Meredith Corporation & Subsidiaries v. Commissioner

108 T.C. No. 7

UNITED STATES TAX COURT

MEREDITH CORPORATION & SUBSIDIARIES, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 18248-95. Filed February 27, 1997.

P moved for partial summary judgment, claiming
that it is entitled to a $1,555,428 ordinary deduction
in its TYE 1990 stemming from contingent asset
acquisition costs that became fixed in that year, after
the expiration of the useful life of the asset to which
they correspond. R objected to P's motion and filed a
cross-motion for partial summary judgment, arguing:
(1) the contingent asset acquisition costs were not
attributable to the subscriber relationships asset but
must be allocated to nonamortizable intangibles; and,
in the alternative, (2) the expiration of the useful
life of the subscriber relationships bars any further
cost recovery by P. Held: The contingent acquisition
costs at issue are allocable to the basis of the
subscriber relationships in P's TYE 1990. Meredith
Corp. & Subs. v. Commissioner, 102 T.C. 406 (1994),
followed. Held, further, P is entitled to an ordinary
deduction in full in its TYE 1990 for contingent asset
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acquisition costs incurred in that year, after the
underlying asset had been fully amortized. Arrowsmith
v. Commissioner, 344 U.S. 6 (1952) and sec. 1.338(b)-
3T, Temporary Income Tax Regs., 51 Fed. Reg. 3592 (Jan.
29, 1986), applied.

James L. Malone III, for petitioner.

Lawrence K. Letkewicz and Jan E. Lamartine, for respondent.

OPINION

NIMS, Judge: This matter is before the Court on

petitioner's motion and respondent's cross-motion for partial

summary judgment filed pursuant to Rule 121 on July 26, 1996, and

November 8, 1996, respectively. Petitioner moves for partial

summary judgment in its favor, arguing that it is entitled to

deduct contingent acquisition costs incurred after the asset to

which they pertain has been completely amortized. Respondent

objects to petitioner's motion and also moves for partial summary

judgment in her favor, arguing in part that the expiration of the

useful life of the asset bars any further cost recovery by

petitioner. For the reasons detailed below, we shall grant

petitioner's motion, and deny respondent's cross-motion for

partial summary judgment.

Unless otherwise indicated, all Rule references are to the

Tax Court Rules of Practice and Procedure. All section

references are to sections of the Internal Revenue Code in effect

as of the date of the initial transaction underlying the dispute.
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At the time the petition was filed, petitioner's principal

place of business was Des Moines, Iowa.

A motion for summary judgment or for partial summary

judgment may be granted if no genuine issue of material fact

exists and the decision can be rendered as a matter of law. Rule

121; Sundstrand Corp. & Consol. Subs. v. Commissioner, 98 T.C.

518, 520 (1992), affd. 17 F.3d 965 (7th Cir. 1994); Shiosaki v.

Commissioner, 61 T.C. 861, 862-863 (1974). In their respective

Statements of Undisputed Facts, the parties have agreed to fully

incorporate the stipulation of facts that is part of the record

in Meredith Corp. & Subs. v. Commissioner, 102 T.C. 406 (1994)

(Meredith I). The parties have also agreed to fully incorporate

the facts as set forth in the Court's Opinion in Meredith I.

This reference incorporates herein the Statements of Undisputed

Facts and attached exhibits. As such, there is no genuine issue

of material fact, and this matter is ripe for resolution by means

of summary judgment. We shall repeat the facts as necessary to

clarify the ensuing discussion.

Background

Meredith Corporation (petitioner or Meredith) was organized

in 1902. It is a diversified media company involved in magazine

and book publishing, television broadcasting, real estate

marketing, franchising, and until recently, printing. Meredith

has continued to expand its operations in the media industry over
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the years through internal growth and acquisitions. Petitioner

is an accrual basis taxpayer that keeps its books and records,

and files its Federal income tax returns, on a taxable year

ending (TYE) June 30th.

In connection with its January 3, 1986, purchase of the

magazine Ladies' Home Journal (LHJ), Meredith assumed certain

contingent obligations of the seller, Family Media, Inc. (FMI),

relating to an intangible asset designated "subscriber

relationships". Meredith agreed to produce and deliver copies of

LHJ to subscribers already existent on the acquisition date for

the remainder of their subscription terms, necessarily entailing

fulfillment costs for which Meredith was to receive no

reimbursement from FMI. Such costs included, but were not

limited to, expenses associated with paper, printing, editorial

salaries, and delivery (editorial costs). The fulfillment costs

were contingent for two reasons: (1) The costs were variable;

and (2) LHJ subscribers were permitted to request cash refunds

for the remaining terms of their subscriptions at any time, for

which FMI remained solely liable. The contingent expenditures at

issue herein were editorial costs incurred by Meredith during its

TYE 1990.

