for benefits.82 She equated the possibility an employee would not file the claim form with the jackpot never being paid in Hughes Properties.83 Justice O’Connor argued that, as in Hughes Properties, “the potential of nonpayment of a liability always exists, and it alone does not prevent accrual. The beneficiary of a liability always has the option of waiving payment, but a taxpayer is still unquestionably entitled to deduct the liability.”84 Citing, inter alia, the original all events test Supreme Court decision, Anderson, she asserted that “[e]ven if, in a technical sense, the Court is correct that the filing of a claim is a necessary precondition to liability as a matter of law, the failure to file a claim . . . [is] insufficient to preclude accrual and deductibility.”85 She concluded that “the right to reimbursement for medical benefits . . . at issue in this case arises once medical services are rendered; the filing and processing of a claim is purely routine and ministerial.”86 Finally, Justice O’Connor asserted that by applying the all events test “in an essentially mechanistic and wholly unrealistic manner”87 the Court “unneces- sarily burdens taxpayers by further expanding the difference between tax and business accounting methods without a compelling reason to do so.”88 She lamented that the Court’s action in General Dynamics “ignores the pragmatic roots of the ‘all events’ test.”89 II. Giant Eagle v. Commissioner

A. The Tax Court Decision Giant Eagle, Inc., a Pennsylvania corporation, with its principal place of business in Pittsburgh, Pennsylvania and its subsidiaries (collectively “Giant Eagle” or the “Taxpayer”) filed a consolidated corporate income tax return and used the accrual method of accounting to compute its federal income tax liability.90 During the years at issue, Giant Eagle operated a chain of supermarkets, pharmacies, gas stations, and convenience stores.91

82 Id. at 249 (citation omitted). 83 See id. 84 Id. 85 Id. at 250. 86 Id. 87 Id. at 251. 88 Id. 89 Id. 90 Giant Eagle, Inc., v. Commissioner, 108 T.C.M. (CCH) 67, 67, 2014 T.C.M. (RIA) ¶ 2014-146, at 3. 91 Id. at 67, 2014 T.C.M. (RIA) ¶ 2014-146 at 3.

Tax Lawyer, Vol. 71, No. 3 THE FACT OF THE LIABILITY REQUIREMENT 647 According to the Taxpayer, “The retail sale of groceries and related goods [had] evolved . . . into a high-volume, low-margin business characterized by keen competition among comparatively few, generally substantial retailers.”92 One of the Taxpayer’s strategies for successfully retaining customers and increasing store traffic for groceries and healthcare products was the institu- tion of an incentive, known as “fuelperks!” and the corresponding use by customers of a “Giant Eagle Advantage Card [referred to hereafter as Advantage Card].”93 Under the fuelperks! program: For every qualifying $50 spent [using an Advantage Card at a Giant Eagle or GetGo store customers were entitled to] a 10-cent reduction in the retail price per gallon of gasoline or diesel fuel acquired in one transaction of up to 30 gallons at [Giant Eagle’s] GetGo gas stations.94 This could, if sufficient in total, result in customers obtaining one or more free fill-ups, but the rebates could not be redeemed for cash.95 Participants’ fuelperks! “expired three months after the last day of the month in which they were earned.”96 This latter point, as discussed below, was critical as to why Judge Hardiman dissented from the opinion of the Third Circuit.97 Giant Eagle “deducted the estimated cost of redeeming a certain portion of the issued fuelperks! that were unexpired and unredeemed at the end of each year at issue.”98 The Service disallowed the deduction because it asserted the liability was not fixed at that time and thus did not meet the first prong of the all events test.99 That is, the Service’s view was that the liability did not become fixed until the fuelperks! were actually redeemed.100 The Taxpayer

92 Brief for Appellant at 5, Giant Eagle, Inc. v. Commissioner, 822 F.3d 666 (3d Cir. 2016) (No. 14-3961), 2014 WL 7036144, at *5. 93 Id. at 6-8. 94 Giant Eagle, 108 T.C.M. (CCH) at 67, 2014 T.C.M. (RIA) ¶ 2014-146 at 3-4. According to the government’s brief to the Third Circuit, “Certain price-controlled items, including milk and tobacco, were excluded from the promotion, but most items sold in . . . [the Taxpayer’s] stores were included.” Brief for the Appellee at 4 n.1, Giant Eagle, Inc. v. Commissioner, 822 F.3d 666 (3d Cir. 2016) (No. 14-3961), 2015 WL 416611, at *4 (citations omitted). 95 Giant Eagle, 108 T.C.M. (CCH) at 67, 2014 T.C.M. (RIA) ¶ 2014-146 at 4. 96 Id. at 67, 2014 T.C.M. (RIA) ¶ 2014-146 at 4. 97 Giant Eagle, 822 F.3d at 678. 98 Giant Eagle, 108 T.C.M. (CCH) at 67, 2014 T.C.M. (RIA) ¶ 2014-146 at 4. The Third Circuit opinion in Giant Eagle details how the deduction was computed as follows: 1) ascertaining the total dollar amount spent at its supermarkets on discount-qualifying items, (2) dividing that figure by 50 to determine the number of outstand- ing accumulated discounts, and (3) multiplying the quotient by $.10 to determine the face value of the discounts. Next, Giant Eagle (4) multiplied the discounts’ face value by the historical redemption rate of discounts in their expiring month, and (5) multiplied that product by the average number of gallons purchased in a discounted fuel sale. Giant Eagle, 822 F.3d at 669. 99 Giant Eagle, 108 T.C.M. (CCH) at 68, 2014 T.C.M. (RIA) ¶ 2014-146 at 6. 100 Id. at 68, 2014 T.C.M. (RIA) ¶ 2014-146 at 8.

Tax Lawyer, Vol. 71, No. 3 648 SECTION OF TAXATION had argued that the “program constituted a unilateral contract under which it became legally obligated to redeem fuelperks! as they were accumulated.”101 Note that the Tax Court did not address the other two prongs of the all events test. The Service did not dispute the second prong, the reasonableness of the Taxpayer’s computation of the liability. As to the economic performance requirement, the Taxpayer argued that since the discount program was a “recurring item” within the meaning of I.R.C. § 461(h)(3) and Treas. Reg. § 1.461-5, and all accumulated discounts not claimed by year-end would all be redeemed or expire within three months, it did not have to satisfy the economic performance requirement of the test.102 As to the first prong of the all events test, the Tax Court held that “the purchase of gas was . . . a condition precedent to the redemption of fuelperks!” precluding Taxpayer from obtaining a deduction for the liability until that point in time.103 The Tax Court cited a number of cases including General Dynamics and Hughes Properties although the court acknowledged that “these cases are factually distinct from this case.”104 Although not explicitly stated, presumably the Tax Court equated the redemption of the fuelperks! rebate with the employee’s need to file a properly documented claim for medical benefits in General Dynamics. Giant Eagle cited, as an alternative ground for permitting the deductions, Regulation section 1.451-4(a)(1),105 which provides an exception to the all events test: (1) Subtraction from receipts. If an accrual method taxpayer issues trading stamps or premium coupons with sales, or an accrual method taxpayer is engaged in the business of selling trading stamps or premium coupons, and such stamps or coupons are redeemable by such taxpayer in merchandise, cash, or other property, the taxpayer should, in computing the income from such sales, subtract from gross receipts with respect to sales of such stamps or coupons (or from gross receipts with respect to sales with which trading stamps or coupons are issued) an amount equal to— (i) The cost to the taxpayer of merchandise, cash, and other property used for redemptions in the taxable year.

101 Id. at 68, 2014 T.C.M. (RIA) ¶ 2014-146 at 8-9. 102 Brief for the Appellee at 10, Giant Eagle, 822 F.3d 666 (No. 14-3961), 2015 WL 416611, at *10 (citation omitted). The Taxpayer in its brief to the Third Circuit observed that the “IRS offered no affirmative testimony at trial . . . [regarding whether the Taxpayer met the recurring item exception], and . . . [the Taxpayer’s] witnesses in uncontroverted testimony established that the recurring item exception was adhered to from inception of the fuelperks! program.” Brief for Appellant at 53, Giant Eagle, 822 F.3d 666 (No. 14-3961), 2014 WL 7036144, at *53. 103 Giant Eagle, 108 T.C.M. (CCH) at 68, 2014 T.C.M. (RIA) ¶ 2014-146 at 9 (footnote omitted). 104 Id. at 68, 2014 T.C.M. (RIA) ¶ 2014-146 at 7. 105 Id. at 69, 2014 T.C.M. (RIA) ¶ 2014-146 at 10.

