Federal Circuit allows cash-method issuer to deduct interest payments before due date.

• Author: Godshalk, Rich

Dana Corporation, 174 F3d 1344 (Fed. Cir. 1999) allowed a cash-method taxpayer to deduct accrued interest paid before its payment date. Dana holds that the Service abused its discretion in asserting that the early payment did not clearly reflect income.

In a consolidated return, the income of Dana's subsidiary, Leverage Leasing, was reported on the cash method of accounting, while Dana and other subsidiaries reported gross income and expenses using the accrual method. Leverage Leasing was entitled to receive accrued rents in arrears; in turn, it was obligated to pay interest, also in arrears, on loans related to the properties for which rent was received. Under financing agreements, Leverage Leasing paid interest in arrears that accrued in 1984 but, by the terms of the loan, was not actually due for payment until the following tax year. It repeated the same process for the following year.

As a consequence, Leverage Leasing's ordinary and necessary business expenses exceeded gross income for 1984 and 1985, which resulted in no tax liability. The IRS determined that the cash method of accounting caused excess interest deductions and did not clearly reflect Leverage Leasing's income. The court held that advance payments of accrued interest in arrears were deductible because they represented a charge for the use or forbearance of borrowed money. The court reasoned that the Code allows the payment of interest obligations in advance for tax advantages, provided that they have already been accrued.

Conceding that the...