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Boston University School of Law




In recent years the Supreme Court has limited its substantive decisions in federal income tax matters.I For the most part, the handful of tax cases it has considered each year deal with collection, liens, or other issues peripheral to doctrinal development in the tax area.2 The Court's recent decision in Diedrich v. Commissioner,3 however, dealt with a realization question involving net gifts; and its grant of certiorari consolidating the cases of Bliss Dairy, Inc. v. United States and Hillsboro National Bank v. Commissioner4 promises a continuing interest in substantive tax law. Bliss Dairy will enable the Court to resolve a conflict in the circuits over the application of two tax doctrines-the tax benefit rule and the General Utilities doctrine-to corporate liquidations. Hillsboro National Bank also involves the application of the tax benefit rule, but in a different corporate setting.

The tax benefit rule requires a taxpayer to include in income the amount of a deduction taken in a prior year for costs and expenditures that are not ultimately incurred. In a tax system based on an annual reporting period, taxpayers claim deductions for a particular year based on actual cash expenditures or items accrued. But subsequent events sometimes deprive a transaction of its deductible character. For example, suppose in year one a taxpayer donates property to a charity and claims a deduction for its fair market value. Then in year five the charity unexpectedly returns the property. Under the tax benefit rule the taxpayer must include in income for year five the amount of the recovery.5 Although Congress never expressly enacted this rule, section 111 of the Internal Revenue Code6 establishes the principle indirectly. This section allows the taxpayer to exclude from income any portion of a recovery if it did not give rise to an earlier tax benefit. Thus, in the example above, if the taxpayer had no taxable income from which to deduct the amount of the donation in year one, section 111 would exclude from income the return of the property in year five. The tax benefit rule thus operates to "correct" the initial deduction, but only if the taxpayer earlier enjoyed a reduction in tax liability.

The other principle under consideration in Bliss Dairy, the General Utilities doctrine, also arose initially in the courts. It provides that a corporation recognizes no gain when it distributes appreciated property to its shareholders, whether as a dividend or other distribution from an ongoing corporation or as a distribution in partial or comp!ete liquidation. 7 Section 311(a) now applies this rule to distributions,8 and section 336(a) provides for nonrecognition in complete or partial liquidations. 9 In both instances, the Code and the case law create a number of exceptions. 10

The problem Bliss Dairy presents-and that this Article attempts to resolve-is the extent to which the tax benefit rule modifies the Code's General Utilities nonrecognition provisions in a liquidation, so as to require an inclusion in the corporation's income of an amount previously deducted. On the other hand, Hillsboro National Bank presents a more orthodox application of the tax benefit rule, and the case is susceptible of an easier solution.

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