CCA 200003038: Landfill removal costs fall outside section 468 reserve

Plain-English summary

A landfill operator used § 468 reserves to deduct expected reclamation, closing, and excess waste removal costs before paying them. Chief Counsel advised that removing stockpiled material and correcting overfilled tracts were not qualifying reclamation or closing costs for that reserve. Those deductions therefore had to wait for economic performance under § 461, and the office advised an accounting method change with a § 481 adjustment to address earlier deductions. The memorandum also analyzed when remaining reclamation and closing reserves must be recaptured, noting that the treatment of individual tracts depends on whether each is a separate reserve property. This was Field Service Advice, which the document says was not binding on Examination or Appeals.

Ruling snapshot

• Question: Were the landfill's reserve deductions and recapture treatment proper under § 468?
• Outcome: Advice: excess removal costs did not qualify, and the earlier deductions were subject to an accounting method adjustment.
• Key authorities: IRC §§ 461(h), 468, 446, 481.

Full text (IRS public release)

                            DEPARTMENT OF THE TREASURY
                                I N T E R N AL R E V E N U E S E R V I C E
                                     WASHINGTON, D.C. 20224
                                           October 26, 1999


Number: 200003038
Release Date: 1/21/2000
CC:DOM:FS:P&SI
TL-N-3509-99
UILC: 468.02-00
      481.00-00

  INTERNAL REVENUE SERVICE NATIONAL OFFICE FIELD SERVICE ADVICE


MEMORANDUM FOR DISTRICT COUNSEL


FROM:                 Deborah A. Butler
                      Assistant Chief Counsel CC:DOM:FS

SUBJECT:              Solid Waste Reclamation and Closing Costs


This Field Service Advice responds to your memorandum dated July 20, 1999.
Field Service Advice is not binding on Examination or Appeals and is not a final
case determination. This document is not to be cited as precedent.


LEGEND:

Taxpayer =




County    =

Date 1    =

Year 1    =

Year 2    =


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ISSUE(S):

(1) Is the Taxpayer required to recapture the balance of its reserve for reclamation
costs with respect to tracts that were totally reclaimed by date 1?

(2) Does the Taxpayer’s reserve for “removal excess” constitute qualified
reclamation costs or closing costs that can be deducted under I.R.C. section 468
before economic performance?

(3) If the amounts designated as “removal excess” are not deductible under
section 468, are the amounts deducted in year 2 and previous years subject to
recapture in year 2 as a change of accounting method under section 481?

CONCLUSION:

(1) The taxpayer is required to recapture the balance of its reserve for reclamation
costs on the completion of closing with respect to those tracts regardless of when
reclamation was complete.

(2) The Taxpayer’s reserve for “removal excess” does not constitute qualified
reclamation costs or closing costs that can be deducted under section 468 before
economic performance provided all the requirements of section 468 are met.

(3) The amounts designated as “removal excess” are not deductible under
section 468. Thus, the amounts deducted in year 2 and previous years are subject
to recapture in year 2 as a change of accounting method under section 481.

FACTS:

The taxpayer operates a construction and demolition debris landfill in the County.
The landfill is divided into 10 acre tracts. The taxpayer’s revenues are derived from
fees paid for dumping debris on the tracts. This waste is later processed to
separate wood, metal, tires, and other environmentally hazardous materials from
the other waste. The recyclable materials are then sold to third parties.

The taxpayer elected to deduct qualified reclamation and closing costs before
economic performance pursuant to section 468. The taxpayer created reserves for
reclamation costs, closing costs and “removal excess.” The “removal excess”
reserve is for costs expected to be incurred for certain tracts that have been
overfilled by the taxpayer. The facts presented do not indicate the number of
separate properties or sites for which accounts were established.

The County inspected the landfill in year 1 and discovered that (a) several tracts
were inactive, but not properly closed out, (b) these tracts were overfilled and had


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excessive levels of nitrogen-ammonia in water samples, and (c) solid waste such as
vegetation, lumber, metal and plastic was stockpiled on the tracts. The taxpayer
maintains that the County required it to accept excess construction debris as a
result of a natural disaster. The County issued an inspection report which required
the taxpayer to dispose of the waste. Later, the County and the taxpayer entered
into a consent agreement requiring the taxpayer to remove the excess debris
stockpiled on the tracts, to restore the landfill height to flood criteria for the site, and
to perform groundwater restoration and monitoring. The taxpayer submitted and
the County approved a Remedial Action Plan/Closure Plan (Plan). The Plan
provided for each affected tract to be mined to the clean fill base and the material
removed to be sent to a recycling plant for processing. Recyclable material was to
be sold, contaminated material was to be shipped to an approved site and the
acceptable residue was to replaced in the site. No mined material will be mixed
with new material. The taxpayer established the “removal excess” reserve by which
it has deducted under section 468 the anticipated cost of complying with its Plan.