Tax Lawyer, Vol. 71, No. 3 THE FACT OF THE LIABILITY REQUIREMENT 649 (ii) Plus the net addition to the provision for future redemptions during the taxable year (or less the net subtraction from the provision for future redemptions during the taxable year). The Tax Court commented that the purpose of the regulation was “to match sales revenues with the expenses incurred in generating those revenues, and taxpayers are entitled to a present deduction for only the portion of the coupons that will eventually be redeemed.”106 The Taxpayer had asserted that the provision was applicable to its fuelperks! program and it was “thus allowed to offset certain sales revenues by its estimated future costs of redeeming out- standing fuelperks!.”107 The Tax Court rejected the Taxpayer’s position citing Revenue Ruling 78-212.108 While the court acknowledged that it was not bound by a Revenue Ruling, it explained that a Revenue Ruling may be considered based on its “power to persuade.”109 The Tax Court observed that, in Revenue Ruling 78-212: The Commissioner reasoned that applying the section in such circumstances would be inconsistent with the section’s purpose—to match sales revenues with expenses incurred to generate those revenues. According to the revenue ruling, this is because the retailer has no obligation to redeem the coupon until the additional purchase—making the coupon expense at- tributable to the additional purchase and not to the initial purchase with which the coupon was issued.110 The Tax Court reasoned that “[a]llowing a present deduction with respect to redemptions conditioned on an additional purchase can result in a mismatch- ing of expenses and revenues, contrary to the regulation’s primary purpose.”111 The Tax Court indicated that in the case of the fuelperks! program the benefit is “conditioned on a subsequent purchase, making them not redeemable for merchandise, cash and property.”112 Thus, it found Regulation section 1.451-4(a)(1) inapplicable to the Taxpayer’s fact-pattern and sustained the

106 Id. 107 Id. 108 Rev. Rul. 78-212, 1978-1 C.B. 139. 109 Giant Eagle, 108 T.C.M. (CCH) at 69, 2014 T.C.M. (RIA) ¶ 2014-146 at 11. 110 Id. at 69, 2014 T.C.M. (RIA) ¶ 2014-146 at 11. 111 Id. at 69, 2014 T.C.M. (RIA) ¶ 2014-146 at 12. 112 Id.

Tax Lawyer, Vol. 71, No. 3 650 SECTION OF TAXATION Service’s position to deny the deductions in the years claimed.113 The Taxpayer filed an appeal with the Third Circuit. B. The Third Circuit Decision In a 2–1 decision, the Third Circuit reversed the Tax Court and concluded that the Taxpayer in Giant Eagle had satisfied the first prong of the all events test, which was the only element of the all events test contested, and thus was entitled to the deductions claimed.114 The Third Circuit began the substance of its analysis addressing Hughes Properties and General Dynamics. To hold for the Taxpayer, the court had to conclude that Hughes Properties remained via- ble after General Dynamics. Indeed, the court emphasized, “Hughes Properties expressly survives General Dynamics.”115 The majority opinion offered the following attempt to reconcile the two decisions: Whereas the casino operator in Hughes Properties “could not escape” its “fixed liability for the jackpot . . . as a matter of state law,” the General Dynamics

113 While the focus of this Article is on whether or not the Taxpayer met the first prong of the all events test and not the applicability of Regulation section 1.451-4(a)(1), at least one possible line of attack was that fuel could be obtained in theory, without a further purchase. This was however dismissed by Judge Hardiman in his dissent to the opinion of the Third Circuit in Giant Eagle, as follows: As advertised, a fuelperks! reward entitled its holder to “10¢ off every gallon of gas on your next fill-up at GetGo.” App. 1161. Therefore, the benefits provided by fuelperks! were discounts on the purchase price of gasoline, not an entitlement to gasoline itself or the discount’s cash value. This is true even though fuelperks! could be accumulated and redeemed en masse for free gas. In those situations, shoppers did not exchange fuelperks! for gas as such, but rather for a 100% discount on the price of gas—a functional equivalent to be sure, but reflective of an important distinction respect- ing the nature of fuelperks! redeemability. It is this nature of redeemability—i.e., that fuelperks! can be exchanged only for discounts—that leads me to conclude that fuelperks! were not redeemable “in merchandise, cash, or other property.” Giant Eagle, Inc. v. Commissioner, 822 F.3d 666, 679-80 (3d Cir. 2016) (Hardiman, J., dissenting). 114 Giant Eagle, 822 F.3d 666. The second prong of the all events test was not at issue in the case. As to the recurring item exception, the government’s brief only disputes its application “because taxpayer’s liability is not fixed.” Brief for the Appellee at 16, Giant Eagle, 822 F.3d 666 (No. 14-3961), 2015 WL 416611, at *16. The Third Circuit observed: The Commissioner does not contest that fuelperks! rewards qualify as both “a rebate, refund, or similar payment” and a “recurring expense” subject to the less onerous “economic performance” requirement. Moreover, the Commissioner concedes that Giant Eagle calculated its anticipated fuelperks!-related liability “with reasonable accuracy,” and that economic performance had occurred by the time of Giant Eagle’s tax filing. Thus, the only issue on appeal is whether “the fact of liability” was fixed at year’s end—that is, before the end of the tax year, had Giant Eagle become liable to pay the fuelperks! 10-cent discount to its customers who had purchased qualifying groceries with their Advantage Cards. Giant Eagle, 822 F.3d at 670-71 (footnotes omitted). 115 Giant Eagle, 822 F.3d at 671.

Tax Lawyer, Vol. 71, No. 3 THE FACT OF THE LIABILITY REQUIREMENT 651 Court emphasized that employees’ “[m]ere receipt of services . . . does not, in our judgment, constitute the last link in the chain of events creating [employer] liability.”116 While this distinction may be intellectually unsatisfying, it provides a clear lesson for taxpayers with a potential fact of liability issue—Hughes Properties is alive and well, and a taxpayer should attempt to analogize its fact-pattern to fit within its parameters. In holding that the fuelperks! program met the requirement that the liability be fixed, the Third Circuit relied on the reasoning of two decisions in other circuit courts as well as another decision of the Third Circuit. The first case cited by the Third Circuit was Massachusetts Mutual Life Insurance Co. v. United States.117 The issue in that case was whether certain insurance companies were entitled to deduct policyholder dividends declared in boardroom resolutions, that had also been disclosed to state regulators, at the time when the insurance companies guaranteed the dividend (the position of the taxpayers) or when they were actually distributed. In that decision, the Federal Circuit rejected the government’s contention “that, because the liability to pay the dividends at issue is contingent on other events, such as a policyholder’s decision to maintain his or her policy through the policy’s anniver- sary date, the liability has not been established in the year the dividends were determined.”118 Furthermore, the government asserted that the promised

116 Id. (footnotes omitted). In its brief to the Third Circuit, the Taxpayer addressed General Dynamics as follows: However correct General Dynamics may have been on the facts presented, the courts and IRS in its public and private rulings have frequently limited reliance on that decision to the principles that (1) expenses can be accrued and deducted before they become due and payable so long as ‘liability first must be established’ and (2) making a claim or demand for payment is not an impediment to the earlier fixing of liability if the claim form or demand is ministerial or “a mere technicality.” Brief for the Appellant at 28-29, Giant Eagle, 822 F.3d 666 (No. 14-3961), 2014 WL 7036144, at *28-29 (citations omitted). As one would expect, the government’s position in its brief to the Third Circuit expressed a far different view on the application of General Dynamics to the fuelperks! program, writing that: Taxpayer’s discount program is analogous to the fact pattern presented in General Dynamics. Each potential gasoline customer has taken some action (the purchase of $50 in groceries) that renders him preliminarily eligible to receive the payment (a reduction in price on a future purchase of fuel) subject only to other conditions that are within his exclusive control (the decision to buy that fuel, and the election to apply his accumulated discounts to that transaction). Unlike the situation in Hughes Properties, taxpayer’s obligations under the discount program were not irrevocably fixed by state law, but rather were subject to a condition precedent: viz., the customer’s election to purchase fuel and use his discounts. Brief for the Appellee at 28, Giant Eagle, 822 F.3d 666 (No. 14-3961), 2015 WL 416611, at *28. 117 Mass. Mut. Life Ins. Co. v. United States, 782 F.3d 1354 (Fed. Cir. 2015). 118 Id. at 1357.

