Hyatt Hotels Corporation & Subsidiaries

United States Tax Court

T.C. Memo. 2023-122

HYATT HOTELS CORPORATION & SUBSIDIARIES,
Petitioner

v.

COMMISSIONER OF INTERNAL REVENUE,
Respondent

—————

Docket No. 13858-17. Filed October 2, 2023.

—————

Carter Cabell Chinnis, Jr., Maria C. Critelli, John T. Hildy, Tyler M.
Johnson, Thomas Lee Kittle-Kamp, Anthony D. Pastore, William A.
Schmalzl, Joshua M. Schneider, Scott M. Stewart, Gary B. Wilcox, and
Joel V. Williamson, for petitioner.

James M. Cascino, David B. Flassing, Angela B. Reynolds, H. Barton
Thomas, and Thomas D. Yang, for respondent.

MEMORANDUM FINDINGS OF FACT AND OPINION

NEGA, Judge: Since 1987, Hyatt Hotels Corp. and Subsidiaries
(Hyatt) has operated a customer rewards program, known as the Gold
Passport Program (Program). Participating travelers who stayed at
Hyatt-branded hotels received rewards points, which when amassed in
a sufficient number could be redeemed for a free stay at any Hyatt-
branded hotel. Hyatt owned roughly 25% of all Hyatt-branded hotels;
the rest were owned by a variety of third parties, who contracted with
Hyatt for use of its hotel management services and/or its brand name
and other intellectual property. When a participating traveler received
rewards points for a stay at a Hyatt-branded hotel, Hyatt required the
hotel owner to make a payment into an operating fund, which was held
by a Hyatt subsidiary and known as the Gold Passport Fund (Fund).
When a participating traveler redeemed rewards points for a stay at a

Served 10/02/23
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[*2] Hyatt-branded hotel, Hyatt would make a compensation payment
to the hotel owner out of the Fund. Portions of the Fund’s unused
balance were invested in marketable securities and resulted in realized
gains and accrued interest. Hyatt also used the Fund to pay
administrative and advertising expenses that it determined were
related to the Program.

For federal income tax purposes, Hyatt essentially ignored the
Fund, including none of its revenue in gross income and claiming no
deductions for expenses paid. The Commissioner audited Hyatt’s
returns and determined that this tax treatment was improper. Going a
step further, the Commissioner determined that Hyatt’s treatment was
a method of accounting and that Hyatt thus must include in income as
a transitional adjustment its net revenue from the Program since 1987.
The Commissioner issued a notice of deficiency memorializing those
determinations, and Hyatt timely filed a Petition with this Court. Hyatt
maintains that its treatment of the Fund was proper, arguing that it
held the Fund as a trustee, agent, or conduit for the hotel owners and
not as the true owner for federal income tax purposes. In the
alternative, Hyatt contends that the Commissioner overreached by
characterizing its treatment as a method of accounting and thus the
transitional adjustment should not be sustained. Also in the
alternative, Hyatt contends that it should be able to offset its gross
receipts with the estimated cost of future compensation payments to
hotel owners by way of a longstanding regulatory provision known as
the trading stamp method.

Accordingly, the issues for decision are (1) whether Program
payments received, interest accrued, and investment gains realized
were includible in Hyatt’s gross income for tax years 2009, 2010, and
2011 (years at issue); (2) whether a change in Hyatt’s tax treatment of
such receipts constitutes a change in method of accounting subject to
section 481 adjustment; and (3) whether Hyatt may adopt the trading
stamp method with respect to the years at issue. 1

1 Unless otherwise indicated, statutory references are to the Internal Revenue

Code, Title 26 U.S.C., in effect at all relevant times, regulation references are to the
Code of Federal Regulations, Title 26 (Treas. Reg.), in effect at all relevant times, and
Rule references are to the Tax Court Rules of Practice and Procedure.
 3

[*3] FINDINGS OF FACT

I. Hyatt

Hyatt is a corporation organized under the laws of Delaware. 2 At
all relevant times, including when it timely filed the Petition in this
case, Hyatt’s principal office was in Illinois. During the years at issue
Hyatt was the U.S. consolidated parent for the Hyatt group of companies
for federal income tax purposes. Petitioner’s wholly owned subsidiary,
Hyatt Corp., was its primary relevant operational subsidiary, housing
its executive-level personnel. We will refer to Hyatt, Hyatt Corp., and
other relevant subsidiaries collectively as petitioner. 3

II. Petitioner’s Business

Petitioner is a well-known hospitality provider which owns,
leases, manages, and franchises hotel, residential, and timeshare
properties (Hyatt-branded hotels) in the United States and
internationally. During the years at issue petitioner owned (in whole or
in part) or leased a number of Hyatt-branded hotels. Petitioner was the
largest single owner of all Hyatt-branded hotels, owning approximately
20%–25% of all Hyatt-branded hotels during the years at issue. The
remaining approximately 75%–80% of Hyatt-branded hotels were
owned by a variety of third-party hotel owners (TPHOs). Some of the
TPHOs had entered into hotel management agreements with petitioner,
appointing petitioner as their agent to manage and operate a particular
hotel for a set term. In managed hotels, Hyatt employees would be
stationed on site and handle day-to-day operations. Under the
management agreements, the TPHO would pay petitioner a base fee,
consisting of a percentage of the hotel’s gross revenue, and an incentive
fee, consisting of a percentage of some profitability measure.

Other TPHOs entered into more limited franchise agreements
with petitioner, in which petitioner would license Hyatt intellectual
property for a set term to the TPHO, which would operate the hotel itself

2 Hyatt was formerly known as Global Hyatt Corp., before changing its name

in June 2009. In November 2009 Hyatt completed an initial public offering and became
a publicly traded company.
3 The Court issued protective orders adopting procedures to protect petitioner’s

trade secrets and other confidential information during this case. The facts set forth
in this Opinion have been adapted accordingly. All information included herein has
been determined by the Court not to constitute “trade secrets or other confidential
information” within the meaning of section 7461(b).
 4

[*4] or engage a separate management company to do so. Under the
franchise agreements, the franchising TPHO would pay petitioner an
upfront application fee and monthly royalty fees consisting of a
percentage of its gross revenues (generally ranging from 4% to 6% and
escalating over the franchise agreement’s term). The franchise
agreements typically included a provision by which petitioner expressly
disclaimed the existence of an agency relationship between it and the
TPHO.

The inventory of Hyatt-branded hotels was not static during the
years at issue. Certain hotels owned by TPHOs, whether managed or
franchised, sometimes removed their affiliation with the Hyatt brand,
in a process known in the hospitality industry as “deflagging.”
Deflagging was not an uncommon occurrence for petitioner (or for the
hospitality industry writ large), and hotels left the Hyatt chain during
the years at issue. Conversely, during the years at issue new TPHOs
entered into management or franchise agreements with petitioner.
Petitioner also acquired, leased, or entered into joint ventures that
added new Hyatt-branded hotels to the chain. During the years at issue
a small number of hotels already within the Hyatt chain shifted
ownership from a TPHO to petitioner itself or vice versa.

Petitioner maintained a number of different sub-brands intended
to appeal to different market segments. For instance, its Hyatt Place
line of hotels was marketed for business travelers, while its Park Hyatt
line was marketed for customers interested in a more upscale leisure
experience. During the years at issue the majority (approximately 50%)
of all Hyatt-branded hotels were marketed under the Hyatt Regency
sub-brand, which was marketed to both business and resort travelers.
Some of the sub-brands were traditional, full service hotels, while others
were select service hotels with only limited food and beverage amenities
and no business or banquet facilities. Certain sub-brands also marketed
residential apartment units and timeshare vacation properties. A key
aspect of petitioner’s business strategy was maintaining a consistent
positive customer experience across the hotels in each sub-brand.

III. The Program

During the years at issue petitioner operated the Program as well
as the Fund. Petitioner initiated the Program in April 1987. Petitioner
created the terms and conditions of the Program for members; per the
terms, only an officer of petitioner was authorized to modify the terms.
The terms stated in relevant part that petitioner retained the right to
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[*5] change significant aspects of the Program, including the points
requirements for member redemption of awards. 4 The terms also stated
that petitioner “has the right to end the [Program] by providing written
notice to then Active Members six months in advance.” Finally, the
terms stated that “[a]ccrued points do not constitute property of the
Member” and “are not transferable to another person for any reason.”
The Program was operated by a team of individuals employed by
petitioner’s marketing department. Proposed changes to the terms of
the Program were reviewed and approved by senior executives employed
by petitioner.

Pursuant to the terms, customers could enroll as Program
members and earn rewards points based on their eligible spending at
Hyatt-branded hotels. 5 Customers could become Program members by
visiting petitioner’s website, calling petitioner’s call center reservation
phone line, or physically visiting a Hyatt-branded hotel’s front desk.
During the years at issue members earned Program rewards points at a
rate of five points per dollar of eligible spending. Alternatively,
customers could opt to receive a number of travel miles, redeemable with
one of petitioner’s third-party travel partners. 6 Members could also
convert already-earned rewards points into travel miles with one of
petitioner’s travel partners. Petitioner would sometimes run limited-
time promotions in which members could earn bonus numbers of
rewards points or miles for a qualifying stay. Not all bookings at Hyatt-
branded hotels were eligible for rewards points. For instance, if a
member booked a stay through a third-party intermediary, such as

4 Hyatt exercised this right on occasion; for instance, in 2010 Hyatt added a

new rewards category that effectively required a higher rewards points balance to
redeem for stays at particular hotels.
5 If members met a particular amount of qualified spending at Hyatt-branded

hotels, they would graduate to becoming higher tier program members, which entailed
some additional perks during their stays.
6 Customers did not need to be Program members to receive travel miles for

their eligible spending, so long as they were members of a participating travel partner’s
corresponding frequent traveler program. The travel partners included a number of
domestic and foreign airlines and Amtrak. Petitioner had entered into a number of
agreements with the various travel partners in order to make travel miles available
for members, with petitioner being liable to make compensation payments to the travel
partner when miles were awarded.
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[*6] Expedia or Booking.com, instead of through petitioner directly, that
member would not receive rewards points for the stay. 7

Members could redeem their rewards points to pay for hotel stays,
room upgrades, and other goods and services at Hyatt-branded hotels. 8
The various Hyatt-branded hotels were placed within tiered award
categories, which required set numbers of points for particular stays or
services. In 2009 the lowest award category for a one-night free stay
was 5,000 points, while the highest was 27,000 points. Effective June 4,
2010, petitioner reclassified the categories of a number of Hyatt-branded
hotels and added a new sixth category.

Members could not redeem rewards points for cash. During the
years at issue the Program’s terms and conditions did not state that
rewards points would expire. However, during the years at issue Hyatt
personnel involved with the Program had discussions about changing
the Program so that earned rewards points would expire if not redeemed
within a certain period. In 2012 petitioner implemented that change,
making rewards points expirable after a certain period of inactivity by
a member.

Petitioner considered the Program highly successful and a central
component of its marketing efforts. Petitioner’s internal analytics
indicated that Program members tended to stay at Hyatt-branded hotels
more frequently and longer. During the years at issue the Program
experienced incremental growth. At the end of 2009, the Program had
over 9 million members with members having booked 23.4% of total
room nights at Hyatt-branded hotels that year. By the end of 2011, the
Program had over 12 million members with members having booked
30.3% of total room nights at Hyatt-branded hotels that year. The
percentage of hotel stays booked by members varied for each hotel; for
instance, a flagship hotel, such as the Grand Hyatt New York (owned by
petitioner), would historically tend to have a higher percentage of stays
by members.

7 This arrangement was consistent with the financial self-interest of the hotel

owners, including petitioner, who would be charged additional commission fees for
stays booked through third-party intermediaries.
8 When a hotel deflagged from the Hyatt brand, members would no longer be

able to earn rewards points at that hotel and generally would not be able to redeem
already-earned rewards points at that hotel, even if a qualifying stay had been booked
before the deflagging date.
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[*7] Petitioner created and controlled a Program manual detailing the
procedures and requirements for TPHOs’ participation in the Program,
which was made available to employees of both petitioner and the
TPHOs. Petitioner required that all Hyatt-branded hotels (including
international hotels) participate in the Program and did not allow
TPHOs to request refunds of payments made to the Fund. 9 Petitioner
also required that all Hyatt-branded hotels allocate a certain percentage
of total room inventory for potential redemptions by Program members.
Similarly, the Program manual stated that there were no blackout dates
for rewards stays booked by Program members, though the TPHOs
could request that the percentage of rooms reserved for Program
members be reduced during limited high demand periods, subject to
petitioner’s approval.

