Practical Advice on Current Issues.

• Author: Brooke, Beth

ACCOUNTING METHODS & PERIODS

Casino May Deduct Slot Club Points in Year Accumulated

Affirming the district court, the Ninth Circuit has ruled that a casino using the accrual method of accounting may deduct the value of slot club points in the tax year in which the slot club member has accumulated the minimum number of points required to redeem a prize (Gold Coast Hotel & Casino, 10/16/98). The casino's liability to redeem accumulated slot club points is fixed once a club member acquires the minimum number of points.

The Gold Coast Decision

Gold Coast Hotel & Casino, a Nevada bruited partnership, has operated a slot club since March 1987. Slot club members receive a club card, similar to an ATM card. When the card is inserted into a slot machine, a computer tracks the accumulation of slot club points. Slot club points can be redeemed for prizes, ranging from coffee mugs to Hawaiian vacations; the minimum number of points needed to redeem a prize is 1,200. The parties stipulated that the market value of each club point is $0.0021.

On its 1989 tax return, Gold Coast deducted as an expense the difference between the total value of slot club points accumulated by club members and the total value of points redeemed by club members. In addition, Gold Coast recaptured as income the value of accumulated slot club points in accounts in which there had been no activity for over a year, and which had been deducted as an expense in the prior year.

The IRS challenged the deduction, citing General Dynamics Corp., 481 US 239 (1987) and arguing that the casino did not incur the expense of accumulated points until they were redeemed for a prize. In General Dynamics, a company had established a reserve account reflecting its estimated liability for medical care received by employees but unpaid by General Dynamics. General Dynamics sought to deduct the amount of its estimated liability as an accrued expense, but the Supreme Court ruled that the "all events" test had not been met because the last event necessary to fix the liability (the filing of a claim by the employee) had not occurred by the end of the tax year. Relying on General Dynamics, the Service argued that the "last event" for Gold Coast's accounting purposes was the actual redemption of club points.

Citing Hughes Properties, Inc., 476 US 593 (1986), Gold Coast argued that the "last event" fixing its liability occurred when the minimum number of club points necessary to earn a prize was accumulated; at that time, the liability became fixed pursuant to Nevada gaming regulations. In Hughes, the Supreme Court ruled that a casino operator could deduct the amount of money guaranteed for payment on progressive slot machines; under Nevada law, the liability was fixed at yearend even though the amount had not been won by the end of the tax year.

The Ninth Circuit, comparing Gold Coast's guaranteed prize to the guaranteed payout in Hughes, agreed that, even though not all slot club members will redeem their points, an "absolute liability" existed. The court also found the IRS's reliance on General Dynamics to be misplaced, ruling that a slot club member's demand for payment is nothing more than making a demand for payment of an uncontested liability. "Unlike in General Dynamics, there is no involvement of third parties necessitating that slot club members establish or otherwise offer proof of their right to payment."

The court, relying on the fact that the parties had stipulated to the value of each point, held that the amount of Gold Coast's liability was determinable with reasonable accuracy, thus meeting the second prong of the all-events test.

The tax years at issue in this case were prior to the effective date for the economic performance rules for payment liabilities. Regs. Sec. 1.4614(g) (4) provides that economic performance occurs with respect to a liability to pay an award, prize or jackpot when payment is made to the person to whom the liability is owed. Thus, the economic performance rules for payment liabilities would bar the deduction permitted in Gold Coast, unless an exception applies. The recurring item exception is available under Regs. Sec. 1.461-5 to allow generally a deduction in the tax year in which a recurring liability for a prize, award or jackpot was fixed and determinable, if payment is made within eight and one-half months after the end of such tax year.

FROM JANE A. ROHRS, WASHINGTON, DC

CHARITABLE CONTRIBUTIONS

Publicly Traded Stock Exception for Gifts to Private Foundations Made Permanent

Congress passed, and President Clinton signed into law, legislation extending a host of business tax breaks, including a provision to make permanent the special rule contained in Sec. 170(e)(5) on the deductibility of contributions of qualified appreciated stock to private foundations.