Tax Lawyer, Vol. 71, No. 3 652 SECTION OF TAXATION dividends were revocable because the policyholders were never informed about the dividends.119 The Federal Circuit observed that: While MassMutual and ConnMutual ultimately would determine the portion of the guarantee eligible policyholders would receive based on the size of the surplus and the number of policyholders who were eligible for the payments, policyholders had a contractual expectation nonetheless that they would receive a policyholder dividend.120 As to the government’s argument that a policyholder could cancel his or her policy, the Third Circuit responded that “[b]ecause MassMutual guaranteed the dividend to a class of policyholders, an individual’s decision to terminate his or her policy does not affect MassMutual’s obligation to pay a dividend to the remaining . . . policyholders.”121 Citing Washington Post Co. v. United States122 as well as Hughes Properties,123 the Federal Circuit stated that “[w]hile the composition of the class could change throughout the year, this does not change the outcome of this case, because not knowing the ultimate recipient of the payment does not prevent a liability from becoming fixed.”124 In other words, the fact that some policies may be cancelled “affects only how much MassMutual would pay the remaining members of the class.”125 The Third Circuit, in Giant Eagle, stressed that “[i]n the court’s [the Federal Circuit in Massachusetts Mutual Life Insurance] view, General Dynamics did not disturb Hughes Properties’ holding that a liability may be fixed in fact without being fixed as to the amount or date of payment.”126 The Giant Eagle court indicated that in Massachusetts Mutual Life Insurance, “[b]ecause boardroom resolutions conclusively established the fact of the life insurance provider’s liability for future dividends, the court held that the anticipated liabilities were not subject to a condition precedent and therefore qualified as deductible expenses under the ‘all events’ test.”127 The Third Circuit next cited Gold Coast Hotel & Casino v. United States in support of its position that the Taxpayer satisfied the establishment of the fact of liability.128 The taxpayer, inGold Coast, utilized the accrual method of accounting. Slot machine players at the taxpayer’s casino received points that they could redeem for prizes. These points were tracked on club cards, which the court said were similar to ATM cards.129 Gold Coast deducted the accrued liability for the points. The Service had contended “that a casino using the

119 Id. at 1362. 120 Id. at 1363. 121 Id. at 1364-65. 122 Wash. Post Co. v. United States, 405 F.2d 1279, 1284 (Ct. Cl. 1969). 123 United States v. Hughes Props., Inc., 476 U.S. 593, 601 (1986). 124 Mass. Mut. Life Ins. Co., 782 F.3d at 1365. 125 Id. 126 Giant Eagle, Inc. v. Commissioner, 822 F.3d 666, 672 (3d Cir. 2016). 127 Id. 128 Gold Coast Hotel & Casino v. United States, 158 F.3d 484 (9th Cir. 1998). 129 Id. at 485.

Tax Lawyer, Vol. 71, No. 3 THE FACT OF THE LIABILITY REQUIREMENT 653 accrual method of accounting does not incur the expense of accumulated slot club points until such time as the points are actually redeemed for a prize because until the time of redemption ‘all events’ fixing the casino’s liability have not occurred.”130 The Ninth Circuit equated Gold Coast to Hughes Properties, maintain- ing that “[h]ere, like the guaranteed prize on the jackpot in Hughes, Gold Coast’s liability to redeem accumulated slot club points is fixed and unconditional under state law once a slot club member accumulates 1,200 points.”131 Furthermore, the court asserted that “the fact that a club member may choose not to redeem his/her points immediately does not render Gold Coast’s otherwise fixed liability conditional.”132 The Ninth Circuit cited Hughes Properties to the effect that in satisfying the first prong of the all events test, “what is critical is the existence of an absolute liability, not an absolute certainty the liability will be discharged by payment.”133 The Third Circuit, in Giant Eagle, quoted this pronouncement with approval.134 As to the Service’s reliance on General Dynamics, the Ninth Circuit in Gold Coast noted that “[s]ubmitting documented proof of a covered claim . . . [in General Dynamics was] found . . . [not to be] a technicality. . . . [In contrast in Gold Coast,] a slot club member’s demand for payment (redemption of points) is a technicality.”135 This reasoning too was cited and endorsed by the Third Circuit in Giant Eagle.136 The Ninth Circuit in Gold Coast noted that “Gold Coast has a fixed, unavoidable, and uncontested obligation to redeem accumulated slot club points for prizes upon demand.”137 The court further asserted that the Service’s position that “the liability represented by an uncontested obligation is not unconditional until such time as it is presented for payment, [would] render . . . the difference between accrual and cash-based accounting methods virtually meaningless.”138 The Ninth Circuit concluded that “demand for payment is not a condition precedent to fixing Gold Coast’s liability.”139 To hold otherwise, according to the Ninth Circuit would be “inconsistent with the express recognition by the Court in General Dynamics that there is a legal difference between a liability being ‘due and payable’ and it being ‘firmly established.’”140 The final case the Third Circuit relied upon was a 1971 decision of the same circuit, Lukens Steel Co. v. Commissioner, a case decided prior to Hughes

130 Id. at 487. 131 Id. at 488. 132 Id. 133 Id. at 489 (referencing United States v. Hughes Props., Inc., 476 U.S. 593, 606 (1986)). 134 Giant Eagle, Inc. v. Commissioner, 822 F.3d 666, 672 (3d Cir. 2016). 135 Gold Coast, 158 F.3d at 490. 136 Giant Eagle, 822 F.3d at 672. 137 Gold Coast, 158 F.3d at 490. 138 Id. 139 Id. 140 Id.

Tax Lawyer, Vol. 71, No. 3 654 SECTION OF TAXATION Properties and General Dynamics.141 In Lukens Steel, an accrual basis taxpayer established a Supplemental Unemployment Benefit Plan (the Plan) “to ame- liorate the effects of cyclical unemployment in the steel industry by supple- menting state unemployment benefits available to laid off employees.”142 For the tax years in question, the employer was required to make a cash contribution of 4.5 cents to the Plan trust for each hour worked by an eligible employee and an additional five cents per hour to be credited to what was referred to as a “contingent liability” account.143 While it was referred to as a “contingent liability” account, the court noted “it was . . . [Lukens Steel’s] fixed and absolute liability and the only uncertainty pertaining to it was the time of payment.”144 The Lukens court upheld the employer’s right to deduct the unpaid liability because it was fixed, that is “at some future date this money would be paid. It was not possible for Lukens to cancel the contingent liability account without paying it to the Union.”145 Critical to the Taxpayer’s successful argument to the Third Circuit in Giant Eagle was its assertion that the fuelperks! program amounted to a unilateral contract “formed at checkout, which conferred instant liability on the supermarket chain to its customers for the rewards they accrued.”146 Thus, once a customer holding an Advantage Card purchased $50 of qualifying goods or services at a Giant Eagle store, the company was “contractually bound under a ‘unilateral contract’ to redeem the fuelperks! earned and was liable for the cost of that redemption.”147 The Third Circuit commented that “[u]nlike bilateral contracts, which are premised on reciprocal promises, ‘unilateral contracts . . . involve only one promise and are formed when one party makes a promise in exchange for the other party’s act or performance.’”148 The Third Circuit pointed out that “[a] unilateral contract also differs from an unen- forceable contingent gift in that a reasonable person would understand that she could accept the offer and reap the promised reward simply by perform- ing the task specified.”149

141 Lukens Steel Co. v. Commissioner, 442 F.2d 1131 (3d Cir. 1971). 142 Id. at 1132. 143 Id. at 1133. 144 Id. at 1135. 145 Id. at 1134. The second sentence was quoted by the Third Circuit in Giant Eagle. See Giant Eagle, Inc. v. Commissioner, 822 F.3d 666, 673 (3d Cir. 2016). 146 Giant Eagle, 822 F.3d at 673. The government had disputed this point. It maintained that there “is no merit to taxpayer’s argument that its discount program is properly treated as a unilateral contract under Pennsylvania law. Rather, the program is, at best, an offer to the customer to take advantage of a reduced price on fuel.” Brief for the Appellee at 16, Giant Eagle, 822 F.3d 666 (No. 14-3961), 2015 WL 416611, at *16. 147 Brief for Appellant at 40, Giant Eagle, 822 F.3d 666 (No. 14-3961), 2014 WL 7036144, at *40. 148 Giant Eagle, 822 F.3d at 673. 149 Id. (footnote omitted).

Tax Lawyer, Vol. 71, No. 3 THE FACT OF THE LIABILITY REQUIREMENT 655 In its brief to the Third Circuit, the Taxpayer discussed a Pennsylvania court decision, Cobaugh v. Klick-Lewis, Inc.150 The case involved a car dealership’s sign on the ninth hole of a golf course promising a specified discounted price for a Chevrolet Beretta for anyone scoring a hole-in-one on the hole.151 Although the car dealership had intended the offer only to apply in conjunction with a charity tournament, the sign remained after the event was over. A lucky golfer achieved the ace two days after the event and claimed the discounted priced car. The Pennsylvania court in holding for the golfer, reasoned that “[i]t is the manifested intent of the offeror and not his subjective intent which determines the persons having the power to accept the offer.”152 The Third Circuit summarized the lesson about unilateral contracts from the Pennsylvania court as follows: “Because ‘the offeror’s manifested intent, as it appeared from signs posted at the ninth tee, was that a hole-in-one would win the car,’ the dealer was liable in accordance with such reasonable expectations.”153 The Third Circuit likened the golfer in Cobaugh to the shopper in Giant Eagle. The court observed that “[l]ike the golfer who teed off with a promise of reward in mind, a customer anticipated the promised fuel discounts when deciding to shop at Giant Eagle in the first place.”154 The court reasoned that the customer may have frequented a Giant Eagle store, instead of a competi- tor, because of the fuelperks! program.155 The Third Circuit pointed out that the Giant Eagle customer with an Advantage Card was “aware that she could apply the discounts as advertised if she spent fifty dollars on supermarket purchases using her Advantage Card.”156 Thus, the court opined that the customer “was indeed a party to a unilateral contract with Giant Eagle. Liability therefore attached upon her performance, i.e., at checkout.”157 The Third Circuit concluded that the Taxpayer had satisfied the requirement that the fact of the liability be established. The court stated that “it is irrelevant that neither the total amount of Giant Eagle’s anticipated liability nor the identity of all the customers who eventually applied discounts