Petitioner’s primary communication to the managed hotels about
the Program was via system services disclosures included in their
annual business plans for each managed hotel. Over time, petitioner
changed the terms in the system services disclosures relating to the
Program, including a change in 2011 to specify that the assessment fee
charged to the hotel owners would be determined by Hyatt in its
discretion. Petitioner did not seek approval from the TPHOs for this
change.

Some older management agreements still in place during the
years at issue (most obviously agreements that predated 1987) did not
refer to the Program or the Fund. The management and franchise
agreements that did refer to the Program characterized it as a
mandatory service. The management and franchise agreements that
referred to the Fund had a clause generally describing how the Fund
was invested and what costs it was used to cover. Petitioner sometimes
entered into specific service agreements governing the participation in
the Program (as well as participation in other chainwide services
provided by petitioner) of TPHOs operating Hyatt-branded hotels
internationally.

A. The Fund

Operating the Program involved a regular inflow and outflow of
payments between petitioner and the various owners of the Hyatt-
branded hotels. When a Program member opted to receive rewards

9 Hyatt subsidiaries that owned Hyatt-branded hotels also participated in the

Program, making payments into the Fund and receiving compensation payments.
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[*8] points earned from a stay at a Hyatt-branded hotel, the hotel owner
would pay petitioner an assessment fee of four percent of the revenue
derived from that member’s stay (4% payments). In 2011 petitioner
determined to increase the assessment fee to 4.5% for full service Hyatt-
branded hotels, effective January 1, 2012. Petitioner intended for this
change to result in having a higher amount of the Fund available to pay
for Program advertising. When a Program member alternatively opted
to receive travel miles instead of rewards points, the hotel owner would
pay petitioner the actual cost of the miles (miles payments), as
negotiated and agreed to in the contracts between petitioner and the
third-party transportation partners. The 4% payments and the miles
payments were calculated and paid out to petitioner monthly, flowing
into a pair of bank accounts owned and operated by petitioner. 10
Petitioner also sold rewards points directly to customers, hotel owners,
certain car rental companies, and to Hyatt Vacation Club (its timeshare
business). The proceeds of these sales (sale payments) were also
deposited into the same bank accounts owned and operated by
petitioner. Petitioner described the balance of the 4% payments, miles
payments, and sales payments (collectively, Program payments), once
received, as the Fund.

Petitioner entered into agreements with several third-party
custodians to hold portions of the Fund; petitioner also entered into
agreements with several third-party investment advisers to invest
portions of the Fund. 11 Petitioner directed the general investment
strategy of the Fund, which was largely invested in marketable, fixed
income securities. The TPHOs did not have any input or control over
the choice of investment advisers or the Fund’s investment strategy.
During the years at issue the Fund accrued interest and realized gains
from investments. Petitioner received quarterly statements from its
custodians displaying the securities held and transactions made during
the previous quarter. Aside from annual Fund financial statements
provided by petitioner (discussed further below), the TPHOs did not
regularly receive communications about the performance of the Fund
investments.

10 These bank accounts were used only for Program payments, not general

corporate cash.
11 The agreements with the custodians and investment advisers represented

that the client was “Hyatt Corporation, As Agent for the Hotels Owned, Leased,
Operated, Managed, or Franchised By It, Its Subsidiaries, and/or Affiliates, d/b/a
Hyatt Gold Passport.”
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[*9] When a Program member redeemed rewards points at a Hyatt-
branded hotel, petitioner would pay a compensation payment to the
hotel owner out of the Fund. 12 Petitioner based the amount of the
compensation payment on two factors: the hotel’s occupancy rate during
the award stay and the hotel’s forecasted monthly average rate (FMAR)
for rooms. 13 As of January 2009, compensation payments were
calculated via a multitier compensation structure depending on
occupancy rate. If hotel occupancy during the award stay was nearly
full (as measured by a particular percentage threshold), the hotel owner
would receive compensation in an amount equal to a significant portion
of the FMAR (compensation level A). If hotel occupancy during the
award stay was not near to full, the hotel owner would receive
compensation equal to only a small portion of the FMAR.

Effective January 1, 2011, petitioner changed the formula for
compensation payments, which resulted in decreased annual amounts
of compensation payments made and thus had the effect of increasing
the amount of the Fund available for use by petitioner. 14 The TPHOs
did not have any control over the formula for the compensation
payments.

In addition to operating the Fund as a reserve for the
compensation payments, petitioner used the Fund to pay advertising
and administrative costs that it designated as related to operating the
Program. The administrative costs of the Program included (1) costs of
maintaining member call centers and contact centers; (2) the salaries
and benefits of employees involved in operating the Program; 15 and (3)
the cost of maintaining the Program’s member database. The member
database, which had been in existence since 1987 and was managed by
a third-party vendor, recorded extensive information related to
individual members and their stays at Hyatt-branded hotels and

12 In reality, compensation payments would often be recorded as a credit setoff

against the amount of Program payments due to petitioner in monthly invoices.
13 Every January, each Hyatt-branded hotel would submit its FMARs for the

coming calendar year, subject to adjustment by petitioner.
14 The change petitioner made in 2010, which reclassified the hotels in award

categories and added a new award category, resulted in decreased annual amounts of
compensation payments made to hotel owners and thus had the effect of increasing the
amount of the Fund available for use.
15 For certain employees that presumably spent only part of their time on

Program-related activities, only a portion of their salaries and benefits would be
designated as Program expenses.
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[*10] maintained members’ rewards points balances. With regard to
individual members, the database would record information useful for
tailoring future stays to a member’s preferences. For instance, if a
member had demonstrated a preference for a particular beverage or type
of pillow, the member database could record that observation for use in
future stays. Petitioner’s marketing department also used the member
database to generate macro-level analytics about Hyatt customers,
which were then incorporated into targeted advertising of particular
customer demographics. Petitioner owned the member database and
considered it to be highly valuable in its business. The TPHOs did not
have any ownership interest in the database, nor did they have access
to the entirety of the member database; to access the narrow slice of
membership data related to stays at the particular TPHO-owned hotel,
a TPHO could request permission from petitioner. If a TPHO deflagged
from the Hyatt brand, it would not receive a copy of the data from the
member database. 16 Some of the administrative costs paid by petitioner
out of the Fund were made to other Hyatt entities to reimburse them for
expenses that were paid “for the benefit of the Program.”

As part of preparing annual budgets, Hyatt personnel determined
approximately how much of the Fund would be spent on administrative
costs and advertising in a given year upon the basis of projected Fund
balance in excess of an actuarial estimated reserve amount designated
to cover future compensation payments (discussed further below). Hyatt
personnel involved in the Program would designate particular expenses
as Program related and contact petitioner’s treasury department to
make a corresponding disbursement from the Fund. 17 The TPHOs did
not have any control on how the Fund was spent on administrative costs
or advertising.

If a TPHO deflagged from the Hyatt brand, that TPHO was not
entitled to any payment or reimbursement out of the Fund. Instead, the
proportionate amount of the Fund attributable to the deflagging TPHO
would remain available for making compensation payments or
satisfying administrative or advertising expenses.

16 The management and franchise agreements typically included a clause that

defined Program member information as confidential or proprietary (except to the
extent that a TPHO itself lawfully stored information in its own property management
database) and thus not usable by a TPHO upon expiration of an agreement’s duration.
17 If a particular expense was of a sufficiently high dollar amount, approval by

a more senior executive was required prior to disbursement.
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[*11] B. Program Advertising

Hyatt personnel determined how much would be spent on
Program advertising for a given year. Internal analysis by petitioner
during the years at issue indicated that every $1 spent on Program
advertising generated a return on investment of $8 in revenue. As noted
above, in 2011 petitioner increased the number of rewards points to be
redeemed for a stay at certain Hyatt-branded hotels. Petitioner
intended for this change to free up additional amounts of the Fund to
spend on Program advertising that would otherwise have been
earmarked to cover future rewards points redemptions. Hyatt
personnel also determined whether the costs of a particular
advertisement should be borne by the Fund. In making such
determinations, members of petitioner’s marketing department
involved in the Program would sometimes consult with members of
petitioner’s finance and legal departments. Sometimes Hyatt personnel
would determine that only a portion of the costs of a particular
advertisement should be paid by the Fund. The TPHOs did not have
any control over how petitioner spent the Fund on Program advertising.

A common example of Program advertising was sending
membership offer letters to customers of credit cards or airlines with
whom petitioner had partnered. For instance, one typical promotional
joint advertisement with Mastercard had the following tagline: “There
Are Thousands of Reasons to Stay at Hyatt. And Now Every Stay Comes
With 2,500 More.” Some Program advertising was primarily branded
with the Program’s own logo (the trademark of which was owned by
petitioner), while other advertising was primarily branded with Hyatt’s
own logo. Other Program advertising gave equal prominence to both the
Program and Hyatt logos. Program advertising also sometimes
displayed the logos of specific Hyatt sub-brands. Online or emailed
Program advertising typically included a link for customers to book a
stay on Hyatt’s website.

IV. Financial Accounting and Reporting

A. Fund Actuarial Analyses

A third-party accounting firm, PricewaterhouseCoopers (PWC),
prepared regular actuarial analyses of the Fund in order to determine
the amount necessary to cover future potential redemptions by Program
members. On the basis, in part, of the Program’s past rewards points
redemption rates, PWC would estimate the number of rewards points
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[*12] that would be redeemed and determine a range of dollar amounts
that should be held in reserve for anticipated future redemptions. As
part of the actuarial analyses, PWC would also estimate the rate of
“breakage,” i.e., the numbers of rewards points that would never be
redeemed and thus never require a compensation payment out of the
Fund.

B. Fund Financial Statements

Annual financial statements were prepared for the Fund (Fund
statements) in accordance with Generally Accepted Accounting
Principles (GAAP). A third-party accounting firm, Deloitte, audited the
Fund statements for the years at issue. The Fund statements included
income statements, which reported as revenue the following amounts
for the years at issue:

2009 2010 2011

Program $63,168,430 $77,195,168 $103,383,532
Payments

Marketable 7,214,521 7,510,716 7,208,255
Securities
– Net Gain

Interest 12,026,344 10,516,012 8,281,521
Income

Total $82,409,295 $95,221,896 $118,873,308
Income

The income statements reported expenses in a category entitled
“Provision for future award redemptions” in the following amounts:
2009: $38,131,732; 2010: $54,530,389; and 2011: $72,522,615.

The income statements also reported the remaining amounts of costs
and expenses:
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[*13] 2009 2010 2011

Advertising $21,165,826 $16,251,855 $10,620,650

Membership 3,679,263 4,749,127 13,607,160
Acquisition &
Enrollment/Fulfillment

Membership 7,121,477
Communication & — —
Marketing

Membership 1,673,285 1,137,967
Statements & —
Processing

Call Center — — 6,806,864

General & 17,763,862 18,555,852 8,195,723
Administrative

The expense for the provision for future rewards points redemptions was
the largest expense on the income statements, ranging from 46% to 61%
of the total Fund expenses. For each of the years at issue, the income
statements reported a small dollar net loss. The Fund statements also
included balance sheets, which reported as liabilities a reserve for the
future rewards points redemptions, chosen from within PWC’s actuarial
range.

The Fund statements made a number of representations and
disclosures concerning the Program and the Fund. The Fund
statements represented that petitioner used the Fund to cover the cost
of the administrative expenses of operating the Program, such as
employee salaries and benefits, rent, and office management expenses.
The Fund statements described the Fund as being owned by the Hyatt-
branded hotel owners during the period in which they participated in
the Program. The Fund statements also addressed income taxes, which
they described as being an obligation of each Hyatt-branded hotel
owner. The Fund statements were made available to TPHOs annually.
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[*14] C. Petitioner’s Form 10–K Financial Statements

Petitioner filed Form 10–K, Annual Report Pursuant to Section
13 or 15(d) of the Securities Exchange Act of 1934, with the Securities
and Exchange Commission for 2009, 2010, and 2011 that included
consolidated financial statements prepared in accordance with GAAP.
Petitioner’s Forms 10–K included the following footnote in relevant part:

The Hyatt Gold Passport Program (the “Program”) is our
loyalty program. We operate the Program for the benefit
of Hyatt branded properties, whether owned, operated,
managed, or franchised by us. The Program is operated
through the Hyatt Gold Passport Fund, which is an entity
that is owned collectively by the owners of Hyatt branded
properties, whether owned, operated, managed or
franchised by us. The Hyatt Gold Passport Fund (the
“Fund”) has been established to provide for the payment of
operating expenses and redemptions of member awards
associated with the Program. The Fund is maintained and
managed by us on behalf of and for the benefit of Hyatt
branded properties. We have evaluated our investment in
the Fund and have determined that the Fund qualifies as
a variable interest entity (“VIE”) and, as a result of the
Company being the primary beneficiary, we have
consolidated the Fund.

