Cleveland State University EngagedScholarship@CSU Law Faculty Articles and Essays Faculty Scholarship 1998 The Myth of the Matching Principle as a Tax Value Deborah A. Geier Cleveland State University, [email protected] Follow this and additional works at: https://engagedscholarship.csuohio.edu/fac_articles Part of the Tax Law Commons How does access to this work benefit ou?y Let us know! Original Citation Deborah A. Geier, The Myth of the Matching Principle as a Tax Value, 15 American Journal of Tax Policy 17 (Spring 1998) This Article is brought to you for free and open access by the Faculty Scholarship at EngagedScholarship@CSU. It has been accepted for inclusion in Law Faculty Articles and Essays by an authorized administrator of EngagedScholarship@CSU. For more information, please contact [email protected]. The Myth of the Matching Principle as a Tax Value DEBORAH A GEIER* Table of Contents I. INTRODUCTION................................................ 18 II. THE MATCHING PRINCIPLE IN FINANCIAL ACCOUNTING AND THE ROLE OF GAAP IN TAX ACCOUNTING........ 27 Ill. THE MATCHING PRINCIPLE IN TAX ACCOUNTING . • 41 A CAPITALIZATION, DEPRECIATION, AND THE IN­ COME-TAX VALUE...................................... 41 1. Capitalization . 42 2. Depreciation..................................... 58 B. ACCRUAL ACCOUNTING-DEDUCTIONS............. 71 1. The Anderson Case . 71 2. Financial Accounting as "Science"?......... 75 3. The Other Early Cases: Drawing the Line at "Contingent" Liabilities. 84 4. Corning to Understand the True Tax Value at Stake: The Anti-Tax Arbitrage Value and the Income-Tax Value Revis­ ited................................................ 91 5. Modern Decision.making . 102 C. ACCRUAL ACCOUNTING-INCOME................... 113 1. Prepaid Gross Receipts ............ .......... 113 2. Other Income.................................... 139 * Professor of Law, Cleveland-Marshall College of Law, Cleveland State University. I would like to thank Charlotte Crane, Calvin Johnson, Michael Lang, and George Ym for their helpful comments on an earlier draft. As several of them did not agree with positions taken in the Article, the reader should be careful in ascribing their agreement to the views discussed. I would also very much like to thank Joseph Dodge and Cliff Fleming, who were gracious enough to ask me to join with them in writing Federal Income 1b.x: Doctrine, Structure and Policy. The seeds for this Article were germinated during that project. While we do not always agree on everything, I have learned, and continue to learn, a great deal from them. Finally, I would like to thank law librarian Marie Rehmar, whose tireless help in finding some of the historical material was invaluable. 17 18 THE AMERICAN JOURNAL OF TAX POLICY [Vol. 15:17 3. Final Thoughts.................................. 143 D. TWO-PARTY MATCHING . 152 1. In General . 152 2. Premature Accrual of Future Expenses Revisited.......................................... 158 3. Prepaid Gross Receipts Revisited........... 160 4. Final Thoughts.................................. 162 IV. CONCLUSION.................................................. 164 Those of us in the tax law business know that we are bright, engaging, and athletic; we combine animal magnetism with erudi­ tion. However, tax lawyers are lumped with accountants in the public mind, and are burdened with the images of thick specta­ cles, green eyeshades, cluttered minds, and unlimited capacities for boredom. One commentator has even stated that a "tax lawyer is a person who is good with numbers but who does not have enough personality to be an accountant."1 I. INTRODUCTION It is high time we tax lawyers did a better job of educating the world that tax law is not about financial accounting. It is important that we do so not because we dislike accountants; some very nice ones have been students in my classes. It is im­ portant because the often implicit assumption that financial ac­ counting presumptively guides tax accounting can and has un­ dermined tax values. This Article is one modest contribution in the continuing efforts toward the emancipation· of tax law from financial accounting. Those steeped in a financial accounting background often have trouble letting go of that culture when they cross over the great divide into the tax realm. Perhaps more important, those who are not steeped in financial accounting-such as judges­ often assume without reflection that financial accounting princi­ ples ought to govern tax accounting. This tendency is often the strongest when it comes to the financial accounting norm com­ monly referred to as "the matching principle." The principle that expenditures ought to be deducted in the same period as the income to which they relate is a sacrosanct 1. Erik M. Jensen, The Heroic Nature of Tax Lawyers, 140 U. PA. L. REv. 367, 367­ 68 (1991) (book review essay of John Grisham, The Firm) (footnotes omitted). 