150 Brief for Appellant at 41-43, Giant Eagle, 822 F.3d 666 (No. 14-3961), 2014 WL 7036144, at *41-43 (discussing Cobaugh v. Klick-Lewis, Inc., 561 A.2d 1248 (Pa. Super. Ct. 1989)). 151 Cobaugh, 561 A.2d 1248. 152 Id. at 1251 (citing Restatement (Second) of Contracts § 29 (Am. Law Inst. 1981)). 153 Giant Eagle, 822 F.3d at 673 (quoting Cobaugh, 561 A.2d at 1251). 154 Id. at 674 155 Id. 156 Id. at 674-75. 157 Id. at 675. Had this been a bilateral contract, the analysis would have been quite different. As was stated in Revenue Ruling 2007-3, “It is well established that an accrual basis obligor is not permitted to deduct an expense stemming from a bilateral contractual arrangement, that is, mutual promises prior to the performance of the contracted for services by the obligee.” Rev. Rul. 2007-3, 2007-1 C.B. 350; see, e.g., VECO Corp. v. Commissioner, 141 T.C. 440 (2013); Levert v. Commissioner, 57 T.C.M. (CCH) 910, T.C.M. (P-H) ¶ 89,333 (1989).

Tax Lawyer, Vol. 71, No. 3 656 SECTION OF TAXATION toward gasoline purchases could be conclusively identified at year’s end.”158 Furthermore, the court observed that while “there remained an ‘extremely remote and speculative possibility’ that the amount of Giant Eagle’s claimed deductions would overstate the value of the rewards its customers ultimately redeemed,”159 the court was satisfied with the Taxpayer’s steps in “significantly mitigat[ing] that risk.”160 Absent the provision that fuelperks! had to be redeemed within three full months after the last of the month in which they were earned, there is at least some reasonableness, although certainly not free from dispute, to much of the Third Circuit’s analysis. There was clear precedent that the fact-pattern constituted a unilateral contract fixing Giant Eagle’s liability when the qualifying groceries were purchased. The requirement to receive the rebate by obtaining fuel could, at least in theory, be seen as a technicality. The rebate expiration, however, if generally enforced, should have served to bar the Taxpayer from satisfying the first prong of the all events test. This situation is no different than if the car dealership sign in Cobaugh indicated the car discount is inapplicable to holes-in-one after a certain date and the golfer achieved his ace subsequent to this announced termination. Furthermore, there is no indication that the Taxpayer honored expired rebates, which if it had done so could have created an estoppel for enforcing this requirement. Aside from the Third Circuit’s failure to consider and properly address the fuelperks! expiration provision, there were other aspects of the opinion that can be justifiably criticized. The court should have emphasized that although the word “discount” was used by the Taxpayer itself in its fuelperks! brochure and the reward was structured as a discount on fuel purchases, the fuelperks! program did not require the customer to purchase gas or diesel fuel to obtain the rebate. While generally customers would, in all likelihood, purchase gas or diesel fuel in conjunction with redeeming the rebate, as the Tax Court observed the fuelperks! reward could serve to “reduc[e]… the price for a gallon of gas to zero.”161 The Taxpayer pointed out that “[n]owhere does GE’s [Giant Eagle’s] offer state or require that in order to earn the fuelperks! the customer must purchase fuel. Indeed, many customers received a totally free tank of gas and did not have to purchase any fuel whatsoever.”162 Had there in fact

158 Giant Eagle, 822 F.3d at 675 (footnote omitted). 159 Id. (footnote omitted). 160 Id. 161 Giant Eagle, Inc., v. Commissioner, 108 T.C.M. (CCH) 67, 2014 T.C.M. (RIA) ¶ 2014-146, at 4. 162 Reply Brief for Appellant at 8, Giant Eagle, 822 F.3d 666 (No. 14-3961), 2015 WL 1010931, at *8.

Tax Lawyer, Vol. 71, No. 3 THE FACT OF THE LIABILITY REQUIREMENT 657 been a requirement that fuel be purchased to obtain the fuelperks! bonus, it should then have constituted a non-ministerial condition precedent.163 A related and perhaps more problematic aspect of the opinion was that although no purchase was theoretically required to obtain the fuel, since most customers will presumably claim the incentive in connection with buying gas or diesel fuel, a case can be made that this amounted to a de facto non- ministerial condition precedent. Furthermore, one could argue that obtaining fuel is even less ministerial than the filing of medical claims was in General Dynamics. These latter two points are elaborated upon in Part III. The government’s central argument was that “[a] customer’s purchase of fuel was a condition precedent to the taxpayer’s obligation to honor accumulated discounts”164 and that the “Taxpayer’s discount program is analogous to the fact pattern presented in General Dynamics.”165 The government also raised as an issue the impact of the limitations set forth in the Taxpayer’s fuelperks! program brochure.166 In this regard, the government stated that “by their terms, accumulated program discounts expire three months after the last day of the month in which they are earned.”167 The government further pointed out that “taxpayer’s program materials consistently and unambiguously advised consumers that the taxpayer reserved the right to end the discount program without notice at any time.”168 In effect, the government’s position was that these qualifiers served to potentially nullify taxpayer’s obligation. In contrast, the Taxpayer argued that claiming the fuelperks! rebate was a “ministerial [act] or ‘a mere technicality.’”169 Accordingly, the Taxpayer asserted that customers’ obtaining the fuel “was not a condition precedent to

163 See Spitzer Columbus, Inc. v. Commissioner, 70 T.C.M. (CCH) 448, 450, 1995 T.C.M. (RIA) ¶ 95,397, at 4 (noting that the Tax Court did not permit taxpayer to deduct coupons that were either to be used in conjunction with the purchase of goods or services or in the case of a coupon redeemed for cash “merely began the process of determining whether the consumer was entitled, under the terms of the consent judgment, to a cash rebate.”). 164 Brief for the Appellee at 28, Giant Eagle, 822 F.3d 666 (No. 14-3961), 2015 WL 416611, at *28 (more specifically the government contended that “[u]nder General Dynamics, if the remaining condition to the taxpayer’s obligation with respect to any given consumer—the requirement that the customer purchase fuel, and choose to apply his accumulated discounts to the transaction—was ‘not a mere technicality,’ but instead was ‘crucial to the establishment of liability,’ such that it was a ‘true condition precedent,’ then the obligation did not become fixed until that condition was satisfied.”). 165 Brief for the Appellee at 28, Giant Eagle, 822 F.3d 666 (No. 14-3961), 2015 WL 416611, at *28. 166 Id. at 7 (“During the relevant tax years, the discount program was governed by rules and regulations set forth in a ‘Simple Program Guide’ brochure which . . . [was] provided to [the Taxpayer’s] customers.”). 167 Brief for the Appellee at 34, Giant Eagle, 822 F.3d 666 (No. 14-3961), 2015 WL 416611, at *34. 168 Id. 169 Brief for the Appellant at 29, Giant Eagle, 822 F.3d 666 (No. 14-3961), 2015 WL 416611, at *29.

Tax Lawyer, Vol. 71, No. 3 658 SECTION OF TAXATION GE’s [Golden Eagle’s] Fuel Promotion Liability,”170 and that “[t]he redemption or lack of redemption of earned fuelperks! involves a condition subsequent, rather than a condition precedent.”171 As discussed already and elaborated upon below, this assertion, as it applies to the requirement to claim the incentive within approximately three months of the qualifying purchase was, in all probability, wrong. The Third Circuit, with frustratingly limited explanation, addressed the fuelperks! brochure restrictions by stating, “[B]ut none of the published program parameters suggested that Giant Eagle reserved the right to retract rewards that customers had already accrued.”172 The court also noted that “in the entire history of Giant Eagle’s fuel rewards program, ‘[n]o such retroactive termination ever occurred, or was even contemplated.’”173 While can- celling the program after a customer bought the requisite groceries, could certainly be characterized as a “retroactive termination,” that characterization would appear inappropriate with respect to claiming the discount within “3 months after the last day of the month in which they’re earned.”174 In fact, the approximate three-month expiration of the rebates is tracked and seemingly enforced. The Taxpayer’s brief to the Third Circuit stated that its “fuelperks! accounting system comprehensively captured data identified to each Advantage Cardholder . . . . The data included the dollar amount of Grocery sales; current and accumulated fuelperks! earned, used and expired . . . .”175 The brief observed that Giant Eagle “was bound by the Official Rules, that all earned, unexpired and unredeemed fuelperks! had to be honored upon card- holders’ timely demand and that no earned fuelperks! could, or ever would, be rescinded.”176 An expired fuelperks! reward could not be rescinded because the rebate was, by definition, gone. There is no indication as to why the Third Circuit thought the approximate three-month expiration did not impact the decision’s outcome. Did they believe it should be treated as a condition subsequent and not a condition precedent? While repeated waivers could serve as an estoppel to enforcing a condition, that was not apparently the case with the expiration provision. For the dissent, the approximate three-month expiration feature crossed the Rubicon.