On its Form 10–K balance sheets, petitioner consolidated the
total amounts of assets and liabilities that constituted the Fund. The
Forms 10–K did not separately present the Fund assets and liabilities.
On its Form 10–K balance sheets, petitioner included the cash portion
of the Fund in the consolidated amounts reported for “Cash and cash
equivalents” rather than the line for “Restricted cash.” 18 On its Forms
10–K income statements, petitioner also consolidated the Fund’s annual
income and expense activity, after making certain adjustments and
eliminations for intercompany transactions. On its income statements,
petitioner reported a line item, entitled “Net gains (losses) and interest
income from marketable securities held to fund operating programs,” a
category which included the investment gains and interest attributable
to the Fund.

18 The amount of cash associated with the Fund was not separately stated or

disclosed on the Forms 10–K.
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[*15] Deloitte audited petitioner’s financial statements for 2009, 2010,
and 2011 and issued unqualified opinions that the financial statements
presented petitioner’s financial position fairly and were materially
correct. In corresponding audit memoranda, Deloitte personnel noted
that the Fund redemption liability was the largest liability on
petitioner’s balance sheet and described its valuation as an audit risk.

D. Hotel Owners’ Financial Statements

For some of the managed TPHO-owned hotels, petitioner would
prepare annual financial statements for the hotel as part of its
management services. Petitioner did not prepare annual financial
statements for any of the franchised TPHO-owned hotels. The income
statements in the financial statements petitioner prepared for managed
hotels reported the 4% payments made by the particular TPHO as
expenses.

V. Tax Reporting

Petitioner filed consolidated Form 1120, U.S. Corporation Income
Tax Return, for each of the years at issue. Petitioner reported the
Fund’s assets and liabilities in the totals reported on its Schedules L,
Balance Sheets per Books. However, petitioner did not include the total
annual amounts of Program revenue 19 in gross income or claim
deductions with respect to the total annual amounts of Program
expenses. 20 In its capacity as hotel owner, petitioner included in gross
income the amounts of compensation payments that it was paid or was
due from the Fund for the years at issue. Petitioner’s Forms 1120 did
not purport to use the trading stamp method or include any statements
with respect to Treasury Regulation § 1.451-4.

In order to prepare its Schedules M–3, Net Income (Loss)
Reconciliation for Corporations With Total Assets of $10 Million or
More, petitioner’s accounting personnel proportionally allocated the
Fund rewards points redemption reserve to each domestic hotel. 21 The

19 Program revenue is the sum of the Program payments received, the interest

accrued, and investment gains realized on the Fund during the years at issue.
20 On petitioner’s 2009 consolidated Form 1120, a small amount of Program

revenue and Program expenses (which netted to zero) was accidentally included in
gross income and claimed as deductions by petitioner because of a clerical error.
21 Petitioner’s accounting personnel first removed from the total the amount of

the reserve allocable to the international hotels.
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[*16] allocation was intended to result in the estimated total amount of
4% and miles payments made by each domestic hotel that had not yet
been paid out by the Fund as compensation payments (i.e., the amounts
not yet satisfying the economic performance requirement for
deductibility). To allocate the reserve, petitioner’s accounting personnel
would first calculate a weighted average, by dividing each hotel’s net
life-to-date amount of Program payments and compensation payments
by the net life-to-date amount of Program payments and compensation
payments made by all currently participating hotels. Each hotel’s
weighted average percentage would then be applied to the yearend
rewards points redemption reserve, resulting in each hotel’s allocated
share. Next, petitioner’s accounting personnel would compare the
hotel’s prior year allocated share to the current year allocated share. If
there was a year-over-year increase in the hotel’s allocated share (i.e.,
more Program payments coming into the Fund than going out),
petitioner’s accounting personnel would determine to record a
downward adjustment to the hotel’s Program expense deduction in the
amount of the increase for federal income tax purposes. Conversely, if
there was a year-to-year decrease in the hotel’s allocated share,
petitioner’s accounting personnel would determine to record an upward
adjustment to the hotel’s Program expense deduction. Pursuant to the
allocations with respect to the Hyatt-owned hotels, petitioner made
adjustments on its Schedules M–3 to the Fund rewards points reserve
book expense. 22

During each of the years at issue petitioner issued standardized
letters to all of the domestic TPHOs. The letters described the structure
of the Program and the Fund and reported to each TPHO that owned a
managed hotel the dollar amount of Program payments made by the
TPHO in that year that related to future year compensation payments.
The letters recommended that the TPHOs consult their tax advisers to
decide how to treat the amounts for federal income tax purposes.
Petitioner’s personnel considered the amounts described in the letters
to be the portion of each TPHO-owned hotel’s allocated expenses that
would not be currently deductible for federal income tax purposes
because not yet paid out (i.e., not yet meeting the economic performance
requirement for deductibility).

In sum, with respect to the Program revenue and expenses,
petitioner thus took the tax position that it operated in two distinct

22 This again reflected the position that the economic performance requirement

was not met until payments were actually made out of the Fund.
 17

[*17] capacities. In its role as “agent” for the hotel owners, petitioner
consistently did not include any Program revenue in gross income or
claim any deductions with respect to Program expenses. In its role as
owner of 20%–25% of the hotels, petitioner claimed deductions for its
(Schedule M–3 adjusted) share of Program expenses, for the tax year in
which compensation payments were made out of the Fund. Similarly,
in its role as owner of 20%–25% of the hotels, petitioner included in gross
income the compensation payments made to it out of the Fund.

In contrast, during the years at issue a substantial majority of the
domestic TPHOs deducted the 4% payments they made under the
Program on their federal income tax returns for the year they made the
payments into the Fund. Accordingly, those TPHOs’ returns reflected
the contrary position that economic performance had been satisfied with
respect to the 4% payments upon payment to petitioner. Petitioner did
not prepare federal income tax returns for any of the TPHOs during the
years at issue.

VI. The Notice of Deficiency and the Petition

Respondent conducted an examination of petitioner’s returns for
the 2009, 2010, and 2011 tax years. On March 22, 2017, respondent
issued to petitioner a notice of deficiency, which made the following
determinations:

Deficiency
Tax Year
(Overpayment)

2005 $72,058,943

2008 3,227,772

2009 0

2010 (4,230,046)

2011 0

The deficiency amounts reflected respondent’s determination that
the Program revenue (net of deductible Program expenses paid out of
 18

[*18] the Fund) was includible in petitioner’s income in the following
amounts:

Year Amount

2009 $222,559,183

2010 (3,440,170)

2011 20,962,322

For each year, respondent determined the amount of Program
revenue by subtracting petitioner’s allocated share of the future rewards
points redemption liability (in its role as hotel owner) from the year-
over-year total increase or decrease in the amount of the estimated
future rewards points redemption liability. Put more simply,
respondent essentially used the increase or decrease in amount of the
redemption reserve as a proxy for the amount by which the Program
revenue exceeded or was exceeded by deductible Program expenses for
a given year.

Tax year 2009 reflected a transitional adjustment of $228,017,823
made by respondent under section 481(a) to account for amounts of
Program revenue (net of Program expenses paid out of the Fund) that
were not included in petitioner’s taxable income for tax years 1987
through 2004. As a result of the Program revenue determinations,
respondent adjusted the carryback of a net operating loss applied by
petitioner from tax year 2009 to 2005, which resulted in a deficiency for
tax year 2005. Similarly, as a result of the Program revenue
determinations, respondent adjusted the carryback of amounts of
allowable foreign tax credit and general business credit, which resulted
in a deficiency for tax year 2008. Ultimately, the section 481 adjustment
was the source of most of the determined deficiency.

On June 20, 2017, petitioner timely filed a Petition with this
Court.
 19

[*19] OPINION

I. Burden of Proof

In general, the Commissioner’s determinations set forth in a
notice of deficiency are presumed correct, and the taxpayer bears the
burden of proving them erroneous. Rule 142(a)(1); Welch v. Helvering,
290 U.S. 111, 115 (1933); Pittman v. Commissioner, 100 F.3d 1308, 1313
(7th Cir. 1996), aff’g T.C. Memo. 1995-243. For this presumption to
adhere in cases involving receipt of unreported income, the
Commissioner generally must make a minimal evidentiary showing
connecting the taxpayer with the income-producing activity or
demonstrating that the taxpayer actually received unreported income.
See Walquist v. Commissioner, 152 T.C. 61, 67 (2019). We conclude that
respondent has made the requisite showing to shift the burden to
petitioner.

II. Inclusion of Program Revenue in Gross Income

Section 61 broadly defines gross income as “all income from
whatever source derived.” We narrowly construe any exclusions from
this sweeping definition. See Commissioner v. Schleier, 515 U.S. 323,
328 (1995). Receipt and possession of property “constitutes taxable
income when its recipient has such control over it that, as a practical
matter, he derives readily realizable economic value from it.” James v.
United States, 366 U.S. 213, 219 (1961) (quoting Rutkin v. United States,
343 U.S. 130, 137 (1952)); see Burnet v. Wells, 289 U.S. 670, 678 (1933)
(“Liability may rest upon the enjoyment by the taxpayer of privileges
and benefits so substantial and important as to make it reasonable and
just to deal with him as if he were the owner, and to tax him on that
basis.”); Corliss v. Bowers, 281 U.S. 376, 378 (1930) (“[T]axation is not
so much concerned with the refinements of title as it is with actual
command over the property taxed—the actual benefit for which the tax
is paid.”); see also Rogers v. Commissioner, T.C. Memo. 2011-277, 102
T.C.M. (CCH) 536, 538 (“The economic benefit accruing to the taxpayer
is the controlling factor in determining whether a gain is income.”), aff’d,
728 F.3d 673 (7th Cir. 2013). “The mere fact that income received by a
taxpayer may have to be returned at some later time does not deprive it
of its character as taxable income when received . . . .” Nordberg v.
Commissioner, 79 T.C. 655, 665 (1982) (quoting Woolard v.
Commissioner, 47 T.C. 274, 279 (1966)), aff’d, 720 F.2d 658 (1st Cir.
1983); see Healy v. Commissioner, 345 U.S. 278, 282–83 (1953)
(observing that a later year judicial declaration of constructive trust on
 20

[*20] funds cannot retroactively render funds nontaxable for year
received, when taxpayer initially had control and economic benefit); Ill.
Power Co. v. Commissioner, 792 F.2d 683, 689 (7th Cir. 1986) (“Where,
unlike the case of a trustee or a collection agent or a borrower, the
taxpayer’s obligation to refund or rebate or otherwise repay money that
he has received is contingent, the money is taxable as income to him.”),
aff’g in part, rev’g in part 83 T.C. 842 (1984). Conversely, courts have
long recognized that “a cardinal purpose of the income tax laws is to tax
the income to the person who has the right or beneficial interest therein,
and not to throw the burden upon a mere collector or conduit through
whom or which the income passes.” Cent. Life Assur. Soc., Mut. v.
Commissioner, 51 F.2d 939, 941 (8th Cir. 1931), rev’g 18 B.T.A. 667
(1930); see Pascarelli v. Commissioner, 55 T.C. 1082, 1091 (1971)
(observing that transferor’s retention of dominion and control over
transferred funds would suggest that transferee “acted merely as a
conduit” and “not as the beneficial owner”), aff’d, 485 F.2d 681 (3d Cir.
1973).

