Appeal from the United States District Court for the Eastern District of Wisconsin. No. 81 C 462 -- Robert W. Warren, Judge.
Wood and Posner, Circuit Judges, and Dumbauld, Senior District Judge.*fn* Dumbauld, Senior District Judge, dissenting.
A.O. Smith Corporation appeals from an adverse judgment in a suit for refund of federal income taxes. Its appeal brings up to us the question whether the additional income tax due as a result of a recapture of investment tax credits pursuant to section 47 of the Internal Revenue Code must be paid on an estimated basis.
The Code allows a 7 percent investment tax credit to be taken in the year in which the investment is made. 26 U.S.C. §§ 38, 46(a)(1). But because of the way in which the credit is figured, the amount of the credit depends on the useful life of the investment. If it is eight years or more, then the full amount of the investment is the basis on which the 7 percent credit is figured, but if it is less than eight years the basis is reduced. See 26 U.S.C. § 46(c)(2). Therefore, if the taxpayer disposes of the asset in which he invested before the end of the useful life that was used in figuring the credit he took when he made the investment, it means he got a bigger credit than he was entitled to, and section 47 (by a complicated formula unnecessary to dwell on here) makes him add the excess credit to his taxable income for the year in which he disposed of the asset.
A. O. Smith took investment tax credits in years prior to 1974 and thereby reduced the amount of taxes it paid in those years. It had no taxable income in 1974, but because it sold certain property on which it had previously taken tax credits before the end of the property's useful life it was required to recapture some of its previous investment tax credits and add them to its 1974 tax liability. As a result, instead of owing zero income tax for 1974 it owed $148,000. It did not pay this tax on an estimated basis, i.e., currently, and the question is whether it should have done so. Section 6154(a) of the Code requires that every corporation subject to taxation under section 11 of the Code pay estimated income tax. A. O. Smith contends that a tax that is due to recapture of investment tax credits need not be paid on an estimated basis, because it is not a section 11, but a section 47, tax.
We find this unpersuasive as either a textual or a policy argument. Section 47 provides that when recapture occurs "the tax under this chapter for such taxable year shall be increased." Section 11 is the corporate income tax, is in the same chapter as section 47, and is an obvious referent of that section, just as it is an obvious referent of section 38, which authorizes investment tax credits to be taken in the first place. When it deducted investment tax credits from its corporate income tax in years prior to 1974 A. O. Smith must have believed that the reference in section 38 to "the tax imposed by this chapter" included section 11 -- for it was from its section 11 tax that A. O. Smith deducted its investment tax credits.
In referring to section 11, section 6154(a) sweeps in all the other provisions that feed into section 11, including section 47. Suppose that midway through its taxable year a corporation lost a deduction that it had been counting on in estimating its income tax. The higher taxable income resulting from the loss of that deduction would result in a higher section 11 tax and more estimated tax due, even though section 6154(a) does not refer to the deductions that affect a corporation's section 11 tax. We are given no reason for a different treatment of credits. Investment tax credits would reduce the section 11 tax -- they reduced it for A. O. Smith in earlier years -- and with it the amount of estimated tax due. The loss of credits that were used to reduce section 11 taxes should therefore increase the section 11 tax and with it the amount of estimated tax due.
We cannot imagine a theory on which Congress could have desired asymmetrical treatment. Of course the event triggering a recapture of investment tax credits may be quite unexpected, but that is true of many events that affect liability for the section 11 tax. As it happens, the estimated-tax provisions of the corporate income tax are quite lenient -- more so, oddly, than the provisions relating to individual income tax. For example, if (for a calendar-year corporate taxpayer) the event leading to an unexpected increase in tax liability occurs after December 1, no additional estimated tax need be paid at all. 26 U.S.C. § 6154(b).
Not only can we think of no feature of the recapture of investment tax credits that suggests it should be treated differently from other events that increase tax liability, and with it the amount of estimated taxes that must be paid; but A. O. Smith's argument, if accepted, would give firms an incentive to dispose prematurely of property on which investment tax credits had been taken in previous years -- especially at the beginning of the taxable year, so that the taxpayer would have the use of the money he owed the IRS for an entire year, interest-free. It is in part to discourage the strategic timing of events that yield taxable income that income taxes are required to be paid on a current basis rather than in a lump at the end of the taxable year; and we cannot see why the evil of strategic timing is less when it relates to the premature disposition of property on which investment tax credits have been taken in previous years.
A. O. Smith's other arguments, which relate to its 1975 liability, do not merit discussion.