170 Reply Brief for the Appellant at 15, Giant Eagle, 822 F.3d 666 (No. 14-3961), 2015 WL 1010931, at *15. 171 Id. at 17. 172 Giant Eagle, 822 F.3d at 674. 173 Id. (footnote omitted). 174 Id. 175 Brief for Appellant at 17-18, Giant Eagle, 822 F.3d 666 (No. 14-3961), 2014 WL 7036144, at *17-18 (emphasis added). 176 Id. at 14 (emphasis added).

Tax Lawyer, Vol. 71, No. 3 THE FACT OF THE LIABILITY REQUIREMENT 659 C. The Third Circuit Dissent In his dissenting opinion, Judge Thomas M. Hardiman pointed out that by virtue of the precedent of Cobaugh v. Klick-Lewis, Inc., “Giant Eagle’s advertisements constituted an offer to its shoppers to enter into a unilateral contract for the opportunity to redeem fuelperks! for discounted gas by purchasing $50 or more in groceries.”177 He then asserted that “[n]evertheless, the liabilities that accrued to Giant Eagle on account of its fuelperks! program were not absolute.”178 For Judge Hardiman, the fatal flaw to the fact of the liability being established in Giant Eagle was that “Giant Eagle made each liability temporary by providing that ‘fuelperks! discounts expire 3 months after the last day of the month in which they’re earned.’”179 While Judge Hardiman didn’t dispute the truth of the majority’s comments that “none of the published program parameters suggested that Giant Eagle reserved the right to retract rewards that customers had already accrued”180 and “[n]o such retroactive termination ever occurred, or was even contemplated,”181 he essentially found these to be irrelevant at least with respect to the approximate three-month expiration provision.182 Judge Hardiman wrote that these statements “do not change the fact that the company’s liabilities were extinguishable.”183 He wrote that the “expiration has the effect of eliminating liability for the benefit of Giant Eagle.”184 While apparently not itself decisive for him,185 Judge Hardiman was also perturbed that the majority had engaged in “a conversion of Giant Eagle’s individual liabilities into a group liability.”186 Judge Hardiman stated that “its liabilities [to shoppers using the Advantage Card and purchasing $50 worth of qualifying groceries] were several and fixed on an individual basis.”187 Judge Hardiman asserted that the majority’s analysis was faulty in “treating the company’s numerous individual liabilities as an amalgamation.”188

177 Giant Eagle, 822 F.3d at 677 (Hardiman, J., dissenting). Judge Hardiman’s dissent also concluded that “[b]ecause fuelperks! are not redeemable ‘in merchandise, cash, or other property,’ I agree with the Tax Court and would hold that § 1.451-4(a)(1) does not authorize Giant Eagle’s deductions.” Id. at 679. 178 Id. 179 Id. 180 Id. at 674. 181 Id. 182 Id. at 677. 183 Id. 184 Id. 185 Judge Hardiman commented later in the dissenting opinion, “Had Giant Eagle not included an expiration provision in its terms and conditions, I would be inclined to agree with my colleagues that the company incurred a fixed and absolute liability to each shopper at checkout.” Id. at 678. He did say, however, that “[t]his errant tack is critical because whether liability is fixed on an individual or collective basis is a ‘significant’ fact with the potential to ‘dictate . . . different outcome[s]’ in our cases.” Id. 186 Id. at 677. 187 Id. at 678. 188 Id.

Tax Lawyer, Vol. 71, No. 3 660 SECTION OF TAXATION He believed that Giant Eagle was different from, for example, Massachusetts Mutual because the “insurance company [MassMutual] determined the fact of its liability to make dividend payments to a class of policyholders after the board of directors ‘passed an absolute resolution to pay the guaranteed dividend and . . . at least some policyholders were already qualified recipients of that guarantee.’”189 That is, the total amount of the dividend is certain, just not who the recipients would be. Judge Hardiman’s point here is well taken. Of even more importance was Judge Hardiman’s comment that “the fact that the store did include an expiration provision—thereby conditioning its liability to each shopper upon fuelperks! redemption at a Giant Eagle-owned gas station within approximately 3 months’ time—made ‘redemption’ a condition precedent to the establishment of an absolute liability.”190 Interestingly, Judge Hardiman ignored the other limitations in the fuelperks! program brochure including that the promotion “may end at any time without prior notice”191 which he may have viewed as a condition subsequent or something Giant Eagle was estopped from asserting, or both. As quoted above, Judge Hardiman referred to the approximate three-month redemption period as a “condition precedent” without any discussion of condition precedent versus condition subsequent, something also ignored by the majority. It is critical to analyze whether this provision constituted a condition precedent or condition subsequent. The Article also examines what result should have occurred if Giant Eagle had not tracked and enforced the expiration provision. D. Condition Precedent, Condition Subsequent & Waivers In his text Accounting Methods-General Principles, George White wrote that “[i]f the taxpayer’s obligation is fixed, the possibility that the liability might be reduced or eliminated by later events or amounts paid returned is

189 Id. at 676; see also Mass. Mut. Life Ins. Co. v. United States, 782 F.3d 1354, 1364-65 (Fed. Cir. 2015) (“[B]ecause MassMutual guaranteed the dividend to a class of policyholders, an individual’s decision to terminate his or her policy does not affect MassMutual’s obligation to pay a dividend to the remaining members of the class of policyholders.”). 190 Giant Eagle, 822 F.3d at 678 (Hardiman, J., dissenting). 191 Id. at 674.

Tax Lawyer, Vol. 71, No. 3 THE FACT OF THE LIABILITY REQUIREMENT 661 ignored.”192 He indicated that “[c]ourts frequently refer to the distinction as being between conditions precedent and conditions subsequent.”193 Assuming arguendo that the time limitation for redeeming the discount served in fact as a condition precedent as asserted by Judge Hardiman, had Giant Eagle’s practice been to honor late claims, would it have served to waive its rights? The renowned treatise Williston on Contracts answered this question as follows: Under the doctrine of implied waiver, a waiver of contractual rights may be found to exist when there is either an intention to waive, clearly inferable from the parties’ actions and conduct, or no intention in fact to waive, but conduct by one party which misleads the other into a reasonable belief that a provision of the contract has been waived, or that the first party will not insist on compliance with it. A condition precedent to performance may be said to be waived by estoppel when a promisor’s words or conduct justify the promisee in believing that a conditional promise will be performed despite the failure of the condition to occur or be performed, and the promisee relies on the promisor’s manifestations to its substantial detriment.194 The Williston treatise then provides an alternative ground for waiving a contractual right as follows: In contrast to a true waiver by implication, a waiver by estoppel implied from conduct focuses not on the intent or purpose of the waiving party but on the effect of its conduct on the other party. It is not the intention of the party estopped but the natural effect on the other party which gives vitality to an estoppel. To prove waiver by estoppel, a party need only show that it was misled to its prejudice by the conduct of the other party into the honest and reasonable belief that the latter was not insisting on, and was therefore giving up, some right. It is the justifiable belief of the party relying on the waiver which is the essential element. The waiver and the effect of the conduct on the party relying on it may have been unintentional, but a waiver is nevertheless properly found because the estopped party reasonably should

192 White, supra note 8, § V.C.1.a.(1). The terminology “condition precedent” and “condition subsequent” has been subject to criticism and the Restatement (Second) of Contracts eliminates the terms with the Reporter’s Note indicating that “conditions precedent are referred to simply as ‘conditions.’” See Restatement (Second) of Contracts § 224 reporter’s note (Am. Law Inst. 2017). TheRestatement (Second) of Contracts provides that the term “‘[c]ondition’ is used in this Restatement to denote an event which qualifies a duty under a contract.” See Restatement (Second) of Contracts § 224 cmt. a. (Am. Law Inst. 2017). According to the Reporter for the Restatement of Contracts (Second) § 224, while some courts describe a condition as something “that must be performed before the contract comes into existence . . . it is better to view a contract as already in existence, but with the parties’ respective performances subject to the specified event, which is a condition to their respective performances.” See Restatement (Second) of Contracts § 224 reporter’s note (Am. Law Inst. 2017). 193 White, supra note 8, § V.C.1.a.(1). 194 Richard A. Lord, 13 Williston on Contracts § 39:29 (4th ed. 2017) (footnotes omitted).