In Seven-Up Co. v. Commissioner, 14 T.C. 965, 979 (1950), this
Court recognized a particular exclusion from gross income, which has
come to be known as the trust fund doctrine. There, the taxpayer
created and maintained a collective fund for the purpose of paying for
national advertising of its signature soft drink beverage. Id. at 968–71.
Some third-party bottlers of the 7-Up beverage, who regularly
purchased 7-Up extract from the taxpayer, voluntarily contributed into
the fund, which was then used to pay for national radio and magazine
advertising. Id. at 970–71. The question before this Court was whether
the payments into the fund were includible in the taxpayer’s gross
income. Id. at 976. We characterized the payments made by the bottlers
as neither “for services rendered or to be rendered” by the taxpayer nor
“part of the purchase price of the extract.” Id. at 977. We concluded
that the payments were not includible in gross income, reasoning that
the taxpayer did not gain or profit because of the fully offsetting
restriction on its use of the fund. Id. at 979.

Since Seven-Up Co., this Court has refined the applicable legal
test, which now holds that when a taxpayer (1) receives funds in trust,
subject to a legally enforceable restriction that they be spent in their
entirety for a specific purpose and (2) does not profit, gain, or benefit
from spending the funds for that purpose, then the taxpayer may
exclude such funds from gross income. See Ford Dealers Advert. Fund,
Inc., Jacksonville Div. v. Commissioner, 55 T.C. 761, 771 (1971), aff’d,
456 F.2d 255 (5th Cir. 1972). When both elements of the trust fund
 21

[*21] doctrine are present, the taxpayer is deemed to be a mere conduit
or custodian of funds and not the beneficial owner for federal income tax
purposes. See Florists’ Transworld Delivery Ass’n v. Commissioner, 67
T.C. 333, 345–47 (1976); N.Y. State Ass’n of Real Est. Bds. Grp. Ins.
Fund v. Commissioner (NYS Ass’n), 54 T.C. 1325, 1335 (1970); Dri-Powr
Distribs. Ass’n Tr. v. Commissioner, 54 T.C. 460, 478–79 (1970); Broad.
Measurement Bureau, Inc. v. Commissioner, 16 T.C. 988, 1001 (1951);
see also Affiliated Foods, Inc. v. Commissioner, 154 F.3d 527, 532–33
(5th Cir. 1998), aff’g in part, rev’g in relevant part and remanding T.C.
Memo. 1996-505. In applying the trust fund doctrine, we also draw upon
the reasoning of older precedents, particularly a line of cases involving
payments made by cemetery lot customers to cemetery associations for
perpetual care or capital improvements. See, e.g., Commissioner v.
Cedar Park Cemetery Ass’n, 183 F.2d 553, 556–57 (7th Cir. 1950), aff’g
8 T.C.M. (CCH) 177 (1949); Portland Cremation Ass’n v. Commissioner,
31 F.2d 843, 845–46 (9th Cir. 1929), rev’g 10 B.T.A. 65 (1928); Am.
Cemetery Co. v. United States, 28 F.2d 918, 919 (D. Kan. 1928).

The parties dispute whether the Program revenue paid or due to
petitioner was properly excluded from petitioner’s gross income
pursuant to the trust fund doctrine. Petitioner contends that it was
legally restricted in its use of the Fund by (1) the applicable
management and franchise agreements, (2) a course of dealing between
it and the TPHOs, and (3) fiduciary duties arising by way of an agency
relationship between it and the TPHOs. Petitioner further contends
that it did not directly benefit from its use of Fund. Respondent asserts
in turn that petitioner’s use of the Fund was not so restricted and that
petitioner directly benefited from the Fund.

Petitioner also contends, in what it characterizes as an
alternative argument, that it is entitled to exclude the Program revenue
from gross income under the claim of right doctrine. See N. Am. Oil
Consol. v. Burnet, 286 U.S. 417, 424 (1932) (“If a taxpayer receives
earnings under a claim of right and without restriction as to its
disposition, he has received income . . . .”); Bates Motor Transp. Lines,
Inc. v. Commissioner, 200 F.2d 20, 24 (7th Cir. 1952), aff’g 17 T.C. 151
(1951); Diamond v. Commissioner, 56 T.C. 530, 541–42 (1971), aff’d, 492
F.2d 286 (7th Cir. 1974). We do not understand that doctrine to provide
an independent basis for exclusion of the Program revenue in these
circumstances. The trust fund doctrine is best understood as a more
tailored application of claim of right principles; if a taxpayer holds funds
in trust subject to a use restriction and for the primary benefit of others,
it naturally follows that such funds are not “received and treated by a
 22

[*22] taxpayer as belonging to [it]”—i.e., without a claim of right. See
Healy v. Commissioner, 345 U.S. at 282; see also Seven-Up Co., 14 T.C.
at 977 (observing that payments into trust fund were not “earnings
received by [the taxpayer] under a claim of right and without restriction
as to disposition”); Na v. Commissioner, T.C. Memo. 2015-21, at *21–22
(characterizing Seven-Up Co. as an application of the claim of right
doctrine). We thus analyze the parties’ contentions under the more apt
framework of the trust fund doctrine.

Turning back to that doctrine, we start (and ultimately end) our
inquiry in reverse order, by first reviewing the nature of the benefit to
petitioner from the Fund. Accordingly, first assuming arguendo that the
Fund was received in trust subject to a legally enforceable restriction,
“our task is to determine whether the economic benefit to [petitioner] as
trustee is such that [petitioner] should be taxable on receipt of the
payments, notwithstanding whatever power the [TPHOs] may have to
enforce the trust terms under state law.” Angelus Funeral Home v.
Commissioner, 407 F.2d 210, 212 (9th Cir. 1969) (citing Gracelawn
Mem’l Park, Inc. v. United States, 260 F.2d 328, 332 (3d Cir. 1958)
(assuming that valid trust fund existed but concluding that funds were
“readily available to promote future capital improvements in the
taxpayer’s property” and thus includible in gross income)), aff’g 47 T.C.
391 (1967); see Nat’l Mem’l Park, Inc. v. Commissioner, 145 F.2d 1008,
1013 (4th Cir. 1944) (concluding that, even if fund had been shown to be
a valid trust fund, it would be includible in gross income because “the
benefit of the fund inured primarily to the [taxpayer]”).

Under the trust fund doctrine, any benefit inuring to the taxpayer
from use of a purported trust fund cannot be more than “incidental and
secondary.” See Angelus Funeral Home, 47 T.C. at 396, 398 (concluding
that taxpayer’s contractual option to use a purported trust fund to pay
for capital improvements to its facilities or to acquire real estate was “of
sole benefit to the [taxpayer] and of no conceivable benefit to the [the
trust fund contributors])”); Na, T.C. Memo. 2015-21, at *43 (citing
Pierson v. Commissioner, T.C. Memo. 1976-281, 35 T.C.M. (CCH) 1256,
1259, 1261) (characterizing benefit to taxpayer from use of funds as
“incidental” when spent only to facilitate her perceived duty to her
employer). “If a purported trustee has the right to use the funds for his
own benefit—even if that right is limited—no trust exists, and the funds
are includible in gross income.” Berry v. Commissioner, T.C. Memo.
2021-42, at *11 (citing Angelus Funeral Home, 47 T.C. at 398); see Na,
T.C. Memo. 2015-21, at *24 (“[I]f a taxpayer receives and disburses
funds strictly as an intermediary for transactions between other parties
 23

[*23] and receives no material benefit from the funds, the taxpayer need
not include the funds in [its] gross income.”). For instance, if a
taxpayer’s use of the purported trust fund directly increases the value
of its property, the trust fund doctrine is typically inapplicable. See, e.g.,
United States v. Md. Jockey Club of Balt. City, 210 F.2d 367, 371 (4th
Cir. 1954) (holding that portion of horse race betting receipts set aside
in fund by taxpayer pursuant to state law were includible its gross
income when usable by taxpayer for capital improvements at its
racetrack). To illustrate, we borrow a (somewhat fitting) older
hypothetical:

If, upon the completion of an hotel, its directors created a
trust requiring twenty per cent of the proceeds of the
rentals from all rooms to be placed in trust for the purchase
of land for the building of a golf course, tennis courts and
swimming pool and providing that all fees exacted from
guests for the use of these facilities be paid into the trust
but that, upon the final payment for such facilities, they be
deeded to the hotel corporation in trust forever, could it be
reasonably argued that, although for the use and benefit of
hotel guests, the hotel corporation did not also benefit?

Gracelawn Mem’l Park, Inc. v. United States, 157 F. Supp. 516, 519–20
(D. Del. 1957) (holding that contributions to capital improvement fund
held by taxpayer-cemetery association were includible in taxpayer’s
gross income), aff’d, 260 F.2d 328 (3d Cir. 1958). In the hypothetical,
the fees paid by hotel guests would still constitute income to the hotel,
because its use of the fees directly enhanced the value of its property,
rather than incidentally doing so as a byproduct of benefiting the hotel
guests. See id.; cf. Angelus Funeral Home v. Commissioner, 407 F.2d at
212–13 (distinguishing between “incidental benefit” to taxpayer of
simply holding use-restricted funds and the direct benefit of using funds
to improve property); Gracelawn Mem’l Park, Inc., 260 F.2d at 332
(observing that taxpayer’s spending of purported trust fund on capital
improvements might be “convenient” or “more desirable” for customers
but that such spending was “for the corporation’s benefit”). In
determining the nature of the economic benefit to petitioner, our inquiry
is thus a practical one. See James, 366 U.S. at 219 (framing question as
whether taxpayer’s control over funds resulted in economic value “as a
practical matter”); Chi., R.I. & P. Ry. Co. v. Commissioner, 47 F.2d 990,
992 (7th Cir. 1931), rev’g 13 B.T.A. 988 (1928); Knowland v.
Commissioner, 29 B.T.A. 618, 624 (1933); see also Mount Vernon
Gardens, Inc. v. Commissioner, 298 F.2d 712, 716 (6th Cir. 1962) (“The
 24

[*24] questions of control by, and inurement to the benefit of, the
taxpayer, are of prime importance.”), aff’g in relevant part, rev’g and
remanding 34 T.C. 598 (1960).

Respondent identifies several ways in which petitioner primarily
benefited from the Fund and asserts that the Program revenue was thus
includible in petitioner’s gross income. Ultimately, we agree with
respondent. We find that petitioner mandated that the TPHOs
participate in the Program and pay into the Fund, controlled the
amounts of Program payments in and compensation payments out of the
Fund, decided how to invest the Fund, accrued interest and realized
investment gains from holding the Fund, and determined whether
particular advertising or administrative costs would be paid for by the
Fund—all without oversight or input from the TPHOs. In turn we find
that petitioner benefited in a number of ways from how it exercised its
control over the Program and Fund. On the basis of these findings, we
conclude that petitioner had a sufficient beneficial economic interest and
thus should have included the Program revenue in gross income for the
years at issue. To illustrate the benefit to petitioner, we examine the
interplay of the various features of the Program and the Fund.

First, we find significant that petitioner controlled the up-front
amounts of 4% payments, miles payments, and sales payments, the
former two of which were mandatory for all TPHOs when a Program
member made a qualifying stay. With respect to the 4% payments,
petitioner exercised its control when it required full service hotel owners
to make larger 4% payments in 2011. That change increased the size of
the Fund available to petitioner and decreased the TPHOs’ profit
margins. The TPHOs could not prevent this change. Similarly, with
respect to the miles payments, petitioner directly negotiated agreements
with third-party transportation partners and then obligated hotel
owners to make reimbursing miles payments into the Fund when a hotel
guest chose to receive miles. Again, the TPHOs did not have input into
the choice of third-party transportation partners, the negotiated costs of
miles, or the number of miles received by customers for a stay.

Once the 4% payments, miles payments, and sales payments were
constituted as the Fund, petitioner had significant control and discretion
over spending. Petitioner controlled the investment of the Fund,
engaging custodians and investment advisers of its choice and dictating
the investment strategy and amounts to be invested—again without
oversight or input by the TPHOs. In turn any accrued interest or
 25

[*25] realized gains from such investment remained within the control
of petitioner as an addition to the Fund.