1998] THE MYTH OF MATCHING 19 one in the financial accounting world.2 The income tax, however, is not uniformly wedded to this matching principle. In some cases, the Code seems to require what smacks of "matching," not in the financial accounting sense described above, but in the sense that income or expenses can be deferred to the future or accelerated in order to be accounted for in the same period as offsetting deductions or inclusions. One example is the rule in section 121!3 that deductible capital losses are allowable in any year only to the extent of includable capital gain; unused losses must be deferred. Sections 163(d), 465, 469, and 1092 similarly require delay of otherwise deductible amounts to future years in which income is realized. The capitalization of expenditures that do not create or purchase a distinct asset but will produce a sig­ nificant economic benefit in future years is a similar, though distinct, manifestation of the phenomenon, as is depreciation. And the matching of inclusion and deduction between two differ­ ent taxpayers, required by sections 83(h), 267(a)(2), 483, 404(a)(5), and the original issue discount rules of sections 1271­ 1275, is yet another distinct facet of the idea. But the income tax (and cases construing it) also selectively departs from the matching principle. Prepaid services income re­ ceived by an accrual basis taxpayer must usually, though not al­ ways, be included in the year of receipt under current law, even though the related expenses will not be incurred (and deducted) until future years.4 Similarly, the "economic performance" re­ quirement of section 461(h) may result in what accountants would argue is a "mismatch" of income and deduction.5 These income tax rules that require deviation from the matching principle are usually perceived by accountants as ei­ ther indefensible or as introducing unnecessary complexity to the tax accounting world. 6 They are also often perceived as un­ fair, in that they sometimes combine to create a "one-way street" in favor of the fisc. 7 Accountants typically argue that tax 2. For a fuller description of the matching principle, see infra notes 25-29 and ac­ companying text. 3. All references are to the Internal Revenue Code of 1986, as amended, unless otherwise noted. 4. See infra notes 319-414 and accompanying text. 5. See infra notes 255-288 and accompanying text. 6. See infra notes 31-37 and accompanying text. 7. See William L. Raby & Burgess J.W. Raby, '.Abuse of Discretion' and 'Clearly Re­ flect Income', 71 TAX NCYl'Es 227, 229 (Apr. 8, 1996) (chastising "indiscriminate IRS at­ tempts to switch all and sundry to methods of accounting that will maximize the Trea­ 20 THE AMERICAN JOURNAL OF TAX POLICY [Vol. 15:17 accounting should simply follow financial accounting.8 Even some tax lawyers, policymakers, and judges (and justices), insuf­ ficiently conscious of the tax values that should inform tax ac­ counting and with no formal background in financial accounting, are often lulled into agreement with the rhetoric of the financial accountants. As recently as 1992, for example, the Supreme Court has (unfortunately) stated: "The Code endeavors to match expenses with the revenues of the taxable period to which they are properly attributable, thereby resulting in a more accurate calculation of net income for tax purposes."9 Accounting norms can exude an enticing siren song to those insufficiently schooled in tax values. Accounting norms seem to some to be formal, tested, and have the aura of an entire profession behind them,10 which can lend them solidity in the unquestioning judge's eye. And, after all, both tax accounting and financial accounting measure "income," don't they? Nowhere does this tension between the income tax world and the world of financial accounting manifest itself so explicitly as in section 446(b), which provides that "if the [taxpayer's ac­ counting method] does not clearly reflect income, the computa­ tion of taxable income shall be made under such method as, in the opinion of the Secretary, does clearly reflect income." Under this authority, the Commissioner can challenge not only the tax­ payer's use of a particular regime of tax accounting in general, such as the cash method, the accrual method, or inventory ac­ counting, but also the taxpayer's treatment of a particular item or transaction under those methods. Most courts are quite deferential to the Commissioner's ex­ ercise of authority under this provision.11 Yet, the authority is not without limits under the statute, for it is constrained by the sury's revenue" and characterizing the IRS approach as one that "comes close to asserting that the King can do no wrong"). 8. See Harold Dubroff et al., Tux Accounting: The Relationship of Clear Refl.ection ofIncome to Generally Accepted Accounting Principles, 47 ALB. L. REv. 354, 359 n.20 and 389 n.143 (1983) (both collecting authorities); Raby & Raby, supra note 7. 9. INDOPCO, Inc. v. Commissioner, 503 U.S. 79, 84 (1992). 10. See, e.g., United States v. Anderson, 269 U.S.