Tax Lawyer, Vol. 71, No. 3 662 SECTION OF TAXATION have expected that its actions would induce reliance by the party claiming that a waiver occurred.195 Thus, had the Taxpayer in Giant Eagle consistently ignored the approximate three-month redemption expiration, one could presumably treat the distinction between conditions precedent and conditions subsequent as academic. But the Taxpayer did not ignore the redemption expiration, despite some language in the majority opinion that could be construed as somewhat unclear.196 Absent the termination specification in the fuelperks! program, Judge Hardiman indicated he “would be inclined to agree with my colleagues that the company incurred a fixed and absolute liability to each shopper at checkout.”197 One clear lesson, for other similarly situated taxpayers, is to eschew such a provision. According to Williston on Contracts, “[a] condition precedent . . . must be performed or happen before a duty of immediate performance arises on the promise which the condition qualifies.”198 The text further provides that “[a] condition precedent is either an act of a party that must be performed or a certain event that must happen before a contractual right accrues or a contractual duty arises.”199 The treatise quotes courts that “[a] condition precedent may relate either to the formation of contracts or to liability under them.”200 In contrast to a condition precedent, Williston on Contracts defines a condition subsequent “as a future event, the happening of which discharges the parties from their otherwise binding agreement.”201 The text compares the terms as follows: “The term ‘condition subsequent,’ as normally used in contracts in contrast to ‘condition precedent,’ should mean an event which occurs subsequent to a duty of immediate performance, that is, a condition which divests a duty of immediate performance of a contract after it has once accrued and become absolute.”202 The Williston treatise stresses that “[t]rue conditions subsequent are very rare in the law of contracts.”203 It explains that “they do exist . . . most com-

195 Lord, supra note 194 (footnote omitted). 196 The Third Circuit commented that “none of the published program parameters suggested that Giant Eagle reserved the right to retract rewards that customers had already accrued . . . . ‘[n]o such retroactive termination ever occurred, or was even contemplated.’” Giant Eagle, 822 F.3d at 674. 197 Id. at 678 (Hardiman, J., dissenting). 198 Lord, supra note 194, § 38:7 (footnote omitted). 199 Lord, supra note 194, § 38:7 (footnote omitted). 200 Lord, supra note 194, § 38:7 (footnote omitted). 201 Lord, supra note 194, § 38:9 (footnote omitted). 202 Lord, supra note 194, § 38:9 (footnote omitted). 203 Lord, supra note 194, § 38:9.

Tax Lawyer, Vol. 71, No. 3 THE FACT OF THE LIABILITY REQUIREMENT 663 monly in insurance contracts.”204 Another example the treatise provides of a condition subsequent is in an “agreement for the sale of goods [with the immediate obligation to pay the price upon sale] with a right to return [the goods where the duty to pay] . . . although violated by the failure to pay at once, may be divested by the return of the goods.”205 In its brief to the Third Circuit in Giant Eagle, the government cited the Restatement (Second) of Contracts, which states that “a duty may be conditioned upon the failure of something to happen rather than upon its happening, and in that case its failure to happen is the event that is the condition [precedent].”206 The Restatement further explains: Occasionally, although the language of an agreement says that if an event does not occur a duty is ‘extinguished,’ ‘discharged,’ or ‘terminated,’ it can be seen from the circumstances that the event must ordinarily occur before performance of the duty can be expected. When a court concludes that, for this reason, performance is not to become due unless the event occurs, the event is, in spite of the language, a condition of the duty.207 As noted, the Restatement refers to “conditions precedent” simply as “conditions.”208 In short, the government’s position was that the Restatement supports treating the approximate three-month time frame for claiming the gasoline-diesel fuel discount as a condition or a condition precedent, and not a condition subsequent. In contrast, the Taxpayer argued: The redemption or lack of redemption of earned fuelperks! involves a condition subsequent, rather than a condition precedent . . . if redemption does not occur, say because of expiration of fuelperks! under the terms of the program rules, tax accrual precedent has explicitly held that the possibility of such an expiration is properly treated as a condition subsequent to the earlier fixing of liability.209 The Taxpayer relied principally on the Tax Court decision in Burnham Corp. v. Commissioner,210 and to a lesser extent on an earlier Tax Court decision,

204 Lord, supra note 194, § 38:9. 205 Lord, supra note 194, § 38:9 (footnote omitted). 206 Brief for the Appellee at 29, Giant Eagle, Inc. v. Commissioner, 822 F. 3d 666 (3d Cir. 2016) (No. 14-3961), 2015 WL 416611, at *29 (footnote omitted). 207 Restatement (Second) of Contracts § 224 cmt. e (Am. Law Inst. 2017) (occurrence of event as discharge). 208 Restatement (Second) of Contracts § 224 reporter’s note (Am. Law Inst. 2017). 209 Reply Brief for the Appellant at 17-18, Giant Eagle, Inc. v. Commissioner, 822 F.3d 666 (3d Cir. 2016) (No. 14-3961), 2015 WL 1010931, at *17-18 (citations omitted). 210 Burnham Corp. v. Commissioner, 90 T.C. 953 (1988), aff’d, 878 F.2d 86 (2d Cir. 1989).

Tax Lawyer, Vol. 71, No. 3 664 SECTION OF TAXATION Wien Consolidated Airlines, Inc. v. Commissioner,211 both discussed below. It also asserted that the Tax Court’s footnote 5 reference regarding conditions precedent in Giant Eagle “truncated and unfairly paraphrased the headnote” from American Jurisprudence.212 Footnote 5 of the Tax Court opinion provided that “[a] condition precedent is some act or event that must occur before the duty of immediate performance of a promise arises.”213 The Taxpayer asserted that “American Jurisprudence digests are not authority in Pennsylvania, and the rule in the headnote to which the Tax Court alluded actually involved the obligor’s need to perform an existing contract.”214 It then maintained that “[i]n that context, the obligation had already arisen, and the condition addressed was a condition subsequent.”215 The American Jurisprudence summary of the law in this area clearly con- tradicts the Taxpayer’s contention. The latest American Jurisprudence revised summary of “types of conditions precedent” provides: There are two types of conditions precedent. A condition may be either a condition precedent to the formation of a contract or a condition precedent to performance under an existing contract. That is, conditions precedent may relate to either the formation of contracts or to liability under them.216 In the case of a condition precedent to formation of a contract, the contract does not exist unless and until the condition occurs. Thus, no binding contract is formed when a condition precedent to its formation never occurs. In the case of a condition precedent to performance, a contract exists that may be enforced pursuant to its terms.217 Under this analysis, if the customer in Giant Eagle did not redeem the rebate within the prescribed period, the customer did not satisfy the condition precedent to Giant Eagle’s performance, thus relieving Giant Eagle of liability for the rebate. A timely redemption constituted “a condition precedent to performance under an existing contract.”218 This conclusion is supported by the Supreme Court in BG Group, PLC v. Republic of Argentina, which

211 Wien Consolidated Airlines, Inc. v. Commissioner, 60 T.C. 13 (1973), aff’d, 528 F.2d 735 (9th Cir. 1976). Both Wien and Burnham were cited in the Reply Brief for the Appellant at 18, Giant Eagle, 822 F.3d 666 (No. 14-3961), 2015 WL 1010931, at *18, and Burnham was extensively discussed in the Brief for Appellant at 50-51, Giant Eagle, 822 F.3d 666 (No. 14-3961), 2014 WL 7036144, at *50-51. 212 Brief for Appellant at 49, Giant Eagle, 822 F.3d 666 (No. 14-3961), 2014 WL 7036144, at *49. 213 Giant Eagle, Inc. v. Commissioner, 108 T.C.M. (CCH) 67, 68 n.5, 2014 T.C.M. (RIA) ¶ 2014-146, at 9 n.5 (citing 17A Am. Jur. 2d Contracts § 458 (2014)). 214 Brief for Appellant at 50, Giant Eagle, 822 F.3d 666 (No. 14-3961), 2014 WL 7036144, at *50 (footnote omitted). The American Jurisprudence section cited by the Tax Court in Giant Eagle is now revised and set forth in 17A Am. Jur. 2d Contracts § 447 (2017). 215 Brief for Appellant at 50, Giant Eagle, 822 F.3d 666 (No. 14-3961), 2014 WL 7036144, at *50. 216 17A Am. Jur. 2d Contracts § 448 (2017) (footnotes omitted). 217 Id. 218 Id.