Petitioner also had the discretion to increase its spending from
the Fund on whatever advertising and administrative costs it
designated as associated with the Program. 23 The record is devoid of
documentary evidence showing the specifics of how petitioner
determined which “administrative costs” and “advertising” would be
covered by the Fund. 24 Trial testimony by Messrs. Zidell and Stapp
suggested that, at a high level, it was largely a matter of discretion by
senior executives to designate particular costs as related to the Program,
in consultation with other Hyatt personnel, and then allocate or
disburse corresponding portions of the Fund. Petitioner’s discretion to
self-designate Program expenses in order to reimburse itself for
advertising costs weighs against a conclusion that the trust fund
doctrine is applicable. See Sherwood Mem’l Gardens, Inc. v.
Commissioner, 350 F.2d 225, 230 (7th Cir. 1965) (focusing on taxpayer’s
“wide discretion in use” of purported trust fund and holding that the
fund was includible in gross income), aff’g 42 T.C. 211 (1964); Nat’l
Mem’l Park, Inc. v. Commissioner, 145 F.2d at 1012 (holding that
purported trust fund receipts were includible in gross income where
taxpayer had discretion as to what expenses would be paid “within the
wide range of general construction and improvement”); Memphis Mem’l
Park v. Commissioner, 28 B.T.A. 1037, 1043 (1933) (concluding
purported trust fund receipts were includible in gross income where “the
nature and extent” of the fund’s spending “was entirely within the
discretion” of the taxpayer), aff’d, 84 F.2d 1008 (6th Cir. 1936); cf.
Schochet v. Commissioner, T.C. Memo. 1982-416, 44 T.C.M. (CCH) 556,
564 (finding that taxpayer-trustees lacked discretion and control over
use of fund where they were required to spend fund as directed by
advertising committee); L.A. Cemetery Ass’n v. Commissioner, 2 B.T.A.
495, 497 (1925) (holding that trust fund was excludable from gross
income where taxpayer could “exercise no discretion in the accumulation
or distribution of the fund” because of state law restrictions). In

23 The only practical restraint on the amount of this spending arose from
petitioner’s decision to retain a reserve for future redemptions in an amount within
PWC’s range of actuarial estimates.
24 At trial, Jeffrey Zidell, the former vice president of the Program division, did

not testify to specifics of how petitioner calculated or ensured that such services were
indeed provided at cost. Mr. Zidell suggested generally that the primary internal
procedure was an annual budgetary process conducted by personnel involved in the
Program and senior executives.
 26

[*26] contrast, the TPHOs did not have oversight over which costs were
designated. Cf. Affiliated Foods, Inc. v. Commissioner, 154 F.3d at 532
(finding that co-op grocery store members chose which advertising
promotions would be paid for out of trust fund); Schochet, 44 T.C.M.
(CCH) at 560 (observing that advertising committee that directed
spending of trust fund was made up equally of personnel from primary
entity/franchisor and franchisees). Aside from access to the generalized
Fund financial statements, which summarized expenses at a high
categorical level, the TPHOs had no access to the details of what specific
expenses were being paid out of the Fund. Accordingly, we find that
petitioner essentially retained the right to reimburse itself out of the
Fund at its own discretion. In total, petitioner controlled (1) the
amounts of 4% payments, miles payments, and sales payments, (2) how
(and how much of) the Fund was invested, and (3) the designation of
expenses to be paid. 25 This significant control weighs in favor of the
inference that petitioner had a beneficial interest in the Fund.

We now consider specifically how petitioner benefited from its
control over the Fund. As noted above, we have previously encountered
similar collective funds in the trust fund doctrine context. However, this
case is unlike much of our other collective fund precedent in a key
respect. In both this case and Seven-Up Co., the entity holding the fund
is the primary entity/franchisor itself or a subsidiary of that primary
entity/franchisor, operating as a for-profit corporation. In similar
collective fund precedents, the taxpayer was typically a separate entity,
often a nonprofit, nonstock corporation or a formal trust, set up to hold
the fund separately from the primary entity/franchisor’s corporate
structure. See Ford Dealers Advert. Fund, Inc., 55 T.C. at 762 (nonstock
corporation); NYS Ass’n, 54 T.C. at 1326 (trust); Dri-Powr Distributors
Ass’n Tr., 54 T.C. 462–63 (trust); Schochet, 44 T.C.M. (CCH) at 557
(trust); Greater Pittsburgh Chrysler Dealers Ass’n of N. Pa. v. United
States, No. 76-218, 1977 WL 1100, at *1 (W.D. Pa. Mar. 10, 1977)
(nonstock corporation); cf. Florists’ Transworld Delivery Ass’n, 67 T.C.
at 334, 344 (applying trust fund doctrine to collective advertising fund
held by parent membership organization organized as a nonstock

25 Indeed, petitioner’s own Forms 10-K implicitly disclosed that it maintained

significant control over the Fund; by consolidating the Fund as a “variable interest
entity,” petitioner took the position that it had “[t]he power . . . to direct the activities
of [the Fund] that most significantly impact the [Fund’s] economic performance.” Fin.
Acct. Standards Bd., Statement of Fin. Acct. Standards No. 167, at 2 (June 2009),
https://fasb.org/Page/ShowPdf?path=fas167.pdf (setting out the applicable financial
accounting rules for when a reporting entity must consolidate another entity over
which it does not hold a majority voting interest).
 27

[*27] corporation). In such cases, the structure, by way of trust
agreement provisions or a corporate charter or bylaws, precluded the
primary entity/franchisor from exerting formal, legal control over the
spending of the fund or directly profiting from use of the fund. See Ford
Dealers Adver. Fund, Inc., 55 T.C. at 762; Schochet, 44 T.C.M. (CCH) at
565. 26 Using a separate entity sidestepped the question of whether a
primary entity/franchisor’s possession and control of a fund itself might
preclude a finding of a trust fund if it substantially benefited from its
use. See, e.g., Neal D. Borden et al., Franchise Advertising Funds:
Structural, Tax, Operational, and Liability Issues, 10 Franchise L.J. 1,
37 (1990) (“[C]areful practitioners who are alert to the potential [tax]
exposure with pooled advertising funds continue to be cautious,
especially where no separate entity—a trust or nonstock corporation—
exists.”).

This structuring may also account for a key finding in Seven-Up
Co. itself. There, the taxpayer was a true wholesaler; its business was
selling extract to the bottlers, and it did not itself did sell any beverages
directly to consumers. Seven-Up Co., 14 T.C. at 966–67. We thus found
that the increased revenue attributable to collective advertising flowed
first to the various third-party bottlers that sold 7-Up to the advertised-
to public, with a secondary “corresponding increase” then flowing to the
taxpayer as the bottlers purchased increased amounts of extract to meet
customer demand. Id. at 973. Accordingly, the taxpayer’s revenue
increased from the use of the collective advertising fund only if third
party bottlers’ sales increased first, and we ultimately concluded that
the taxpayer did not directly gain or profit from receipt of the payments
constituting the fund. Id. at 979.

With this backdrop, the uniqueness of petitioner’s position vis-à-
vis the Fund is clearer. During the years at issue, petitioner owned
20%–25% of the Hyatt-branded hotels and was the largest single owner
of such hotels. Because of that role, having Program advertising paid
for out of the Fund effectively shifted to the Fund the cost of at least
some of the advertising that petitioner otherwise would have paid for to
generate stays at its owned hotels—a direct benefit to petitioner. See

26 To be sure, we found in several of these cases that the parent/franchisor was

still somewhat involved as a practical matter. In Ford Dealers Advertising Fund, Inc.,
55 T.C. at 764, the parent/franchisor (Ford Motor Co.) initially collected fees from each
sale to a car dealer of a Ford car before remitting the fees to the taxpayer for the
advertising fund; in Schochet, 44 T.C.M. (CCH) at 557, the taxpayer, who was trustee
of the advertising fund trust, was also the majority shareholder and an officer of the
parent/franchisor.
 28

[*28] Cato v. Commissioner, 99 T.C. 633, 644 (1992) (concluding that
entities were not mere conduits when receipt of funds relieved them of
budgetary obligation to otherwise pay for services); Lykes Energy, Inc. v.
Commissioner, T.C. Memo. 1999-77, 77 T.C.M. (CCH) 1535, 1538
(concluding that purported trust fund “served to shift the cost” of
customer-driving subsidy from taxpayer to its customers); see also Nat’l
Mem’l Park, Inc. v. Commissioner, 145 F.2d at 1013 (characterizing
purported trust fund as serving “merely as a reimbursing fund to cover”
taxpayer’s spending on capital improvements that were “carried out
without regard” to the fund’s existence); Memphis Mem’l Park, 28 B.T.A.
at 1041 (attributing significance to fact that taxpayer would have
incurred same expenditures regardless of whether purported trust fund
existed). In addition, increased revenue attributable to Program
advertising flowed to petitioner directly when guests stayed at owned
hotels. See Lykes Energy, Inc., 77 T.C.M. (CCH) at 1538 (concluding that
taxpayer’s spending of purported trust fund increased its “rate base,
number of customers, and sales”). Increased revenue would also flow to
petitioner indirectly, through the gross-revenue-based management and
royalty fees charged to the TPHOs. While these latter management and
royalty fees resemble the secondary “corresponding increase” in Seven-
Up. Co., 14 T.C. at 973, the increased revenue to petitioner in its role as
hotel owner is anomalous. This direct benefit weighs against a
conclusion that petitioner did not have a beneficial interest in the Fund,
particularly considering petitioner’s control over the content of the
Program advertising itself. We conclude that petitioner’s receipt of and
control over the Program advertising resulted in additional economic
value to petitioner as a practical matter.

The Program advertising also directly benefited petitioner beyond
the revenue from each individual hotel stay. As several of petitioner’s
witnesses explained, the long-term success of a chain hospitality
business like petitioner’s depends significantly upon maintaining and
increasing the goodwill that customers associate with the Hyatt brand.
See Int’l Multifoods Corp. & Affiliated Cos. v. Commissioner, 108 T.C.
25, 43–44 (1997) (“Goodwill is founded upon a continuous course of
dealing that can be expected to continue indefinitely . . . [and] is the
expectancy of continued patronage.”); Tele-Comms., Inc. & Subs. v.
Commissioner, 95 T.C. 495, 521 (1990), aff’d, 12 F.3d 1005 (10th Cir.
1993); Watson v. Commissioner, 35 T.C. 203, 213 (1960). As the owner
of the Hyatt trademarks, petitioner directly benefited from the Program
advertising, which included such trademarks and thus maintained and
enhanced the value of petitioner’s goodwill. See Int’l Multifoods Corp.,
108 T.C. at 42 (“[T]rademarks embody goodwill.”); H Grp. Holding, Inc.
 29

[*29] v. Commissioner, T.C. Memo. 1999-334, 78 T.C.M. (CCH) 533, 560
(concluding that Hyatt brand name was valuable and “a drawing factor
for potential customers” to Hyatt’s international hotels); Nestle
Holdings, Inc. v. Commissioner, T.C. Memo. 1995-441, 70 T.C.M. (CCH)
682, 696 (“Trademarks lose substantial value without adequate
investment, management, marketing, advertising, and sales
organization.”), vacated and remanded, 152 F.3d 83 (2d Cir. 1998); see
also Coca-Cola Co. & Subs. v. Commissioner, 155 T.C. 145, 241 (2020)
(concluding that advertising of Coke products “enhanced the value” of
Coke trademarks). Not only did customer goodwill generate repeat hotel
stays and thus direct and indirect revenue for petitioner (as discussed
above), but it also granted petitioner additional contractual leverage in
its role as prospective franchisor or manager for hotel properties. Put
another way, petitioner could rely on the increased goodwill associated
with the Hyatt brand in negotiating higher royalties, management fees,
and other fees in new agreements reached with existing or prospective
TPHOs—a direct benefit to it. See Mount Vernon Gardens, Inc. v.
Commissioner, 298 F.2d at 716 (characterizing taxpayer’s use of
purported trust fund to increase value of its unsold inventory as “direct
benefit”); Memphis Mem’l Park, 28 B.T.A. at 1041 (concluding that
purported trust fund of payments from cemetery lot customers was
includible in gross income where taxpayer’s use of fund to improve its
property generated “a benefit through increased sales, at increased
prices” of taxpayer’s services to other cemetery lot customers); see also
Gracelawn Mem’l Park, Inc., 260 F.2d at 332 (“While a chapel [paid for
by a purported trust fund] . . . is convenient for people who have burial
rites to perform in bad weather, it is remembered that part of the income
of [the taxpayer] comes from charges made for services in connection
with burials.”).