LAW AND ANALYSIS

Section 468(a) provides:

       (1) if a taxpayer elects the application of this section with respect to any
       mining or solid waste disposal property, the amount of any deduction for
       qualified reclamation or closing costs for any taxable year to which such
       election applies shall be equal to the current reclamation or closing costs
       allocable to--

       (A) in the case of qualified reclamation costs, the portion of the reserve
       property which was disturbed during such taxable year, and

       (B) in the case of qualified closing costs, the production from the reserve
       property during such taxable year.

Section 468(d)(2)(B)(i) defines solid waste disposal and closing costs as any
expenses incurred for any land reclamation or closing activity in connection with
any solid waste disposal site which is conducted in accordance with any permit
issued pursuant to

       (I) any provision of the Solid Waste Disposal Act (as in effect on
       January 1, 1984) requiring such activity, or

       (II) any other Federal, State, or local law which imposes requirements
       substantially similar to the requirements imposed by the Solid Waste
       Disposal Act (as so in effect).


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Under section 468(d)(2)(B), the definition of the term "qualified reclamation and
closing costs" includes any expenses incurred for any land reclamation or closing
activity in connection with any solid waste disposal site which is conducted in
accordance with any permit issued pursuant to any provision of the Solid Waste
Disposal Act (as in effect on January 1, 1984) requiring such activity, or any other
Federal, State, or local law which imposes requirements substantially similar to the
requirements imposed by the Solid Waste Disposal Act (as so in effect).

The Solid Waste Disposal Act, as amended by the Resource Conservation and
Recovery Act of 1976 (RCRA), Pub. L. No. 94-580, 90 Stat. 2795 (codified as
amended at 42 U.S.C. sections 6901-6992 (1993)) (the Act) requires the
Environmental Protection Agency (EPA) to issue and enforce regulations governing
the disposal of various solid wastes including hazardous wastes. Since 1976,
RCRA has been amended to require additional legal obligations in the waste
disposal area. H.R. Conf. Rep. No. 98-1133, at 116-7 (1984), reprinted in 1984
U.S.C.C.A.N. 5651, 5687-8.

In 1984, the Deficit Reduction Act of 1984, section 91(a), 1984-3 C.B. (Vol. 1) 1,
106 added section 461(h) to the Code. This amendment added the economic
performance requirement to the all-events test contained in the regulations under
section 461. Under Treas. Reg. section 1.461-1(a)(2), a taxpayer on the accrual
method of accounting may deduct an expense in the taxable year in which all the
events have occurred that establish the fact of the liability and the amount of the
liability can be determined with reasonable accuracy, and economic performance
has occurred with respect to the liability. However, section 461(h) provides that in
determining whether an amount has been incurred with respect to any item during
the taxable year, the all events test shall not be treated as met any earlier than
when economic performance with respect to such item occurs.

The Deficit Reduction Act of 1984, section 91(b), 1984-3 C.B. (Vol. 1) 1, 109 also
added section 468 to the Code as an exception to the new economic performance
requirement of section 461(h). Congress believed that, in the case of mine
reclamation and closing costs and solid waste disposal site reclamation and closing
costs, more liberal rules were appropriate. S. Rep. No. 98-169, Vol. 1, 264, 274.
(April 2, 1984). Therefore, taxpayers electing the application of section 468 may
deduct their reasonably estimated "qualified reclamation and closing costs" prior to
economic performance. Taxpayers not electing the application of section 468 are
subject to the economic performance requirements imposed by section 461(h).
See GENERAL EXPLANATION OF THE REVENUE PROVISIONS OF THE DEFICIT REDUCTION
ACT OF 1984, STAFF OF THE JOINT COMMITTEE ON TAXATION (Committee Print 1984).

Solid waste disposal site operators electing the application of section 468 may
currently deduct a portion of the current reclamation or closing costs before
economic performance. Because section 468 is merely an exception to the


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economic performance doctrine of section 461(h), costs eligible for the election
under section 468 must meet the other requirements for deductibility under section
461.

In the case of qualified closing costs, the amount allowable as a current deduction
is equal to the portion of the reasonably estimated current closing costs allocable to
production from the reserve property during the tax year or to units of the reserve
property utilized during the tax year. Section 468 (a)(2)(C). Section 468(d)(1)(B)
defines the term "current closing costs" to mean the amount which the taxpayer
would be required to pay for qualified closing costs if the closing activities were
performed currently. In the case of a solid waste disposal site, the estimated
closing costs are computed on a unit-of-capacity basis. Section 468(d)(1)(B)(ii)(II).

Section 468(a)(5) specifically sets forth three events which would trigger the
recapture of the balance in a reserve. First, if a taxpayer revokes an election under
section 468(a)(1), the balances in the site’s reclamation and closing reserves must
be included in the taxpayer’s income in that tax year. Section 468(a)(5)(A).
Second, in the tax year that site reclamation or closure is completed, the remaining
balances (if any) in that site’s reclamation and closing costs sinking funds must be
recaptured. Section 468(a)(5)(B). Finally, if the reserve property or any portion of
the property is disposed of by the taxpayer, the balance of the reserve funds will be
included in the taxpayer’s income. Section 468(a)(5)(B). Lacking regulations or
other dispositive interpretation of section 468, we see no basis for requiring
recapture of reclamation costs prior to completion of the reclamation of the entire
property, except that the provisions of section 468(a)(4) specifically require income
inclusion when certain limits are reached. section 468(a)(4) provides that a
determination of the current costs to close the property be made yearly. This
estimation, adjusted to reflect the portion of the solid waste facility filled, is
compared to the taxpayer’s reserve which has been decreased for expenditures
actually made and increased by the interest factor. To the extent the adjusted
reserve exceeds the adjusted determined current costs the taxpayer recognizes
income.

