Allocation of Income, Deductions, Credits, and Allowances among Related Taxpayers

Case Western Reserve Law Review, Dec 1964

Harlan Pomeroy

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Allocation of Income, Deductions, Credits, and Allowances among Related Taxpayers

Allocation of Income, Deductions, Credits, and Allowances among Related Taxpayers 0 Thi s Symposium is brought to you for free and open access by the Student Journals at Case Western Reserve University School of Law Scholarly Commons. It has been accepted for inclusion in Case Western Reserve Law Review by an authorized administrator of Case Western Reserve University School of Law Scholarly Commons 1 Harlan Pomeroy, Allocation of Income , Deductions, Credits, and Allowances among Related Taxpayers, 15 Cas. W. Res. L. Rev. 250 (1964) Available at: Harlan Pomeroy - will find it advantageous to forego the election and allocate a single surtax exemption among the members of its group. A Corporation --------------B Corporation ----------------C Corporation --------------D Corporation ---------------E Corporation ----------------$25,000 50,000 10,000 25,000 25,000 A Corporation --------------B Corporation --------------$12,500 12,500 $11,100 23,600 3,600 11,100 11,100 $60,500 $ 2,750 2,750 $ 5,500 III ALLOCATION OF INCOME, DEDUCTIONS, CREDITS, AND ALLOWANCES AMONG RELATED TAXPAYERS Harlan Pomeroy Section 482 of the Internal Revenue Code is one of many weapons in the arsenal of the Commissioner of Internal Revenue for defending the public fisc against raids by resourceful taxpayers. It is, in many respects, his most effective as well as his most lethal weapon. Broad in its literal terms and scope, section 482 provides, in effect, that the Commissioner may, for certain specified purposes, shift among related entities the various items going into the equation determining taxable income. The ends or purposes for which the allocation may be made also are broadly stated. The alternative purposes are the prevention of tax evasion and the clear reflection of income. The language of section 482 is thus deceptively simple and nontechnical. Its terms are brief. The effect of section 482, however, may have very wide range. Moreover, inasmuch as the application of the section has been held to be largely within the Commissioner's discretion, its application is not easily upset. There are scores of cases which have been decided under section 482 and under its predecessors in the 1939 Code and earlier revenue acts. It is the purpose of this article to indicate some of the problems which may arise under section 482 and to highlight certain of the more important cases. OUTLINE OF STATUTORY PROVISION AND ITS BACKGROUND There are certain statutory requirements which must be met before section 482 can be applied. There must be two or more organizations, trades, or businesses. The organizations, trades, or businesses must be owned or controlled "by the same interests." The ownership or control may be direct or indirect. And there must be either an evasion of taxes or a failure dearly to reflect income. Once the conditions required for the application of section 482 are present, the Commissioner has authority under section 482 to "distribute, apportion, or allocate gross income, deductions, credits, or allowances" between or among the related organizations, trades, or businesses. Legislative History Section 482 originated in 1921 in conjunction with consolidated returns. At that time, the Commissioner could "consolidate the accounts" of "related trades or businesses," owned or controlled directly or indirectly by the same interests, in order to make an "accurate distribution or apportionment of gains, profits, income, deductions, or capital."1 In 1924 this was changed so as to permit the consolidation either at the direction of the Commissioner or at the request of the taxpayer.2 Then, in 1928, the Commissioner's sanctions were broadened, from consolidating the accounts to distributing, apportioning, or allocating gross income and deductions. The taxpayer could no longer insist upon application of the provision. At the same time, the requisite conditions for invoking the Commissioner's authority were changed to eliminate the requirement that the trades or businesses be "related." Moreover, the 1. Revenue Act of 1921, ch. 136, ยง 240(d), 42 Stat. 260. This provision was directed particularly at foreign subsidiaries which were "sometimes employed to 'milk' the parent corporation, or otherwise improperly manipulate the financial accounts of the parent company." It was not enacted to permit computing the tax "on the basis of the consolidated return." H.R. RPp. No. 350, 67th Cong., 1st Sess. 14 (1921). 2. Revenue Act of 1924, ch. 234, S 240(d), 43 Stat. 288. Commissioner could act where there was evasion of taxes, and whether or not the trades or businesses were affiliated.? In 1934, the Commissioner's authority was extended to include "organizations" in addition to trades or businesses.4 And finally, in 1943, the Commissioner could allocate "credits" and "allowances" in addition to gross income and deductions. The reason for this change was to broaden the Commissioner's authority under what is now section 482 to equal h (...truncated)


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Harlan Pomeroy. Allocation of Income, Deductions, Credits, and Allowances among Related Taxpayers, Case Western Reserve Law Review, 1964, Volume 15, Issue 2,