Intuitively, an increase in customer goodwill (and thus the value
of a franchisor’s intellectual property) does not ultimately accrue to the
collective benefit of durational affiliates and franchisees like the
TPHOs. See Canterbury v. Commissioner, 99 T.C. 223, 249 (1992)
(concluding that McDonald’s franchisee did not retain any goodwill
“separate and apart from the goodwill inherent in the McDonald’s
franchise”); Zorniger v. Commissioner, 62 T.C. 435, 444–46 (1974); Akers
v. Commissioner, 6 T.C. 693, 700 (1946); see also Coca-Cola Co., 155 T.C.
at 252 (concluding that value derived from advertising of Coke brands
by affiliate exclusively belonged to taxpayer). A TPHO benefited from
flying the Hyatt flag only for so long as it was entitled to do so pursuant
to the duration of the applicable management or franchise agreement.
If a TPHO continued on with the Hyatt brand, any increased goodwill
 30

[*30] value would presumptively be accounted for in higher contract
fees when the time for renewal of a management or franchise agreement
came around. Alternatively, if a TPHO deflagged from the Hyatt brand,
pursuant to the management or franchise agreement, the TPHO would
not retain nor have any financial claim on the value of any goodwill
generated from the Program advertising that it had partially funded.
See Montgomery Coca-Cola Bottling Co. v. United States, 615 F.2d 1318,
1332 (Ct. Cl. 1980) (“Since goodwill is considered to be the value of the
habit of customers to return to purchase a product at the same location,
the absence of the product would destroy the value of the habit . . . .”);
cf. Akers, 6 T.C. at 700 (characterizing General Motors franchise
agreements as making no provision “for payments for good will or going-
concern value in the event of their termination”). We conclude that
petitioner’s use of the Fund on Program advertising was a direct benefit
to petitioner.

This same rationale holds true for other petitioner-owned
intellectual property that the Fund paid for, namely the Program
member database. Again, petitioner’s witnesses characterized the
Program member database as a key, valuable facet of petitioner’s efforts
to maintain and enhance customer goodwill. On the micro level, the
member database recorded specifics about customer preferences that
allowed hotel staff to tailor hotel stays to particular customers and thus
encourage individualized brand loyalty and repeated future stays across
the Hyatt chain. On the macro level, the aggregate customer analytics
generated by the member database were highly useful to petitioner in
its marketing efforts and decision making. The member database was
owned and maintained by petitioner, and deflagging TPHOs were not
entitled to retain the confidential data about members that visited its
hotel. We conclude that petitioner’s use of the Fund to generate and
maintain customer goodwill primarily benefited itself, as opposed to the
TPHOs.

Finally, we turn to petitioner’s back-end control over the timing
and amounts of compensation payments out of the Fund to hotel owners.
Under the Program member terms and conditions, petitioner had the
discretion to raise the bar for rewards points redemptions, make
rewards points expirable, change the awards category for certain hotels,
and create other conditions that would tend to increase the available
balance of the Fund and decrease the amount and frequency of
 31

[*31] compensation payments. 27 In 2010 petitioner exercised that
discretion by raising the number of rewards points required for a stay
at certain award categories of hotels. In 2011 petitioner also changed
its formula for calculating compensation payments to the TPHOs. Each
of these changes decreased the number of compensation payments going
back out to the TPHOs and increased the amount of the Fund available
for whatever petitioner designated as advertising and administrative
costs. Petitioner’s right to defer and decrease the compensation
payments further demonstrates how it was ultimately able to control the
Fund in order to primarily benefit itself.

To sum up, given the totality of petitioner’s control and discretion
over the Program and the Fund and how its use of the Fund directly
benefited it, petitioner has failed to establish that the trust fund
doctrine is applicable to it. We conclude that petitioner was more than
just a mere intermediary or conduit, passively holding funds and then
remitting them on for the convenience of others, with only an incidental
benefit to itself. Cf. Cent. Life Assur. Soc., Mut. v. Commissioner, 51
F.2d at 941. Instead, petitioner had a sufficient beneficial economic
interest in the Fund to be liable for tax. Given this conclusion, we need
not address whether the Fund was received in trust subject to a use
restriction that was legally enforceable by the TPHOs. 28 See Angelus
Funeral Home v. Commissioner, 407 F.2d at 213 (assuming use
restriction was enforceable but concluding that restriction allowed
taxpayer “to benefit itself more than incidentally” and therefore did not
preclude inclusion in gross income). We conclude that the trust fund
doctrine exception is inapplicable and hold that petitioner must include
the Program revenue in gross income.

27 In 2012 petitioner did in fact change the Program to make rewards points

expire after a certain period, which had the effect of reducing the number of future
rewards points redemptions and thus compensation payments to TPHOs.
28 We view petitioner’s contentions on this point with some skepticism, given

the record before us. See Ill. Power Co. v. Commissioner, 792 F.2d at 689 (“The
underlying principle is that the taxpayer is allowed to exclude from his income money
received under an unequivocal contractual, statutory, or regulatory duty to repay it, so
that he really is just the custodian of the money.” (Emphasis added.)). In any event,
however, we think it prudent not to unnecessarily wade into the murky and unfamiliar
waters of state law and equitable principles. Cf. Jenkins v. Commissioner, T.C. Memo.
2021-54, at *26.
 32

[*32] III. Section 481 Adjustment

Section 481(a) provides that, when a taxpayer computes its
taxable income “under a method of accounting different from the method
under which the taxpayer’s taxable income for the preceding taxable
year was computed, . . . there shall be taken into account those
adjustments which are determined to be necessary solely by reason of
the change in order to prevent amounts from being duplicated or
omitted.” Put more simply, if “income escapes taxation because of a
change in the accounting method,” the Commissioner is empowered
under section 481(a) to “make an adjustment by including the omitted
income in the year of the change.” Graff Chevrolet Co. v. Campbell, 343
F.2d 568, 570 (5th Cir. 1965). Section 481 remedies some of the
practical problems posed by annualized tax accounting; for instance,
“[b]ecause different tax accounting methods provide for different dates
on which income or deductions are recognized, a switch in accounting
methods can create a situation in which a taxpayer is able to deduct the
same expense—or is required to recognize the same income—in two
separate tax years.” Nat’l Life Ins. Co. & Subs. v. Commissioner, 103
F.3d 5, 7 (2d Cir. 1996), aff’g 103 T.C. 615 (1994); see Suzy’s Zoo v.
Commissioner, 114 T.C. 1, 13 (2000), aff’d, 273 F.3d 875 (9th Cir. 2001);
Pursell v. Commissioner, 38 T.C. 263, 269–71 (1962) (discussing purpose
and legislative history of section 481), aff’d, 315 F.2d 629 (3d Cir. 1963).

The Commissioner’s authority under section 481 is not limited by
section 6501(a), which otherwise provides the general rule of limitations
on his assessment authority. See Graff Chevrolet Co., 343 F.2d at 572
(“Section 481 is designed to prevent a distortion of taxable income and a
windfall to the taxpayer stemming from a change in accounting at a time
when the statute of limitations bars reopening the taxpayer’s returns
for earlier years.”); see also Peoples Bank & Tr. Co. v. Commissioner, 415
F.2d 1341, 1344 (7th Cir. 1969), aff’g 50 T.C. 750 (1968); Superior Coach
of Fla., Inc. v. Commissioner, 80 T.C. 895, 912 (1983). However, this
otherwise broad authority is bounded by the requirement that any
adjustments to include omitted income be solely due to a change in the
taxpayer’s method of accounting. See Rankin v. Commissioner, 138 F.3d
1286, 1288 (9th Cir. 1998) (“[Section 481] adjustments are made only to
compensate for the change in method of accounting.”), aff’g T.C. Memo.
1996-350. Given the extraordinary authority posed by section 481, “we
examine carefully each instance in which the Commissioner invokes” it.
Pinkston v. Commissioner, T.C. Memo. 2020-44, at *10–11.
 33

[*33] The parties dispute whether petitioner’s treatment of the Fund
constituted a method of accounting and thus whether the inclusion of
Program revenue in gross income (and corresponding taking of
deductions) constitutes a change in method of accounting subject to
section 481 adjustment. As evinced by the parties’ stipulations, 29 which
we accept as binding admissions, see Rule 91(a) and (e), resolution of
this issue is determinative of the bulk of the deficiency at issue in this
case, which is otherwise time-barred from assessment.

To reiterate, a section 481 adjustment is permitted only if omitted
or duplicated income is due solely to a change in the taxpayer’s method
of accounting. The phrase “change in method of accounting” is not
expressly defined in the Code. The applicable regulation states that a
“change in method of accounting to which section 481 applies includes a
change in the over-all method of accounting for gross income or
deductions, or a change in the treatment of a material item.” Treas. Reg.
§ 1.481-1(a)(1). The regulation then directs us to section 446(e) and
Treasury Regulation § 1.446-1(e) for further rules as to what constitutes
a change in method of accounting. See Treas. Reg. § 1.481-1(a)(1).
Treasury Regulation § 1.446-1(e)(2)(ii)(a) defines a “material item” as
“any item that involves the proper time for the inclusion of the item in
income or the taking of a deduction.” The regulation then inversely
provides that “a change in method of accounting does not include
adjustment of any item of income or deduction that does not involve the
proper time for the inclusion of the item of income or the taking of a
deduction.” Id. subdiv. (ii)(b).

In determining whether a taxpayer’s treatment constitutes a
material item, we apply the lifetime income test. Under this test, we
first ask whether the taxpayer’s existing treatment would have
“permanently avoided the reporting of income over the taxpayer’s
lifetime income or merely postponed the reporting of income.” Primo
Pants Co. v. Commissioner, 78 T.C. 705, 723 (1982) (citing Graff
Chevrolet Co., 343 F.2d at 572); see Knight-Ridder Newspapers, Inc. v.
United States, 743 F.2d 781, 798 (11th Cir. 1984) (“The essential
characteristic of a ‘material item’ is that it determines the timing of

29 The parties stipulated that the period of limitations on assessment expired

before the issuance of the notice of deficiency for tax years 1987 through 2004, 2006,
and 2007; the parties similarly stipulated with respect to tax years 2005 and 2008,
while also stipulating that the period of limitations remained open with respect to
assessments of deficiency under section 6501(h) (net operating loss carrybacks) for
2005 and under section 6501(i) (reported foreign tax credit carrybacks) and (j) (general
business credit carrybacks) for 2008.
 34

[*34] income or deductions.”); Fla. Progress Corp. & Subs. v.
Commissioner, 114. T.C. 587, 603 (2000), aff’d, 348 F.3d 954 (11th Cir.
2003); Pelaez & Sons, Inc. v. Commissioner, 114 T.C. 473, 489 (2000)
(deeming taxpayer’s decision to deduct rather than capitalize expense “a
timing question and not a one-time inclusion or deduction”), aff’d, 253
F.3d 711 (11th Cir. 2001); Wienke v. Commissioner, T.C. Memo. 2020-
143, at *29 (“An item is ‘material’ when it affects the timing of reporting
income or deductions, as opposed to ‘how much income is reported, or
whether a deduction would ever have been appropriate.’” (quoting
Rankin v. Commissioner, 138 F.3d at 1288)). If “an accounting practice
does nothing more than postpone the reporting of income,” it is a
material item. Fla. Progress Corp., 114 T.C. at 603; see also Huffman v.
Commissioner, 126 T.C. 322, 343 (2006) (concluding that erroneous
original treatment would not result in “permanent omission of income”
where error would “self correct” in the aggregate over time), aff’d, 518
F.3d 357 (6th Cir. 2008); Hawse v. Commissioner, T.C. Memo. 2015-99,
at *29. If the taxpayer’s treatment is in fact a material item, we proceed
to the second question: whether a change in the taxpayer’s treatment of
the material item would result in no more or less income to the taxpayer
over the course of its lifetime. See, e.g., Primo Pants Co., 78 T.C. at 723–
24. If the change would not affect the taxpayer’s lifetime income, it
implicates timing and is a change in method of accounting. The U.S.
Court of Appeals for the Seventh Circuit—to which an appeal in this
case would lie, absent stipulation to the contrary, see § 7482(b)(1)(B),
(2)—has recognized the rationale for the lifetime income test in the
context of section 481:

When a taxpayer uses an accounting method which
reflects an expense before it is proper to do so or which
defers an item of income that should be reported currently,
he has not succeeded (and does not purport to have
succeeded) in permanently avoiding the reporting of any
income; he has impliedly promised to report that income at
a later date, when his accounting method, improper though
it may be, would require it. Section 481, therefore, does not
hold the taxpayer to any income which he has any reason
to believe he has avoided, and does not frustrate the policy
that men should be able, after a certain time, to be
confident that past wrongs are set at rest.