The years before the Court in Meredith I were petitioner's

TYE 1986 and TYE 1987. Meredith I addressed the issues of

petitioner's entitlement to amortization deductions with
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respect to three intangible assets acquired in its purchase of

LHJ: (1) A noncompetition agreement; (2) an employment

relationship; and (3) the subscriber relationships.

The parties stipulated in Meredith I that the useful life of

the subscriber relationships was 42 months. In addition, the

parties stipulated that the actual editorial costs incurred by

Meredith through June 30, 1991, stemming from its assumption of

FMI's fulfillment obligation, were as follows:

Present Value
FYE Editorial Costs Discounted at 14%

6/30/86 $8,324,660 $8,056,386
6/30/87 7,827,573 6,866,292
6/30/88 2,869,118 2,207,693
6/30/89 1,462,368 987,057
6/30/90 807,267 477,967
6/30/91 321,780 167,122
21,612,766 18,762,517

On March 14, 1994, this Court issued its Opinion in Meredith

I, and on June 16, 1994, a decision was entered. In the Opinion,

we decided that the assumed editorial costs composed part of the

purchase price of the subscriber relationships, but that the

costs could not be included in petitioner's basis of that asset

as of the acquisition date due to their contingency. Instead, we

held that such costs (plus the present value of tax savings

resulting from the amortization of such costs) must be added to

the "basis of the subscriber relationships in the years in which

* * * [they] are incurred". Meredith Corp. & Subs. v.

Commissioner, supra at 455. The Court then permitted those costs
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incurred in petitioner's TYE 1986 and TYE 1987 to be amortized

over whatever remained of the stipulated 42-month useful life of

the subscriber relationships. Id. at 462-463. No appeal was

taken from the Court's decision.

On April 9, 1993, Meredith filed a petition in this Court

involving the same subscriber relationships issue for its TYE

1988. Meredith Corp. & Subs. v. Commissioner, docket No. 7166-93

(Meredith II). Meredith and respondent filed a Joint Motion for

Continuance (Joint Motion) in Meredith II since the Meredith I

opinion was not anticipated prior to the Meredith II trial date.

In the Joint Motion, the parties stated:

The amortization issues in the above-captioned case
relate to the years subsequent to the year of the
initial transaction, 1986, and as such, the parties
anticipate that resolution of the amortization issues
in the 1986 and 1987 taxable years will form the basis
for settlement of the issues in this case.

Meredith II was thereafter settled by the parties, using the

exact methodology set forth by the Court in Meredith I. This

Court entered a decision in Meredith II on October 4, 1994.

The same issue arising in Meredith's TYE 1989 was

subsequently settled with the IRS Appeals Office in Des Moines,

Iowa, applying, without dispute, the identical method used in

Meredith I and Meredith II. In a letter to petitioner dated June

29, 1995, respondent notified Meredith that the Joint Committee

on Taxation (Joint Committee) had officially informed her that it
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had reviewed and "taken no exception" to the settlement reached

by the parties for Meredith's TYE 1989.

Meredith timely filed a Federal income tax return for its

TYE 1990 prior to the Court's decision in Meredith I. Based on

Meredith I, petitioner later claimed an ordinary deduction for

that year of $1,555,428 ($807,267 editorial costs plus tax

savings) relating to the acquisition of the subscriber

relationships. On August 29, 1995, respondent issued a statutory

notice of deficiency to Meredith in which, among other

adjustments to income, Meredith's claimed deduction of $1,555,428

for its TYE 1990 was disallowed completely, and a deficiency of

$744,852 was determined.

Discussion

We must adjudge the proper tax treatment for contingent

editorial costs and correlated tax savings that were allocable to

the basis of the subscriber relationships in Meredith's TYE 1990.

The issue of whether these costs should be allocated to the basis

of that particular asset was resolved affirmatively in Meredith

I. Meredith Corp. & Subs. v. Commissioner, 102 T.C. at 455.

However, the subscriber relationships were completely amortized

after the end of their stipulated 42-month useful life.

In Meredith I, this Court established a methodology for

determining Meredith's tax basis in its subscriber relationships.

