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Wellpoint, Inc. v. Commissioner of Internal Revenue

March 23, 2010


Appeal from the United States Tax Court. No. 13585-05-Diane L. Kroupa, Judge.

The opinion of the court was delivered by: Posner, Circuit Judge.


Before POSNER, ROVNER, and SYKES, Circuit Judges.

The petitioner, WellPoint (suc-

cessor to Anthem, Inc.), is a for-profit seller of health insurance policies through subsidiaries that include a number of Blue Cross Blue Shield insurance companies (licensees of the Blue Cross and Blue Shield Association). In the 1990s, the petitioner, when it was still Anthem, acquired three such companies, one each in Connecticut, Kentucky, and Ohio. Both the acquiring and the acquired companies were at the time mutual insurance companies, so the mergers had no tax consequences; the members of Anthem and of the three acquired companies voted to merge and the mergers made them all members of Anthem, now WellPoint.

The acquired companies had been formed many years earlier as nonprofit entities dedicated to providing health-related benefits on a charitable basis, and that was their status when they were acquired. But sometime after the acquisitions, the attorneys general of the three states of the acquired companies each sued WellPoint charging that it was using the acquired assets to make profits, in violation of the restrictions that the charitable status of the acquired companies had placed on the use of their assets. The cases were eventually settled by WellPoint's paying $113,837,500 to the states. The Internal Revenue Service refused to allow WellPoint to deduct from its taxable income either that amount, or the legal expenses that it had incurred (another $827,595) in the litigation, as "ordinary and necessary" business expenses. 26 U.S.C. § 162(a). WellPoint challenged the ruling in the Tax Court and lost. The court held that WellPoint's settlement payments were capital expenditures and so could not be deducted as ordinary and necessary business expenses.

The parties disagree about the scope of appellate review of such a ruling. WellPoint argues that review should be plenary-we should give no deference to the Tax Court's determination. The government argues that we should defer to the ruling unless convinced that it is clearly erroneous.

Rulings on pure issues of law, such as the meaning of "ordinary and necessary business expense" or "capital expenditure," are subject to plenary review, while findings of fact are reviewed just for clear error. Controversy persists over the proper scope of appellate review of the application of a legal standard to the facts of a particular case (such rulings are often referred to confusingly as "ultimate findings of fact" or resolutions of "mixed questions of law and fact"). The better view, we (and others) have said in previous cases, e.g., United States v. Frederick, 182 F.3d 496, 499 (7th Cir. 1999); Hartford Accident & Indemnity Co. v. Sullivan, 846 F.2d 377, 384 (7th Cir. 1988); Wright v. United States, 809 F.2d 425, 428 (7th Cir. 1987); Wright v. Commissioner, 571 F.3d 215, 219 (2d Cir. 2009); ASA Investerings Partnership v. Commissioner, 201 F.3d 505, 511 (D.C. Cir. 2000), is that the clear-error standard should govern the review of a decision that applies a legal standard to particular facts. The district court (or, as in this case, the Tax Court, the decisions of which are reviewed "in the same manner and to the same extent as decisions of the district courts in civil actions tried without a jury," 26 U.S.C. § 7482(a)(1); see, e.g., ASA Investerings Partnership v. Commissioner, supra, 201 F.3d at 511) has a greater immersion in the facts of a case than the court of ap-peals. Also, when a decision is fact-specific, plenary review is not required in order to maintain uniformity of legal principles throughout the circuit. An appellate court's "main responsibility is to maintain the uniformity and coherence of the law, a responsibility not engaged if the only question is the legal significance of a particular and nonrecurring set of historical events." Mucha v. King, 792 F.2d 602, 605-06 (7th Cir. 1986).

This analysis implies that the clear-error standard should govern the review of a ruling that a particular expenditure was or was not an ordinary and necessary business expense as distinct from a capital expenditure. And so we held in Reynolds v. Commissioner, 296 F.3d 607, 612-15 (7th Cir. 2002). But we have to reckon with the Supreme Court's statement that "the general characterization of a transaction for tax purposes is a question of law subject to review," Frank Lyon Co. v. United States, 435 U.S. 561, 581 n. 16 (1978). (By "review" the Court must have meant plenary review, since factfindings are subject to review, albeit just for clear error.)

Naturally this formula, given its sponsor, has been recited in subsequent cases. E.g., Wellons v. Commissioner, 31 F.3d 569, 570 (7th Cir. 1994); Dow Chemical Co. v. United States, 435 F.3d 594, 599 n. 8 (6th Cir. 2006). But what does "general characterization" mean? Classifying a particular expenditure as an expense on the one hand or as a capital expenditure on the other is applying a legal standard to facts. The Dow opinion interpreted "general characterization" to include such classifications. We are dubious. A judge asked in a bench trial to decide whether the defendant was negligent applies a legal standard (the negligence standard) to the facts of the case-and appellate review is deferential, Thomas v. General Motors Acceptance Corp., 288 F.3d 305, 307-08 (7th Cir. 2002); Downs v. United States, 522 F.2d 990, 999 (6th Cir. 1975); see generally St. Mary's Medical Center of Evansville, Inc. v. Disco Aluminum Products Co., Inc., 969 F.2d 585, 588-89 (7th Cir. 1992), as it should be according to our analysis. We don't see how a negligence case differs in this respect from this tax case.

We needn't wade deeper into this mire, however. For this is not a case in which the standard of review determines the outcome-a case in which we would affirm if the standard were clear error and reverse if it were mere error. We would affirm under either standard.

We'll begin our analysis by explaining the difference between a capital expenditure and an ordinary and necessary business expense, with the aid of examples.

The cost of buying a building is a capital expenditure because a building has "a useful life substantially beyond the taxable year," Treas. Reg. § 1.263(a)-2(a), which is the general understanding of "capital expenditure." See, e.g., U.S. Freightways Corp. v. Commissioner, 270 F.3d 1137, 1143-44 (7th Cir. 2001); Crosley Corp. v. United States, 229 F.2d 376, 379 (6th Cir. 1956); Bruns v. Commissioner, T.C. Memo 2009-168, 2009 WL 2030886, at *9. A capital expenditure is not deductible as a business expense in the year in which it is made; instead it must be depreciated over its useful life, and the amount of depreciation each year is all that is deductible that year. E.g., Crosley Corp. v. United States, supra, 229 F.2d at 379. In this way, cost is matched temporally with revenue, which is a desideratum of tax law.

The purchase price of a capital asset is not the only example of a capital expenditure. Any expenditure is capital if its "utility . . . survives the accounting period" in which it is made. Sears Oil Co. v. Commissioner, 359 F.2d 191, 197 (2d Cir. 1966); see also Clark Oil & Refining Corp. v. United States,473 F.2d 1217, 1219-20 (7th Cir. 1973). So an expense incurred to enhance the ...

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