Peoples Bank & Tr. Co. v. Commissioner, 415 F.2d at 1344 (quoting
Note, Problems Arising from Changes in Tax-Accounting Methods, 73
 35

[*35] Harv. L. Rev. 1564, 1576 (1960)); accord Graff Chevrolet Co., 343
F.2d at 571–72.

The parties base their respective positions on competing versions
of the lifetime income test. Petitioner contends that, because its prior
return treatment permanently excluded the Program revenue and never
claimed deductions with respect to Program expenses, timing issues
were not implicated and thus its treatment was not a material item. In
contrast, respondent argues that the change in petitioner’s tax
treatment of the Fund would not affect the aggregate amount of
petitioner’s lifetime taxable income (i.e., gross income minus deductions,
see § 63(a)). In respondent’s more results-based view, both petitioner’s
prior and current treatment of the Fund as a whole (i.e., encompassing
both income and deduction components) would result in zero aggregate
lifetime taxable income to petitioner, thus implicating questions of
timing rather than inclusion.

We reject respondent’s formulation of the lifetime income test in
that it disregards the preliminary question of whether a taxpayer’s
existing treatment constituted a material item. We largely agree with
petitioner’s formulation of the lifetime income test, which accords with
the text of the regulation 30 and our precedents. 31 See Gen. Motors Corp.

30 As we read the regulatory text, “a change in the treatment of any material

item” can occur only if a material item (i.e., “any item which involves the proper time
for the inclusion of the item in income or the taking of a deduction”) already exists in
the first instance. See Treas. Reg. § 1.446-1(e)(2)(ii)(a), (iii) (example 7) (labeling
taxpayer’s existing treatment a material item before concluding that a “change in such
practice or procedure is a change of method of accounting”).
31 Despite respondent’s contentions otherwise, our decision in Johnson v.

Commissioner, 108 T.C. 448 (1997), aff’d in part, rev’d in part, 184 F.3d 786 (8th Cir.
1999), is not to the contrary. In Johnson, we concluded that a car dealer taxpayer’s
initial erroneous exclusion of part of the proceeds of prepaid car service contracts
implicated timing issues (i.e., postponement of income) at step one of the lifetime
income test. Id. at 494. We noted the possibility that particular amounts of the
proceeds might never be included in gross income (for instance, if a customer canceled
a service contract and received a refund) but observed that the treatment still
implicated timing because, in such instances, the taxpayer’s practice “resulted in
permanent exclusion only where a deduction would have been allowable for a later
period.” Id. at 495. The taxpayer’s initial exclusion of the items of income thus
implicated timing issues in all instances, because the underlying position was one of
temporary deferral and only became permanent in the event of later contingencies.
See Peoples Bank & Tr. Co. v. Commissioner, 415 F.2d at 1344 (observing that a section
481 adjustment is appropriate where a taxpayer’s original treatment “impliedly
promised to report that income at a later date”). This made the “exclusion” akin to an
 36

[*36] & Subs. v. Commissioner, 112 T.C. 270, 296 (1999) (“An
accounting practice that involves the timing of when an item is included
in income or when it is deducted is considered a method of accounting.”);
Wayne Bolt & Nut Co. v. Commissioner, 93 T.C. 500, 511 (1989) (“Since
[the taxpayer’s] pre-1982 method of determining inventory involved the
proper time for reporting income, it was a ‘material item.’”); Starer v.
Commissioner, T.C. Memo. 2022-124, at *15 (“Where a taxpayer’s
accounting practice permanently avoids reporting of income and
accordingly distorts its lifetime income, the practice is not a method of
accounting and section 481(a) is inapplicable to a change of the
accounting practice.” (citing Schuster’s Express, Inc. v. Commissioner,
66 T.C. 588 (1976), aff’d, 562 F.2d 39 (2d Cir. 1977))). To reiterate,
consistent with the purpose of section 481, we understand the lifetime
income test to require looking first to whether the taxpayer’s original
treatment of an item implicated timing. See Peoples Bank & Tr. Co. v.
Commissioner, 415 F.2d at 1344 (framing the question as whether the
taxpayer’s erroneous original treatment “impliedly promised” to report
future income). Only when a taxpayer’s original treatment implicates
timing (i.e., acceleration or postponement of income) do we proceed to
analyzing whether a proposed change would distort the taxpayer’s
lifetime income. See Knight-Ridder Newspapers, Inc., 743 F.2d at 798–
99 (characterizing taxpayer’s reserve as “an item which affected the
timing of a deduction” and concluding that it was a material item and
method of accounting).

Framed in these terms, resolution of this issue is clearer.
Petitioner’s consistent, total exclusion of the Program revenue and
nontaking of deductions for Program expenses did not involve timing, at
least so long as the Program continued in perpetuity. See Tate & Lyle,
Inc. v. Commissioner, 103 T.C. 656, 668 (1994) (“The total exclusion of
an item from the recipient’s gross income is a question of
characterization that is unrelated to the taxpayer’s method of
accounting.”), rev’d on other grounds, 87 F.3d 99 (3d Cir. 1996);
Hamilton Indus., Inc. v. Commissioner, 97 T.C. 120, 126 (1991) (stating
that a taxpayer does not use a method of accounting where it “entirely

accelerated deduction and thus a material item within the meaning of the regulations.
See Treas. Reg. § 1.446-1(e)(2)(ii)(a); cf. Knight-Ridder Newspapers, Inc., 743 F.2d at
799 (analyzing reverse situation where taxpayer erroneously deducted up-front
contributions to a reserve and observing that “an equal amount of income” is
essentially taxed later upon payment out of the reserve due to the “absence of
deductions” that would otherwise have properly been taken). In contrast, petitioner’s
treatment of the Fund was a position of permanent, total exclusion from gross income
and nontaking of deductions, which did not implicate timing issues.
 37

[*37] avoids the inclusion of income in any year”); Saline Sewer Co. v.
Commissioner, T.C. Memo. 1992-236, 63 T.C.M (CCH) 2832, 2834
(concluding that taxpayer’s consistent exclusion of certain fees from
gross income was “clearly not a timing issue” implicating section 481).

The only remaining question is how petitioner would have treated
any remaining portions of the Fund in the event the Program was
terminated. See Rankin v. Commissioner, 138 F.3d at 1289 (recognizing
timing issue where any remaining money in already-deducted third-
party fund would have resulted in income inclusion in the event of
termination of fund); Knight-Ridder Newspapers, Inc., 743 F.2d at 799
(recognizing timing issue where already-deducted reserve would have
been includible in gross income in the event of a “Day of Armageddon”
when reserve was abandoned); Pinkston, T.C. Memo. 2020-44, at *15 n.5
(“In determining whether an item postpones or accelerates the reporting
of income, courts have generally assumed that relevant future events
. . . will ultimately occur.”); cf. Schuster’s Express, Inc., 66 T.C. at 596
(finding no method of accounting, where Commissioner bore burden of
proof, because taxpayer’s existing treatment did not involve any
“procedure or intention” to include excessive deduction amounts in gross
income in future tax years).

Petitioner produced testimony from Hyatt personnel and expert
testimony from an accounting expert, all of which professed that any
remaining balance of the Fund would have been refunded to the
participating hotel owners in the event of Program termination, and
thus petitioner would still not have reported the Fund in gross income
or taken deductions. We find that testimony to be credible as to
petitioner’s position and largely uncontroverted by respondent.
Communications between petitioner and its external auditors at
Deloitte and several state revenue agencies reinforced this testimony.
In such communications, which were made in the context of auditing
petitioner’s annual financial statements and addressing its potential
state tax exposure, respectively, petitioner’s representatives repeatedly
represented that the balance of the Fund would be refunded to
participating hotel owners in the event of Program termination.
Further, contractual terms in some of the applicable agreements with
TPHOs represented that any amounts remaining in the Fund on
termination would be distributed to the then-participating Hyatt-
branded hotel owners. On the record before us, we see no reason to
doubt that petitioner would have continued to adhere to its erroneous
exclusionary treatment of the Fund, even in the event of Program
 38

[*38] termination. 32 Cf. George K. Herman Chevrolet, Inc. v.
Commissioner, 39 T.C. 846, 848–49 (1963) (discussing analogous
practice by which General Motors refunded collective advertising fund
to car dealers upon termination of advertising program). We conclude
that petitioner’s prior treatment of the Program revenue was not a
material item and thus not a method of accounting. Consequently, we
will not sustain respondent’s determination of a section 481 adjustment.

Respondent argues that, absent a section 481 adjustment,
petitioner will, for the years at issue and future years, be entitled to
deduct compensation payments relating to Program revenue
permanently excluded from gross income, resulting in a windfall for
petitioner. It is true that respondent has conceded that result for
purposes of the years at issue. 33 But we do not see why the same
treatment would necessarily be appropriate in future years after our
decision. A number of doctrines (e.g., the duty of consistency or clear
reflection of income principles) may prevent a taxpayer from claiming a
deduction when the corresponding income has not been subject to tax,
see, e.g., Kielmar v. Commissioner, 884 F.2d 959, 965 (7th Cir. 1989),
aff’g Glass v. Commissioner, 87 T.C. 1087 (1986); Hintz v. Commissioner,
712 F.2d 281, 284 (7th Cir. 1983), aff’g T.C. Memo. 1981-425, and
respondent is free to assert their application in a future case. That he
did not do so here is no fault of petitioner’s and does not entitle
respondent to a section 481 adjustment when the requirements of that
section are unmet.

32 We note that, even in the unlikely event that all TPHOs deflagged from the

Hyatt brand before such a Program termination, petitioner would still have been able
to pay out the balance of the Fund to its own subsidiaries in their capacity as hotel
owners.
33 See Respondent’s First Amendment to Answer, at 1 (“Hyatt Corporation

must report the Program income in the year received or accrued under IRC § 448 and
IRC § 451, and the expenses of the Program are deductible per IRC § 162 and IRC
§ 461.”); Respondent’s Pretrial Memorandum, at 53 (“[I]f the Court were to determine
that Hyatt Corporation must recognize the Program Revenue and Program expenses
beginning in the taxable year 2009 but section 481 did not apply to this change in
reporting, Hyatt Corporation would be able to deduct amounts paid from the Program
Assets consisting of pre-2009 net Program Revenue whose receipt was not recognized
as income.”); Respondent’s Simultaneous Opening Brief, at 197 (“Were it held
otherwise, Hyatt Corporation would receive a significant windfall, because Hyatt
Corporation would never recognize over $200 million in income and yet be able to
deduct its spending of this income.”).
 39

[*39] IV. Trading Stamp Method

The general rule for accrual method taxpayers is that a liability
is incurred and thus taken into account for federal income tax purposes
once it has satisfied the all events test. See, e.g., Hoops, LP v.
Commissioner, T.C. Memo. 2022-9, at *9–10, aff’d, 77 F.4th 557 (7th Cir.
2023). Under the all events test, a liability is incurred for the taxable
year when (1) “all the events have occurred that establish the fact of the
liability”; (2) “the amount of the liability can be determined with
reasonable accuracy”; and (3) “economic performance has occurred with
respect to the liability.” Treas. Reg. § 1.461-1(a)(2)(i); see § 461(h). The
economic performance requirement does not apply “to any item for
which a deduction is allowable under a provision of this title which
specifically provides for a deduction for a reserve for estimated
expenses.” § 461(h)(5). The regulations instruct that, for accrual
method taxpayers, applicable statutory or regulatory provisions and
guidance may also otherwise prescribe when an incurred liability is
taken into account. See Treas. Reg. §§ 1.461-1(a)(2)(i), 1.446-
1(c)(1)(ii)(A).