The general rule of Sec. 170(e)(1)(B) is that taxpayers can deduct only their basis when they donate long-term capital gain property to a private foundation. However, Sec. 170(e)(5) permitted both individual and corporate taxpayers to obtain a fair market value (FMV) deduction for contributions of appreciated publicly traded stock to a private foundation--as long as the contribution was made by June 30, 1998. The Tax and Trade Relief Extension Act permanently extended this special rule; it is effective retroactively for contributions of qualified appreciated stock to private foundations made after June 30, 1998.

One limitation on this technique under Sec. 170(e)(5)(C) is that total donations made by the donor (and members of the donor's family) to private foundations of stock in a particular corporation may not exceed 10% of that corporation's outstanding stock.

Corporations can donate treasury stock to a private foundation and obtain an FMV deduction without relying on Sec. 170(e)(5). This approach may continue to be useful for non-publicly traded corporations. The rule in Sec. 170(e)(1)(B)(ii) limiting deductions to basis actually provides that, when a charitable contribution is made to a private foundation (other than a so-called conduit foundation described in Sec. 170(b)(1)(E)), the deduction is reduced by "the amount of gain which would have been long-term capital gain if the property contributed had been sold by the taxpayer at its fair market value...." In the case of a sale or exchange by a corporation of its own stock (including treasury stock), Sec. 1032 provides that no gain or loss is recognized. Therefore, the cutback rule of Sec. 170(e)(1)(B) does not apply to donations by a corporation of its own stock to a private foundation; see Rev. Rul. 75-348.

Gifts by individuals of closely held stock or other non-publicly traded business interests (which never qualified for the now-resurrected exception under Sec. 170(e)(5)) may be made to so-called conduit foundations (described in Sec. 170(b)(1)(E)(ii)) with excess distribution carryovers to obtain FMV deductions.

For a foundation to be treated as a conduit foundation eligible to be treated as a public charity (with resulting 30% of adjusted gross income (AGI) and FMV deductibility), all contributions received during the year must be distributed within the two and one-half month period following the close of the tax year or applied against excess distribution carryovers. If anything less than all contributions received is distributed, the foundation is not a conduit. If excess distribution carryovers are to be used, an election must be made under Regs. Sec. 53.4942(a)-3(c)(2)(iv).

A limited exception applies to this conduit rule. Solely for purposes of determining the FMV deductibility of property, the foundation only has to distribute an amount equal to property contributions (not all contributions) received during the year. The contributor would continue to be subject to the 20%-of-AGI limitation.

FROM ROBERT B. COPLAN, WASHINGTON, DC

CORPORATIONS & SHAREHOLDERS

Sec. 338 Treatment Denied for Bankruptcy Workout

In Letter Ruling (TAM) 9841006, the IRS rejected a taxpayer's claim that the stock of a corporation was acquired in a Sec. 338 qualified stock purchase. Instead, the Service's position was that the stock was acquired in a Sec. 368 reorganization.

Corporation B was the common parent of an affiliated group filing consolidated returns. B owned all the stock of corporation C, which owned all the stock of corporation E, which owned all the stock of corporation E B also owned all the stock of corporation D. D, E and F owned stock of corporation I. I owned all the stock of corporation J. C and F were holding companies, which combined to own all the stock of corporation H (which was an operating company). The B group experienced financial difficulties following several leveraged stock acquisitions. As a result, B, C, E, F, I and J filed voluntary Chapter 11 bankruptcy petitions. As part of a bankruptcy reorganization, C and F contributed their H stock to a new corporation (G) for the stock of G and then distributed the G stock to the B creditors. The B creditors included corporation X, which had received a lien on the H stock when it had lent money to B several years before. Pursuant to the bankruptcy plans of reorganization, C and E were liquidated; the plan also called for the eventual dissolution of B. In addition, F was merged with and into J, which became a new corporation, New Corp. All of the stock of F and J was canceled and shares of New Corp stock were issued to creditors. After the transaction, C and G made a Sec. 338(h)(10) election with respect to G's acquisition of the H stock.

Sec. 338 provides that, if a purchasing corporation makes a qualified stock purchase (QSP), it can elect Sec. 338(h)(10) treatment. The selling corporation recognizes no gain or loss on the sale of the target stock; the target is treated as (1) selling all its assets at their fair market value, (2) a new corporation that purchases such assets and (3) liquidating.

Under Sec. 338(d)(3), a QSP means any transaction in...