Zaninovich v. Commissioner
Encyclopedia
Zaninovich v. Commissioner, 616 F.2d 429 (9th Cir. 1980), is a United States
court case about the deductibility of advance payments for tax purposes.
in California and used the cash basis method of accounting. The partnership
entered into a lease of farm land from December 1, 1973 to November 30, 1993. Yearly rent of $27,000 for the period running December 1 to November 30 was payable on December 20 of each lease year. On December 20, 1973, the partnership paid $27,000 in rent for the lease year running December 1, 1973 to November 30, 1974. The partnership deducted this entire amount on its return for the taxable year 1973.
The Tax Commissioner disallowed $24,934 of the $27,000 payment—the portion of the rent payment attributed to the eleven months rental period that fell in 1974. The United States Tax Court
upheld this ruling. The 9th Circuit reversed. On appeal, the court concluded that the test for determining if this rental prepayment could be fully deducted during the actual payment year (thus whether the payment was a deductible expense or a capital expenditure) depended on whether or not eleven months is "substantially beyond" the taxable year. The court decided to adopt the "one-year rule" applied by several circuits in distinguishing between currently deductible expenses and capital expenditures having a useful life extending "substantially beyond" the tax year. Under the "one year rule", an expenditure is treated as a capital expenditure if it creates an asset, or secures a like advantage to the taxpayer, having a useful life in excess of one year. The court reasoned that the overriding advantage to the "one year rule" was its ease of application. Additionally the rule eliminates pointless complexity in the calculation of the timing of deductions.
The court found that its reasoning for the "one year rule" was well illustrated by the facts of the case before it. If the taxpayers in this situation were forced to deduct their rental payments on a prorated basis, the simplicity of the cash basis method of accounting was sacrificed for an inconsequential change in the timing of deductions. Under the prorated system the taxpayers could only deduct 1/12 of their rental payment in 1973. But in 1974, and every year until 1992, the taxpayers would be able to deduct both 1/12 of the current payment (for the month of December) and 11/12 for the preceding year's payment that covered the rental period in the current tax year (January–November); thus the taxpayers would be deducting 12/12 of rental payment—an entire year's worth of payments. So there was only a difference between the prorated deduction system and the "one-year rule" for the first and last year of the lease term.
Taxation in the United States
The United States is a federal republic with autonomous state and local governments. Taxes are imposed in the United States at each of these levels. These include taxes on income, property, sales, imports, payroll, estates and gifts, as well as various fees.Taxes are imposed on net income of...
court case about the deductibility of advance payments for tax purposes.
Issue presented
Whether a rental payment by a cash basis taxpayer for a lease year that extended eleven months beyond the year of payment is fully deductible in the year of payment as an ordinary and necessary business expense or must be deducted on a prorated basis as a capital expenditure.Facts
Martin and Vincent Zaninovich were partners in a farming business in San Joaquin ValleySan Joaquin Valley
The San Joaquin Valley is the area of the Central Valley of California that lies south of the Sacramento – San Joaquin River Delta in Stockton...
in California and used the cash basis method of accounting. The partnership
Partnership
A partnership is an arrangement where parties agree to cooperate to advance their mutual interests.Since humans are social beings, partnerships between individuals, businesses, interest-based organizations, schools, governments, and varied combinations thereof, have always been and remain commonplace...
entered into a lease of farm land from December 1, 1973 to November 30, 1993. Yearly rent of $27,000 for the period running December 1 to November 30 was payable on December 20 of each lease year. On December 20, 1973, the partnership paid $27,000 in rent for the lease year running December 1, 1973 to November 30, 1974. The partnership deducted this entire amount on its return for the taxable year 1973.
The Tax Commissioner disallowed $24,934 of the $27,000 payment—the portion of the rent payment attributed to the eleven months rental period that fell in 1974. The United States Tax Court
United States Tax Court
The United States Tax Court is a federal trial court of record established by Congress under Article I of the U.S. Constitution, section 8 of which provides that the Congress has the power to "constitute Tribunals inferior to the supreme Court"...
upheld this ruling. The 9th Circuit reversed. On appeal, the court concluded that the test for determining if this rental prepayment could be fully deducted during the actual payment year (thus whether the payment was a deductible expense or a capital expenditure) depended on whether or not eleven months is "substantially beyond" the taxable year. The court decided to adopt the "one-year rule" applied by several circuits in distinguishing between currently deductible expenses and capital expenditures having a useful life extending "substantially beyond" the tax year. Under the "one year rule", an expenditure is treated as a capital expenditure if it creates an asset, or secures a like advantage to the taxpayer, having a useful life in excess of one year. The court reasoned that the overriding advantage to the "one year rule" was its ease of application. Additionally the rule eliminates pointless complexity in the calculation of the timing of deductions.
The court found that its reasoning for the "one year rule" was well illustrated by the facts of the case before it. If the taxpayers in this situation were forced to deduct their rental payments on a prorated basis, the simplicity of the cash basis method of accounting was sacrificed for an inconsequential change in the timing of deductions. Under the prorated system the taxpayers could only deduct 1/12 of their rental payment in 1973. But in 1974, and every year until 1992, the taxpayers would be able to deduct both 1/12 of the current payment (for the month of December) and 11/12 for the preceding year's payment that covered the rental period in the current tax year (January–November); thus the taxpayers would be deducting 12/12 of rental payment—an entire year's worth of payments. So there was only a difference between the prorated deduction system and the "one-year rule" for the first and last year of the lease term.