Critical to this method--and the current imbroglio--was our
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conclusion that the fulfillment obligation assumed by Meredith on

January 3, 1986, was contingent.

The Court calculated petitioner's initial basis in the

subscriber relationships asset as of January 3, 1986, by first

finding that its value was $40,300,000 (including value

attributed to tax savings). This was determined by using the

income approach of petitioner's expert (Grabowski), and by

assuming an exclusion during the first 35 months of a portion of

the advertising revenues of LHJ attributable to the efforts of

the magazine's editor-in-chief (editor advertising exclusion).

Using Grabowski's amortization factor of .37634, we calculated

this value to be approximately $25,133,500 prior to the addition

of tax savings. The Court thereafter decreased this pretax

savings figure by the present value of the stipulated editorial

costs through June 30, 1991 (approximately $18,762,500) since

these costs were contingent, and increased the resulting figure

by the present value of the 35 months of the editor advertising

exclusion (which we computed to be approximately $2,760,000). We

thus found petitioner's initial basis to be $14,641,000, after

the addition of tax savings of $5,510,000. Meredith Corp. &

Subs. v. Commissioner, supra at 463. The Court reasoned that, to

be consistent with the parties' stipulation requiring

capitalization of the editorial costs and with the income

approach, the proper treatment of the amounts was to charge them

against revenues in determining petitioner's initial basis and to
 - 9 -

add such amounts to the basis in the years in which they were

incurred. Meredith Corp. & Subs. v. Commissioner, supra at 454-

455.

Petitioner claims that respondent erred in disallowing the

ordinary amortization deduction of $1,555,428 in its TYE 1990,

inasmuch as the deduction reflects the portion of the LHJ

purchase price and corresponding tax savings attributable to the

acquired subscriber relationships for that year. Since the 42-

month useful life of the subscriber relationships had expired,

Meredith argues that the entire additional purchase price

becoming fixed during its TYE 1990 should be deducted in that

year in order for it to adequately recover the cost of its

investment.

Respondent contends, on the other hand, that Meredith's

annual recovery of the total cost of the subscriber relationships

must be terminated. Thus, respondent argues that petitioner is

not permitted to deduct $1,555,428 in its TYE 1990 and that at

least $807,267 (actual editorial costs exclusive of tax benefits)

represents a nonamortizable capital expenditure. She proposes

June 30, 1989, as the cut-off date for petitioner's recovery of

costs, even though not all of the costs of the subscriber

relationships had been incurred as of that date. Respondent

states in the notice of deficiency:

The court determined that the subscriber
relationships acquired on January 3, 1986 had a useful
life of 42 months in Meredith Corp. and Subs. v.
 - 10 -

Commissioner, 102 T.C. 406 (1994). As a result of the
opinion and as a result of the determination of the
Commissioner, it has been determined that the deduction
* * * claimed as an amortization deduction with respect
to amounts allocated to a subscription list included in
the intangible assets acquired in the purchase of
Ladies['] Home Journal, is disallowed in full because
the amount paid was for non-amortizable intangibles,
having an indeterminate useful life under Section 167
of the Internal Revenue Code.

We agree with petitioner. Among other things, respondent

misconstrues our holding in Meredith I regarding the contingent

nature of all of the editorial costs described above and the

resulting impact on petitioner's tax basis in the subscriber

relationships. She also disregards general principles of tax law

concerning the treatment of contingent asset acquisition costs

incurred after an asset has been disposed of or has exceeded its

useful life.

I. Meredith I Unequivocally Reasoned That Contingent Editorial
Costs Were To Be Added to the Tax Basis of the Subscriber
Relationships When They Were Incurred

Respondent posits that the post-June 30, 1989, contingent

costs do not increase petitioner's basis in the amortizable

subscriber relationships, but "instead are allocated to the basis

of going concern value or goodwill, neither of which is

amortizable". (The underlying transaction occurred prior to the

effective date of section 197, as enacted by Omnibus Budget

Reconciliation Act of 1993, Pub. L. 103-66, section 13261(a), 107

Stat. 532.)
 - 11 -

It is true, as respondent points out, that the allocable

purchase price exceeded the fair market value of the acquired

tangible and amortizable intangible assets of LHJ. That does not

dictate, however, that editorial costs incurred after the

expiration of the 42-month useful life must be assigned to

nonamortizable goodwill or going concern value. As we stated in

Meredith I, "the sole reason why the subscriber relationships are

not treated as goodwill is that they can be valued and have a

limited useful life which can be estimated with reasonable

accuracy". Meredith Corp. & Subs. v. Commissioner, 102 T.C. at

460. The aforementioned editorial costs were found to constitute

part of the value of that asset, and not of goodwill. In arguing

to the contrary, respondent ignores our rationale in Meredith I

that such contingent costs were to be added "to the basis of the

subscriber relationships in the years in which such amounts are

incurred". Id. at 455 (emphasis added).