A longstanding regulatory provision offers a narrow, de facto
exception to the all events test for an accrual method taxpayer that
(1) “issues trading stamps or premium coupons with sales” and (2) “such
stamps or coupons are redeemable by such taxpayer in merchandise,
cash, or other property.” 34 Treas. Reg. § 1.451-4(a)(1); see Cap. One Fin.
Corp. v. Commissioner, 133 T.C. 136, 197 (2009), aff’d, 659 F.3d 316 (4th
Cir. 2011). If both conditions are applicable, the taxpayer may offset
against gross receipts from such sales an amount equal to “[t]he cost to
the taxpayer of merchandise, cash, and other property used for

34 As the historical analog to modern rewards points, trading stamps and
premium coupons were generally physical pieces of adhesive paper issued by a retailer
as promotions with sales of their product; once collected in a sufficient number, the
stamps or coupons were redeemable for a product chosen from the retailer’s store or a
catalog. See FTC v. Sperry & Hutchinson Co., 405 U.S. 233, 236–38 (1972); Safeway
Stores, Inc. v. Okla. Retail Grocers Ass’n, 360 U.S. 334, 338 (1959); Tanner v. Little,
240 U.S. 369, 370–72 (1916); Sateriale v. R.J. Reynolds Tobacco Co., 697 F.3d 777, 783–
84 (9th Cir. 2012); Sperry & Hutchinson Co. v. O’Neill-Adams Co., 185 F. 231, 233–34
(2d Cir. 1911); Colgate & Co. v. United States, 66 Ct. Cl. 510, 514–16 (1928); see also
Giant Eagle, Inc. v. Commissioner, T.C. Memo. 2014-146, at *12 (holding that reward
discounts on purchase price were not premium coupons), rev’d on other grounds, 822
F.3d 666 (3d Cir. 2016); Staff of J. Comm. on Tax’n, 95th Cong., General Explanation
of the Revenue Act of 1978, JCS-7-79, at 244 (J. Comm. Print 1979) (“Ordinarily, a
discount coupon is individually redeemable, while the premium coupon is intended to
be collected and redeemed in large numbers for a single product.”).
 40

[*40] redemptions in the taxable year” plus “the net addition to the
provision for future redemptions during the taxable year.” Treas. Reg.
§ 1.451-4(a)(1). The “provision for future redemptions” is “the number
of trading stamps or coupons outstanding as of the end of such year that
it is reasonably estimated will ultimately be presented for redemption,”
multiplied by “the estimated average cost” of “acquiring the
merchandise, cash, or other property needed to redeem such stamps or
coupons.” Id. para. (b)(1). A “net addition” exists if the current tax year’s
provision for future redemptions exceeds the previous tax year’s
provision for future redemptions. Id. subpara. (2).

Accordingly, the trading stamp method effectively accelerates
what otherwise would have been future year deductions and serves as
an exception to the general rule that reserves for contingent liabilities
are not deductible. See Brown v. Helvering, 291 U.S. 193, 200–01 (1934);
Lucas v. Am. Code Co., 280 U.S. 445, 452 (1930). The regulation’s
purpose is to match sales revenues with the expenses incurred in
generating those revenues (i.e., effectively treating the future
redemption cost of stamps or coupons as part of the present cost of goods
sold). See Tex. Instruments, Inc. v. Commissioner, T.C. Memo. 1992-306,
63 T.C.M. (CCH) 3070, 3071; see also United States v. O.J. Morrison
Stores of Fairmont, 99 F.2d 77, 79 (4th Cir. 1938). Accordingly, the
trading stamp method recognizes the economic reality that an initial
sale price will reflect both “the value of the goods currently delivered
and the value of the coupon that can be applied toward a future
purchase.” W. Eugene Seago & Edward J. Schnee, Tax Accounting for
Coupons Under the Special Rules in the Regulations, 112 J. Tax’n 295,
297 (2010).

As applied to this case, the trading stamp method would allow
petitioner to offset against gross receipts both (1) the cost of current year
redemptions (i.e., current year compensation payments) and (2) the net
addition to the estimated cost of future tax year redemptions that
corresponds to rewards points issued to members during the taxable
year. The parties vigorously contest whether petitioner is entitled to
adopt the trading stamp method. The parties’ primary disagreement
rests on the question of whether the rewards points were redeemable in
“merchandise, cash, or other property,” as required by the regulation. 35

35 Respondent also raises several other procedural issues that he claims

independently bar petitioner’s adoption of the trading stamp method. Given our
 41

[*41] Respondent argues that petitioner has failed to establish that the
trading stamp method is applicable, because the rewards points at issue
were redeemable for services (i.e., hotel stays and air travel), rather
than “merchandise, cash, or other property.” See Treas. Reg. § 1.451-
4(a)(1). Petitioner contends that the rewards points were redeemable
instead for the right to receive a hotel stay or airline miles, which
petitioner contends are both “other property” within the meaning of
Treasury Regulation § 1.451-4(a)(1). Petitioner characterizes the former
as an intangible property right “in the form of a reservation to use a
hotel room at a particular time and place at no charge.” Petitioner also
emphasizes that a member can redeem her own rewards points for
another person’s hotel stay, which, petitioner claims, is an assignment
of a property right.

As a matter of state law (largely as viewed through the prism of
federal bankruptcy law), the majority view is that hotel guests are
contractual licensees possessing a license to use hotel premises. See,
e.g., Young v. Harrison, 284 F.3d 863, 868–69 (8th Cir. 2002) (South
Dakota law); Patel v. Northfield Ins. Co., 940 F. Supp. 995, 1002 (N.D.
Tex. 1996) (Texas law); Great-W. Life & Annuity Assur. Co. v. Parke
Imperial Canton, Ltd., 177 B.R. 843, 858 (N.D. Ohio 1994) (Ohio law);
Hari Ram, Inc. v. Magnolia Portfolio, LLC (In re Hari Ram, Inc.), 507
B.R. 114, 122–23 (Bankr. M.D. Pa. 2014) (Pennsylvania law); Casco N.
Bank, N.A. v. Green Corp. (In re Green Corp.), 154 B.R. 819, 823–24
(Bankr. D. Me. 1993) (Maine law); Mid-City Hotel Assocs. v. Prudential
Ins. Co. of Am. (In re Mid-City Hotel Assocs.), 114 B.R. 634, 640–41
(Bankr. D. Minn. 1990) (Minnesota law); Kearney Hotel Partners v.
Richardson (In re Kearney Hotel Partners), 92 B.R. 95, 99 (Bankr.
S.D.N.Y. 1988) (Nebraska law). A minority of courts consider hotel
guests to possess leasehold interests, albeit short ones, in their hotel
rooms. See In re Old Colony, LLC, 476 B.R. 1, 21–23 (Bankr. D. Mass.
2012) (Wyoming law); In re Churchill Props. VIII Ltd. P’ship, 164 B.R.
607, 609 (Bankr. N.D. Ill. 1994) (Iowa law); see also Travelers Ins. Co. v.
First Nat’l Bank of Blue Island, 621 N.E.2d 209, 213–14 (Ill. App. Ct.
1993) (characterizing hotel receipts as “rent” and suggesting that
distinction between hotel guest and a tenant is insubstantial). In other
contexts, airline rewards miles are understood to be intangible property.
See United States v. Loney, 959 F.2d 1332, 1336 (5th Cir. 1992)
(construing “property” in federal wire fraud statute to encompass airline
miles); Ficken v. AMR Corp., 578 F. Supp. 2d 134, 143 (D.D.C. 2008)

conclusion below on the merits of whether the trading stamp method is applicable, we
need not address these issues.
 42

[*42] (characterizing party’s airline miles as a “credit with the airline”
and thus an intangible property right).

We need not resolve whether a hotel stay is better characterized
as a license or a leasehold. Regardless of the proper characterization,
the regulatory text does not support a broad reading that a license or
leasehold (or airline miles) would qualify as “other property” within the
meaning of the regulation. In determining the plain meaning of the
catchall category in the phrase “merchandise, cash, or other property,”
the interpretive canon of ejusdem generis is particularly useful. See
AptarGroup Inc. v. Commissioner, 158 T.C. 110, 116 (2022) (“We
interpret regulations using canons of statutory construction . . . .” (citing
Austin v. Commissioner, 141 T.C. 551, 563 (2013))). The canon counsels
that when “a more general term follows more specific terms in a list, the
general term is usually understood to ‘embrace only objects similar in
nature to those objects enumerated by the preceding specific words.’”
Epic Sys. Corp. v. Lewis, 138 S. Ct. 1612, 1625 (2018) (quoting and citing
Circuit City Stores, Inc. v. Adams, 532 U.S. 105, 115 (2001), and citing
Nat’l Ass’n of Mfrs. v. Dep’t of Def., 138 S. Ct. 617, 628–29 (2018)); see
Agro-Jal Farming Enters., Inc. v. Commissioner, 145 T.C. 145, 154
(2015); cf. Mancini v. Commissioner, T.C. Memo. 2019-16, at *19
(describing this Court’s longstanding interpretation that the catchall
category in the phrase “fire, storm, shipwreck, or other casualty” in
section 165 “must mean something like the specific terms that precede
it”), aff’d, 851 F. App’x 769 (9th Cir. 2021).

Applying the canon here readily illustrates the flaw in petitioner’s
broad interpretation of the catchall category. 36 In the tax law,
“merchandise” has long been understood as a term of art, meaning
“goods held for sale” by the taxpayer. See RACMP Enters., Inc. v.
Commissioner, 114 T.C. 211, 221–22 (2000) (noting that all relevant
definitions of “merchandise” “refer to property that is held for sale, not
simply property that is sold”); King Solarman, Inc. v. Commissioner,
T.C. Memo. 2019-103, at *22, aff’d, 840 F. App’x 74 (9th Cir. 2020);
Wilkinson-Beane, Inc. v. Commissioner, T.C. Memo. 1969-79, 28 T.C.M.
(CCH) 450, 456, aff’d, 420 F.2d 352 (1st Cir. 1970). Cash is understood
as “[m]oney or its equivalent,” i.e., “[c]urrency or coins, negotiable
checks, and balances in bank accounts.” Cash, Black’s Law Dictionary

36 The related canon of noscitur a sociis (“a word is known by the company it

keeps”) similarly counsels that we “avoid ascribing to one word a meaning so broad
that it is inconsistent with its accompanying words.” Gustafson v. Alloyd Co., 513 U.S.
561, 575 (1995).
 43

[*43] (11th ed. 2019). Understanding “other property” to broadly
encompass all manner of property rights eclipses the carefully
delineated “merchandise” and “cash” categories and renders them
surplusage—an undesirable interpretive outcome. See Yates v. United
States, 574 U.S. 528, 545–46 (2015) (applying ejusdem generis so as to
preclude broad reading of phrase “tangible object” that would have
rendered statute’s prior use of terms “record” and “document”
surplusage); Sutherland v. Commissioner, 155 T.C. 95, 103–04 (2020).
Further, given the regulation’s use of “or” in the phrase “merchandise,
cash, or other property,” we presume that the categories are disjunctive
and carry nonoverlapping, separate meanings. See United States v.
Woods, 571 U.S. 31, 45–46 (2013). Applying ejusdem generis carefully
gives separate effect to all three categories, by limiting the scope of
“other property” to property similar in nature to “merchandise” and
“cash,” such as, at a high level of generality, tangible property. 37 The
canon thus strongly suggests at the outset that this narrower reading is
the better one.

Treasury Regulation § 1.451-4(b)(1)(iii) lends contextual support
to the narrower reading. Subdivision (iii) provides that the taxpayer
may include in its offset to gross receipts the “transportation or other
necessary charges in acquiring possession of the goods.” (Emphasis
added.) Subdivision (iii) further specifies that the costs of “transporting
merchandise or other property from a central warehouse to a branch
warehouse” or “storing the merchandise or other property” may not be
included in the offset and are instead subject to either section 162 or
263. Id. (emphasis added). The provision thus repeatedly contemplates
“other property” in tangible terms, speaking of physical possession,
transportation, and storage. We find that subdivision (iii) further
reinforces the application of ejusdem generis by suggesting that a
common characteristic of the three categories is tangibility.

We thus interpret the catchall category to apply only to property
similar in nature to “merchandise” and “cash.” We reject petitioner’s
contention that the catchall category encompasses the hotel stays or
airline miles redeemable by petitioner’s Program members.
Accordingly, we conclude that the trading stamp method is not available

37 One reasonable reading, which we note but do not expressly adopt, is that

“other property” contemplates physical goods that are not “merchandise” in the hands
of the taxpayer. We need not determine the exact scope of the “other property” category
here and expressly limit our conclusion to rejecting petitioner’s contention that it
broadly encompasses the intangible property at issue.
 44

[*44] to petitioner with respect to the years at issue; petitioner must
defer its cost recovery until the taxable year for which compensation
payments give rise to a deductible expense.

V. Conclusion

We hold that for the years at issue (1) the Program revenue was
includible in petitioner’s gross income; (2) petitioner’s treatment of the
Fund was not a method of accounting subject to section 481 adjustment;
and (3) petitioner was not entitled to adopt the trading stamp method.

To reflect the foregoing,

Decision will be entered under Rule 155.