When the taxpayer conducts closing activities (such as closing a tract within the
facility), the cost of those activities will decrease the reserve and will lower the
current year’s estimated closing costs to the extent that it is an activity that no
longer must be done and therefore will not be a cost in the estimate. Thus, the
closing of some of the tracts may or may not result in the taxpayer having to
recapture income depending on whether or not each tract is a separate property as
described in section 468(d)(3).

Section 468 permits a deduction for additions to reserves for both solid waste site
reclamation and site closing costs. In this case, the cost to remove the stockpiled
material appears to be more properly allocated to the cost of receiving and


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recycling the material prior to actually placing it in the landfill. As such those costs
cannot be considered reclamation or closing costs as those terms are used in
section 468 and cannot be properly the subject of a section 468 reserve. Further,
the corrective actions were required to bring the landfill site to the maximum site
elevation permitted by the County and were done pursuant to a “Remedial Action
Plan/Closure Plan” approved by the County. Regardless of whether overburdening
is an appropriate form of landfill compaction, the remediation actions detailed in the
plan far exceed the mere removal of excess fill. We do not believe that they can
properly be classified as reclamation or closing costs.

Under the general rule for the year of deductibility, a taxpayer may deduct an
otherwise allowable expense in the taxable year in which the “all events” test has
been met. The all events test is satisfied when (1) all events have occurred that
determine the fact of the taxpayer’s liability, and (2) the amount of the liability can
be determined with reasonable accuracy, but not before economic performance has
occurred. sections 461(h)(4), (h)(1). Notwithstanding the above, section 468
permits taxpayers engaged in mining and solid waste disposal to elect to deduct
certain qualifying reclamation and closing costs prior to economic performance. If a
taxpayer makes a section 468 election and the Service subsequently determines
that the costs deducted do not qualify under section 468, it follows that the question
of the proper timing of the deduction reverts to the default rule of section 461(h).

It appears from the facts provided that taxpayer’s claimed deductions for 1995
relate to reserves accrued for liabilities for which economic performance had not yet
occurred at the end of the taxable year. Therefore, because the claimed
deductions qualify under neither section 468 nor section 461, they are not allowable
for taxable year 1995, even though the other prongs of the all events test have
been met, but must be deferred until economic performance has occurred. Thus,
the deductibility of these costs is a question of timing.

The rules for proper timing of a deduction depend upon a taxpayer’s “method of
accounting,” which, for tax purposes, generally must be the method by which the
taxpayer regularly computes income in keeping its books. section 446(a). A change
in method of accounting involves, inter alia, the treatment of any material item,
which in turn is defined as any item involving the proper time for including the item
in income or claiming it as a deduction. Treas. Reg. section 1.446-1(e)(2)(ii); Rev.
Proc. 97-27, section 2.01(1). If the taxpayer’s practice does not permanently affect
its lifetime income, but does (or could) change the taxable year in which income is
reported, the practice involves timing and is therefore a method of accounting.
Rev. Proc. 97-27, section 2.01(1). If a taxpayer’s method of accounting does not,
in the opinion of the Secretary, clearly reflect income, the taxpayer may be subject
to an involuntary change of its method of accounting. section 446(b).


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In general, an adjustment under section 481 is required in conjunction with a
change in accounting method in order to prevent the items being changed from
being duplicated or omitted in a subsequent year. section 481(a). In the case of an
involuntary change in method of accounting imposed by the Service under
section 446(b), the Service has discretion to impose the entire section 481
adjustment in the taxable year under examination. Capital Federal Savings and
Loan Association v. Commissioner, 96 T.C. 204, 225 (1991).

In this case, taxpayer consistently deducted the removal excess reserves under
section 468 in both the year under examination (1995) and earlier years. Further,
the removal excess reserves disallowed as 1995 deductions presumably will be
deductible under the normal “economic performance” rule in a future taxable year.
Accordingly, taxpayer’s practice of deducting these reserves constitutes an
accounting method adopted by taxpayer, and any change to its practice would
affect the timing of the deductions, rather than taxpayer’s lifetime income.
Therefore, the Service may impose a change in taxpayer’s accounting method
under section 446(b). Additionally, the Service may impose a section 481
adjustment during taxable year 1995 in order to prevent taxpayer from enjoying the
benefit of duplicating its 1991-1994 deductions of this item in some future taxable
year.


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                   Deborah A. Butler
                   Assistant Chief Counsel



               By:
                  William C. Sabin, Jr.
                  Senior Technician Reviewer
                  Passthroughs & Special Industries
                  Branch