Tax Lawyer, Vol. 71, No. 3 THE FACT OF THE LIABILITY REQUIREMENT 665 quoted Williston on Contracts when it stated that “a ‘condition precedent’ determines what must happen before ‘a contractual duty arises’ but does not ‘make the validity of the contract depend on its happening.’”219 As to the treatment and distinction of conditions precedent and conditions subsequent in the federal income tax area, an important early case is Helvering v. Russian Finance & Construction Corp.220 In this case, the taxpayers kept their books on the accrual basis. They had entered into a long-term agreement to purchase ore from an organization of Russian producers, which agreement required the payment of royalties.221 The contract provided that the taxpayer was to be discharged from its obligation upon the occurrence of three specified events:222 (1) Termination of the agreement between the taxpayer and the Soviet Gov- ernment before its expiration, for any cause except breach of the agreement by the taxpayer; (2) Breach of the agreement by the promisee; (3) The existence of a strike sufficient in magnitude seriously to have handi- capped the mining and delivery of the ore for one year.223 The taxpayers deducted their accrued liability to make royalty payments under the contract. In upholding the taxpayers’ royalty deduction, the Second Circuit characterized these three events as “conditions subsequent” that “[do] not prevent its accrual on the taxpayer’s books.” 224 The court indicated that: It was . . . possible that the expense might never be actually incurred. The occurrence of any one of three contingencies would relieve the taxpayer from the liability he incurred upon delivery of the ore. But the taxpayer had a reasonable expectancy at the time it accrued this liability on its books that its liability would be enforced.225 While the case is certainly supportive of treating the Taxpayer’s right, in Giant Eagle, to cancel the program at any time as a condition subsequent not impacting the fact of liability being established, it does not support treating the requirement of a timely redemption of the discount as a condition subsequent. In both its initial and reply brief to the Third Circuit in Giant Eagle, the Taxpayer emphasized the importance of the Tax Court decision in Burnham as

219 BG Grp., PLC v. Republic of Arg., 134 S. Ct. 1198, 1207 (2014) (quoting Richard A. Lord, 13 Williston on Contracts § 38:7-8 (4th ed. 2013)). 220 Helvering v. Russian Fin. & Constr. Corp., 77 F.2d 324 (2d Cir. 1935). 221 Id. at 326. 222 Id. 223 Id. 224 Id. at 327. 225 Id.

Tax Lawyer, Vol. 71, No. 3 666 SECTION OF TAXATION to the distinction between condition precedent and condition subsequent.226 In Burnham, an accrual basis taxpayer was a defendant in a patent infringe- ment lawsuit. In settling the claim, the taxpayer was required to pay one Mrs. Reichhelm $1,250 per month for the rest of her natural life, except that it was unconditionally obligated to pay her $60,000 “regardless of whether . . . [she] continued to live.”227 In its 1980 tax return, Burnham deducted the estimated future payment obligation based on Mrs. Reichhelm’s actuarially estimated life expectancy.228 In Burnham, the court stated: If existence of a liability depends on satisfaction of a condition precedent, the liability is not unconditionally fixed as required by the first requirement of the all events test. Liability does not in fact arise until the condition is satisfied. A taxpayer is, therefore, prevented from obtaining the benefit of a deduction for an expense that he has no liability to pay until some event, other than the passage of time, occurs. A liability subject to a condition subsequent, however, is definitely fixed, subject only to a condition which may cut off liability in the future. An accrual basis taxpayer having such a liability may deduct an expense for which it is presently liable.229 The Tax Court opined that Burnham’s “liability was irrevocably fixed by the settlement agreement.”230 The Tax Court wrote that “[t]he death of Mrs. Reichhelm is a condition subsequent which will terminate, not the fact of petitioner’s liability, but its obligation to pay under the settlement agreement.”231 As a result, the Tax Court observed that “while her death may affect the amount of petitioner’s liability, it will not affect the fact of petitioner’s liability.”232 The Tax Court’s reasoning could, at least superficially, be construed as applicable to that of Giant Eagle in that an event in the future— Mrs. Reichelm’s death and a Giant Eagle customer’s failure to redeem the gasoline discount within the approximate three-month time frame—could serve to terminate liability of the companies. This assumes, I believe incor- rectly, that in such circumstances a liability was deemed to arise in Giant Eagle in the first instance in situations where the rebate was not claimed within the prescribed period. The reasoning of the Second Circuit inBurnham Corp. v. Commissioner serves to further differentiate it fromGiant Eagle.233 The Second Circuit

226 Brief for the Appellant at 50-51, Giant Eagle, Inc. v. Commissioner, 822 F.3d 666 (3d Cir. 2016) (No. 14-3961), 2014 WL 7036144, at *50-51; Reply Brief for Appellant at 18, Giant Eagle, 822 F.3d 666 (No. 14-3961), 2015 WL 1010931, at *18. 227 Burnham Corp. v. Commissioner, 90 T.C. 953, 954 (1988), aff’d, 878 F.2d 86 (2d. Cir. 1989). 228 Id. 229 Id. at 956. 230 Id. at 958. 231 Id. 232 Id. 233 Burnham Corp. v. Commissioner, 878 F.2d 86 (2d. Cir. 1989).

Tax Lawyer, Vol. 71, No. 3 THE FACT OF THE LIABILITY REQUIREMENT 667 opined that “[w]e do not believe that Reichhelm’s continued survival should be viewed as an ‘event’ for purposes of the all events test. . . . Since Reichhelm’s survival is merely a continuation of the status quo, we do not see it as an ‘event’ . . . .”234 This is clearly different from Giant Eagle where under the fuelperks! program terms there is a critical second event (after the purchase of qualifying groceries): if the requirement of claiming the reward within the prescribed time does not occur, the Taxpayer’s obligation extinguishes. Another decision cited by the Taxpayer for treating the approximate three- month termination and other limitations to the fuelperks! program as conditions subsequent is Wien. The case, like Burnham, involved a taxpayer’s liability impacted by the longevity of the payees’ lives. The taxpayer in Wein operated a commercial airline that employed, among others, pilots.235 The taxpayer had self-insured under the applicable workmen’s compensation statute.236 It did, however, carry life insurance on its pilots and other flight personnel.237 In its fiscal 1962 tax year three of its pilots died in airplane crashes.238 Under the Alaskan statute the taxpayer’s obligation to the deceased pilot’s family members “continued to each widow until her death or remar- riage. Payments are made to each child until he reaches age 19, subject to termination upon death.”239 In its fiscal 1962 tax return, Wien “claimed a deduction for the accrual of its estimated liability [to the deceased pilot’s family members] in excess of . . . [its] insurance.”240 In Wien, the Tax Court found that the first prong of the all events test had been satisfied.241 In finding the fact of liability had been established, the court stated, “When each of the pilots died, petitioner’s liability under the Alaska Workmen’s Compensation Act came into existence.”242 The Tax Court distinguished a condition subsequent, which it found in this case, from a condition precedent, as follows: The term “condition subsequent” defines a provision, the occurrence of which will terminate an existing liability. Condition precedent defines a provision which must occur before liability arises. The contingencies contained in the statute were of such a nature that they might terminate the existing liability. Therefore, they were conditions subsequent and not conditions precedent as respondent contends.243

234 Id. at 88. 235 Wien Consolidated Airlines, Inc. v. Commissioner, 60 T.C. 13, 14 (1973), aff’d, 528 F.2d 735 (9th Cir. 1976). 236 Id. 237 Id. 238 Id. 239 Id. 240 Id. 241 Id. at 15. 242 Id. 243 Id.

Tax Lawyer, Vol. 71, No. 3 668 SECTION OF TAXATION The Wien language can be read to undercut the Taxpayer’s position because the language in Wien suggests that the liability in Giant Eagle never arose for rebate claims not timely filed by Giant Eagle customers. III. Further Observations In General Dynamics, the Supreme Court was wrong to conclude that “the failure to file a claim [did not] represent the ‘type of extremely remote and speculative possibility’ that we held in Hughes . . . did not render an otherwise fixed liability contingent.”244 How likely is it that a General Dynamics employee who incurred medical costs for which he is entitled to reimbursement will not file a claim because of “oversight, procrastination, confusion over the coverage provided, or fear of disclosure to the employer of the extent or nature of the services received”?245 The probability of not filing a claim in General Dynamics does not appear so much greater than the casino not making a payment in Hughes. In an article written before General Dynamics was decided by the Supreme Court, Professor Erik Jensen wrote that “[i]n light of precedent, including Hughes Properties, the Court should affirm the decision of the Federal Circuit.”246 He argued: Once medical services were provided to an employee, GD [General Dynam- ics] incurred a fixed obligation to reimburse the employee for the expenses covered by the plan. That the ultimate beneficiaries and the precise time of payment were unknown at the time of the deduction does not matter.247 Furthermore, he asserted that “[r]emote possibilities, such as an employee’s not filing a claim, should not defeat liability.”248 Professor Jensen analogized filing of medical claims to a mechanic providing services. He indicated that “[t]he theoretical possibilities that the mechanic might not submit a bill or might not press for payment after . . . he has performed his contractual obligation—the conceptual equivalents of an employee’s failure to file a claim—have never been considered fatal contingencies.”249 At least on the surface, an argument for the result in General Dynamics is that the filing of the claim was a condition precedent to the employer’s liability. The Court noted that “[e]mployees were informed that submission of satisfactory proof of the charges claimed would be necessary to obtain

244 United States v. Gen. Dynamics Corp., 481 U.S. 239, 244-45 (1987). 245 Id. at 244. 246 Erik M. Jensen, Hughes Properties and General Dynamics: The Supreme Court, the All Events Test, and the 1984 Tax Act, 32 Tax Notes (TA) 911, 920 (1986). 247 Jensen, supra note 246 (footnote omitted). 248 Jensen, supra note 246. 249 Jensen, supra note 246, at 920-21 (footnote omitted). After the article was written, the Service essentially acknowledged the validity of Professor Jensen’s statement in Rev. Rul. 98-39, 1998-2 C.B. 198, with respect to the fact of liability being established in year 1 for cooperative advertising services incurred that year (i.e., year 1, by a retailer, when the claim was not submitted until year 2).