The Court initially subtracted from Grabowski's income

approach valuation of the subscriber relationships the present

value of all of the stipulated editorial costs (including costs

incurred during Meredith's TYE 1990 and TYE 1991) due to their

contingency, and then prescribed adjustments for TYE 1986 and TYE

1987 based on the actual costs incurred by Meredith in each of

those years. Id. at 463. It would be inconsistent with the

analysis in Meredith I to deny petitioner an increase in the
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basis of its subscriber relationships for the editorial costs and

associated tax benefits becoming fixed in its TYE 1990.

II. Meredith I Does Not Preclude Petitioner's Deduction for
Editorial Costs Incurred During Its TYE 1990

Respondent alternatively contends that "Nothing in the

Court's Opinion in Meredith I even remotely suggests that

Petitioner is entitled to an ordinary deduction [in its TYE

1990]" for additional contingent costs becoming fixed in that

year. Nothing, however, in our Opinion suggests otherwise.

Respondent nonetheless claims that "strictly speaking, the

Court's Opinion [in Meredith I] precludes the deduction claimed

by * * * [Meredith] for the taxable year ended June 30, 1990

* * * [because of the expiration of the stipulated 42-month

useful life]". She cites the following language from Meredith I

to support her proposition:

The amounts are not subject to a new depreciation
schedule, but, rather, are to be depreciated over the
remaining useful life of the subscriber relationships
based on a useful life ending 42 months after the
acquisition of the subscribers. * * * Meredith Corp.
& Subs. v. Commissioner, 102 T.C. at 462-463.

However, the language above is inapposite to Meredith's TYE 1990

at issue in the instant matter. Placed in context, the words

"the amounts" refer to the 1986 and 1987 additions to basis only.

The penultimate sentence before the quotation computes dollar

amounts for 1986 and 1987. Moreover, the sentence before the

quoted language refers to "these amounts", meaning the 1986 and

1987 sums.
 - 13 -

In Meredith I, we reasoned that contingent acquisition costs

incurred through TYE 1991 were to be added to the cost basis of

the subscriber relationships when they became fixed, and we held

only that those costs attributable to Meredith's TYE 1986 and TYE

1987 were amortizable over whatever remained of the 42-month

useful life ending June 30, 1989. We did not address the

deductibility of editorial costs incurred in any year after TYE

1987 because such years were not before the Court.

III. Contingent Acquisition Costs Attributable to Fully Amortized
Assets Are Deductible as Incurred

Furthermore, the expiration in mid-1989 of the useful life

of the subscriber relationships does not foreclose a deduction

for those editorial costs incurred by Meredith during subsequent

taxable years. General tax law principles enounced in

regulations and case law provide that contingent asset

acquisition costs that become fixed after the relevant asset is

fully amortized are deductible as they are incurred.

Section 1.338(b)-3T, Temporary Income Tax Regs., 51 Fed.

Reg. 3592 (Jan. 29, 1986), as adopted in T.D. 8072, 1986-1 C.B.

111, concerns the treatment of adjustments to adjusted grossed-up

basis (AGUB) for contingent events that occur after the close of

a new target's first taxable year in certain stock acquisitions.

If an acquisition date asset has been disposed of, or fully

depreciated, amortized, or depleted before a contingent amount is

taken into account in determining AGUB, the contingent amount
 - 14 -

otherwise allocable to such asset is treated "under principles of

tax law applicable when part of the cost of an asset (not

previously reflected in its basis) is paid after the asset has

been disposed of, depreciated, amortized or depleted." Sec.

1.338(b)-3T(d)(2), Temporary Income Tax Regs., 51 Fed. Reg. 3593

(Jan. 29, 1986).

Section 1.338(b)-3T(j), Example (1)(vi), Temporary Income

Tax Regs., 51 Fed. Reg. 3595 (Jan. 29, 1986) considers the

disposition of stock (a capital asset) before a liability became

fixed and determinable. Since the stock had been disposed of

prior to the contingent liability's becoming fixed, no amount of

the increase in AGUB attributable to such asset was allocable to

any other asset, including goodwill and going concern value. See

discussion supra pp. 13-14. Instead, the example directs the

taxpayer to deduct the liability as a capital loss under the

principles of Arrowsmith v. Commissioner, 344 U.S. 6 (1952).

