Cash-Basis Taxpayers Can Deduct Reclamation Costs Under Sec. 468

Section 468 allows a current deduction for mining and solid waste reclmation costs even though the expenses may not be incurred for several years–if not decades–in the future. It has traditionally been thought that only accrual-method taxpayers can benefit from Sec. 468. The court recently dispelled this notion in Gregory v. Commissioner, 149 T.C. 2 (2017).

Facts in the Gregory Case

The taxpayer is privately-owned S corporation. It is a cash-basis taxpayer. It operates a sizeable landfill in Texas.

The taxpayer is regulated by Texas Commission on Environmental Quality (“TCEQ”). The taxpayer kept a $2 million standby letter of credit to ensure that it could pay its remediation costs if it went out of business. The letter of credit was required to comply with the TCEQ rules.

The taxpayer did not initially deduct any remediation costs under Sec. 468. It deducted $100,000 under Sec. 468 for the first time after its accountant determined that the deduction was allowable. Not surprisingly, the IRS audited the taxpayer’s return the first year it took the Sec. 468 deduction.

The IRS determined that the taxpayer was not entitled to a deduction under Sec. 468 as it was a cash-basis taxpayer, not an accrual method taxpayer.

Section 468, Generally

Section 468 allows taxpayers to deduct an accrual currently for reclamation costs that will be incurred in the future. It is used by mining and, as in this case, landfill companies to decut amounts now for clean up or remediation costs that will be incurred in the future.

Remediation costs are reclamation or closing costs mandated by the Surface Mining Control and Reclamation Act of 1977 or the Solid Waste Disposal Act or the state or local equivalent.

The amount of the deduction is based on the change in the reserve that is computed. It is this last feature that seems to make it apply to accrual-method taxpayers.

The Dispute, Definition of “Taxpayer”

It has long been thought that Sec. 468 is only available to accrual-method taxpayers, not cash-basis taxpayers. As noted by the court and conceded by the IRS, Sec. 468 is not limited to cash-method taxpayers. It merely tells taxpayers how to compute the Sec. 468 deduction. But who are the “taxpayers” cited in Sec. 468?

The court looked to the definition of “taxpayer” in Sec. 7701. This code section does not make a distinction between cash and accrual method taxpayers.

The IRS’s primary argument was that Sec. 461 provides the list of expenses cash-basis taxpayers can deduct prior to payment and Sec. 468 is not included in the list. The court noted that the list in Sec. 461 is merely a list of examples, it is not an exclusive list.

The IRS also noted that Sec. 468 uses the word “incurred” rather than “paid.” Most code sections relating to accrual-method taxpayers use the word “incurred.” Most code sections relating to cash-basis taxpayers use the word “paid.” The court didn’t buy it. It countered that reading Sec. 468 to say “all taxpayers” is merely an exception to the general rule, which is a common theme in our tax laws.

The Takeway

Taxpayers, particularly cash-basis taxpayers, who will incur remediation costs, such as taxpayers who operate mines or landfills, should take a close look at this case and the Sec. 468 deduction.

Cash-basis taxpayers who thought they didn’t qualify for Sec. 468 should take a second look at the deduction. It is a timing provision, for a deduction that will be allowable at some point, but one that could be accelerated to the current year when it would othewise not be deductible for several decades or more in the future.