Tax Lawyer, Vol. 71, No. 3 THE FACT OF THE LIABILITY REQUIREMENT 669 payments under the plans.”250 Under these circumstances, according to the Court, “General Dynamics was thus liable to pay for covered medical services only if properly documented claims forms were filed.”251 The issue was whether such a condition precedent was substantive or merely ministerial. While the Court indicated that filing of the claim was “not a mere technicality,” this conclusion is dubious.252 Redeeming accumulated slot points was a condition precedent in Gold Coast, nevertheless the Ninth Circuit found it did not serve as a bar to the taxpayer’s fact of liability being established because it was a technicality. As the Taxpayer in Giant Eagle asserted, even Hughes Properties involved a technical condition precedent in that “the winning slot player would have to deposit a coin or chip in the slot machine to purchase a play and then make the winning pull of the arm.”253 Except for very limited instances, the General Dynamics liability was fixed when the medical procedure was incurred and filing of the claims should have been construed as a ministerial act. As Professors Chirelstein and Zelenak comment: [T]he possibility that an employee might fail (through oversight, etc.) to file a reimbursement claim does seem pretty remote, or at least quite unlikely, for the obvious reason that anyone who thinks herself entitled to reimbursement—especially for a sizeable doctor’s bill—is almost certainly going to ask for it.254 In a later article, written after the Supreme Court decided General Dynamics, Professor Erik Jensen observed that the decision “represents a retreat from the principle that an obligation may exist although there is a possibility that it will not be paid.”255 The case puts taxpayers and their advisors as well as the courts in a quandary as to when the first prong of the all events test will be considered satisfied in somewhat comparable circumstances (i.e., where the condition precedent appears to be merely technical in nature). Absent the Third Circuit’s failure to address and give proper consideration to the issue of the expiration of the fuelperks!, there could be some justifica- tion for the result reached by the Third Circuit. The court may have reached a reasonable result by preventing a ministerial action (timely redemption) from delaying the Taxpayer’s deduction. While the obligation to fuel one’s car to obtain the rebate was a condition precedent that had to be performed before Giant Eagle’s contractual duty arose, could that requirement be viewed, at

250 Gen. Dynamics, 481 U.S. at 244. 251 Id. (footnote omitted). 252 Id. 253 Reply Brief for the Appellant at 15-16, Giant Eagle, Inc. v. Commissioner, 822 F.3d 666 (3d Cir. 2016) (No. 14-3961), 2015 WL 1010931, at *15-16. 254 Chirelstein & Zelenak, supra note 76, at 332. Unlike the Court, they did, however, think the claims review process more significant. Supra note 76, at 332-33. 255 Jensen, supra note 30, at 245-46 (footnote omitted).

Tax Lawyer, Vol. 71, No. 3 670 SECTION OF TAXATION least in theory, as a technicality? If one ignores General Dynamics, there is a reasonable argument that redeeming the fuelperks! should be viewed as a technicality not preventing the liability from being fixed absent the enforced three-month expiration. It is somewhat analogous to redeeming points for prizes earned from the slot machines in Gold Coast. While presumably, many customers will use the fuelperks! rebate when they buy gas or diesel fuel, they are not required to do so.256 It should not make any difference vis-a-vis whether a condition precedent is ministerial if the reward redemption is in the form of dollars, prizes, gas, or diesel fuel. There are, however, valid criticisms of the foregoing line of reasoning. If the Supreme Court should be faulted for reaching a result in General Dynamics that is arguably irreconcilable with Hughes Properties, given the precedential value of General Dynamics, why is the rebate redemption in Giant Eagle any less ministerial than in General Dynamics? Seizing on Hughes Properties may have provided the Third Circuit the linchpin it needed to reach the arguably correct result (ignoring the expiration provision), but there should be some unease with a lower court, in effect, ignoring an at least somewhat analogous Supreme Court decision. Furthermore, even aside from the termination provision, since in practice most customers will presumably purchase the gas or diesel fuel to obtain the rebate, there is a cogent argument that the incentive redemption should be treated as a non-technical condition precedent—a de facto non-ministerial condition precedent. That is, the theoretical possibility of obtaining the rebate without buying fuel should not arguably serve as a crutch to make what in practice is a real condition precedent into a technicality.257 This is in addition to Judge Hardiman’s comment that fuelperks! was structured as a discount on fuel purchases, “not an entitlement to gasoline itself.”258 Judge Hardiman wrote that even in situations where no cash was expended in securing the fuelperks! rebate it operated as “a 100% discount on the price of gas—functional equivalent to be sure, but reflective of an important distinction respect- ing the nature of fuelperks! redeemability.”259 Another potential challenge to the Third Circuit’s conclusion is the rela- tively modest size of the fuelperks! rebate. While the program was instituted to enhance Giant Eagle sales, if in fact gas or diesel fuel with the rebate were not materially less expensive than from competitors, many customers might simply ignore the rebate as not being worth it. There is, however, nothing in the reported decision to suggest that customers ignored the rebate for this reason.

256 Giant Eagle, Inc., v. Commissioner, 108 T.C.M. (CCH) 67, 67, 2014 T.C.M. (RIA) ¶ 2014-146, at 4. 257 For an explanation of the operation of the fuelperks! rebate and the question of whether there was a fuel “purchase” requirement, see supra note 161 and following. 258 Giant Eagle, Inc. v. Commissioner, 822 F.3d 666, 679 (3d Cir. 2016) (Hardiman, J., dissenting). 259 Id. at 679-80.

Tax Lawyer, Vol. 71, No. 3 THE FACT OF THE LIABILITY REQUIREMENT 671 In this writer’s opinion, the Third Circuit got it wrong because the rebate expiration should be treated as a true condition precedent. Unlike Burnham and Wien, in Giant Eagle there was no contractual liability ever to those customers who didn’t claim their fuelperks! rebate within the prescribed time. Thus, the Taxpayer should not have prevailed absent a pattern of waiving this requirement. In other words, while there is certainly sound authority for the Taxpayer’s position that the purchase of the qualifying groceries created a unilateral contract, there was still a condition precedent to Giant Eagle’s liability, which was obtaining the gas or diesel fuel before the Taxpayer’s obligation, by its terms, expired. Giant Eagle is quite different from a case like Ohmer Register where at one point the taxpayer’s liability existed but was nullified by subsequent events. In Giant Eagle, by contrast, a contract but no liability existed to those customers not redeeming their rebate before the reward expired. Had the expiration provision not existed, there would have been a somewhat reasonable position, albeit subject to legitimate dispute, for treating as a ministerial condition precedent the requirement to claim the fuelperks! rebate by procur- ing the gas or diesel fuel. IV. Conclusion A major lesson from Hughes Properties was that to meet the first prong of the all events test “[t]he existence of an absolute liability is necessary; absolute certainty that it will be discharged by payment is not.”260 Following this principle, and absent the approximate three-month expiration provision, there is some legitimacy to the position, although certainly subject to reasonable challenge, that Giant Eagle met the first prong of the all events test. It established the fact of liability when the $50 of qualifying groceries was purchased using one’s Advantage Card. The redemption of the reward by fueling one’s car could be viewed, at least in theory, as only a technicality. The Third Circuit in Giant Eagle was correct in emphasizing that “Hughes Properties expressly survives General Dynamics.”261 This arguably furnished the cornerstone for the somewhat defensible position that, absent the expiration provision, the Taxpayer established the fact of the liability. Where the Third Circuit got it wrong, however, was its failure to analyze and properly address the termination condition in the program. Judge Hardiman correctly determined this to be a fatal flaw. The expiration provision should not be treated as a condition subsequent nor a mere technical requirement, but a true condition precedent. The Taxpayer was very fortunate that only Judge Hardiman of the Third Circuit panel discerned its significance. Even aside from the expiration provision, given both the precedent of General Dynamics as well as the fact that a reward redemption generally involved a purchase of gas or diesel fuel and was

260 United States v. Hughes Props., Inc., 476 U.S. 593, 606 (1986) (citing Helvering v. Russian Fin. & Constr. Corp., 77 F.2d 324, 327 (2d Cir. 1935)). 261 Giant Eagle, 822 F.3d at 671.

Tax Lawyer, Vol. 71, No. 3 672 SECTION OF TAXATION structured as a discount, the Service may very well be successful in challenging a Giant Eagle like fact-pattern in another forum. Nevertheless, tax advisors, with clients in comparable circumstances, should counsel avoiding such a termination feature to put their clients in a better position for a safe landing.

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