In Arrowsmith, a corporation liquidated, and its

shareholders reported their gain as capital. In a later year, a

judgment was rendered against the former corporation. The

erstwhile shareholders paid the judgment for the corporation

because they were transferees of its assets. They deducted the

entire amount paid as an ordinary loss. However, the Supreme

Court determined that the losses that resulted from the payment

of the judgment stemmed from a legal obligation arising out of

the prior liquidation. Since the original transaction was a
 - 15 -

capital one, the Court held that the related transaction was also

capital. Arrowsmith v. Commissioner, supra at 8.

Respondent gainsays the applicability of the foregoing

discussion to the issue herein because, among other reasons,

section 1.338(b)-3T, Temporary Income Tax Regs., 51 Fed. Reg.

3592 (Jan. 29, 1986), postdates Meredith's purchase of LHJ's

assets, and Arrowsmith does not directly address the

deductibility of contingent asset acquisition costs.

We agree with respondent that the regulations and case law

are not controlling authority. Nevertheless, we think the

general principles espoused therein comport equally well with the

increase in basis of fully amortized subscriber relationships as

they do with adjustments to AGUB of fully amortized or disposed

assets under section 338. For present purposes, we descry no

reason to distinguish the two situations.

Moreover, these tax law principles antedate petitioner's

purchase of the assets of LHJ and are thus appropriately

considered by the Court. The Secretary states:

These [section 1.338(b)-3T] rules provide for the
incorporation of general principles of tax law which
are applicable to the determination of the basis of
assets acquired in actual asset purchases. * * *

* * * * * * *

For example, an amount of adjusted grossed-up basis
otherwise allocable to a disposed of capital asset may
be deducted by new target as a capital loss. [T.D.
8072, 1986-1 C.B. 111, 114; citation omitted.]
 - 16 -

The Secretary cites Arrowsmith v. Commissioner, supra, a case

decided well before petitioner's acquisition of LHJ, as authority

for that assertion. See T.D. 8072, supra.

We now apply the preceding analysis to the facts before us.

Meredith is entitled to an increase in the basis of the

subscriber relationships due to contingent acquisition costs

becoming fixed in its TYE 1990. The section 338 regulations

supra provide a template for petitioner to treat the fully

amortized subscriber relationships asset as if it had been

disposed of before the increase in basis, and to determine the

character of the resulting deduction pursuant to Arrowsmith v.

Commissioner, supra. Since the added basis would have resulted

in ordinary amortization deductions if it had been included in

the original acquisition cost, we hold that petitioner is

entitled to an ordinary deduction in its TYE 1990 of the entire

amount of the contingent editorial costs becoming fixed in that

year. See Meredith Corp. & Subs. v. Commissioner, 102 T.C. at

455.

IV. A Deduction for Contingent Costs Incurred During TYE June
1990 Does Not Result in Excessive Cost Recovery for Petitioner

Finally, respondent contends that, "implicit" in the Court's

calculation of petitioner's initial basis in the subscriber

relationships in Meredith I is a "maximum" "fair market value

[basis] * * * as of January 3, 1986 of $44,725,488" and that

since petitioner has already deducted $48,798,243, "over $4
 - 17 -

million more than what its initial basis would have been if the

Court had not excluded the present value of the assumed editorial

costs," any additional deduction is unwarranted. However,

respondent's argument misses the mark. As discussed earlier, we

held that the tax basis of this intangible asset was $14,641,000

as of January 3, 1986 and was to be increased as fulfillment

costs were thereafter incurred, through petitioner's TYE 1991.

Id. at 455. What "would have been" if we had decided differently

is irrelevant.

Moreover, if we had determined in Meredith I that the

editorial costs were not contingent subscriber expenditures, such

that the "maximum" tax basis that respondent theorizes in fact

applied, Meredith would have been entitled to amortize the entire

amount of its editorial costs and associated tax savings through

its TYE 1991 over the stipulated 42-month useful life of the

asset. Id. at 445. The present controversy never would have

materialized. In Meredith I, respondent inveighed against such a

result and prevailed. Respondent cannot have it both ways.

To reflect the foregoing,

An appropriate order

granting petitioner's motion

for partial summary judgment

and denying respondent's
- 18 -

cross-motion for partial

summary judgment will be

issued.