9th Circuit Upholds CCRC’s US Tax Court Victory

October 1, 2024 (San Francisco, CA) – Hanson Bridgett LLP is pleased to announce a significant victory for Continuing Life Communities Thousand Oaks LLC (“Continuing Life” or the “Taxpayer”) in the Ninth Circuit Court of Appeals. The Court upheld a U.S. Tax Court ruling, affirming that Continuing Life’s method of recognizing deferred entrance fees for its retirement community, University Village Thousand Oaks (UVTO), clearly reflects income under federal tax laws.

UVTO is a full-service Continuing Care Retirement Community (CCRC) in Southern California. The Taxpayer had been in a dispute with the Internal Revenue Service (IRS) regarding the timing of income recognition for “Deferred Entrance Fees.” These fees are part of resident contracts, wherein a portion of the entrance fee is repayable, and the remaining part can only be earned by Continuing Life if it fulfills its lifetime care obligation to the resident. The IRS challenged Continuing Life’s accrual method of accounting, claiming it did not clearly reflect income. However, the Tax Court, affirmed by the Ninth Circuit, rejected the IRS’s position. The IRS has opted not to pursue the case further.

“We are pleased with the Ninth Circuit’s decision, which affirms our client’s accounting practices and provides clarity on the tax treatment for similar retirement communities,” said Hanson Bridgett partner, Paul Gordon. “This ruling will have important implications for CCRC operators and other businesses with accrual-based accounting practices.”

Continuing Life’s model, which provides care for residents for the remainder of their lives, is subject to strict regulatory oversight under California law, including the approval of contracts and financial audits by the Department of Social Services (DSS). The Ninth Circuit decision ensures that Continuing Life can continue to operate within this regulatory framework while adhering to its existing financial and accounting practices.

For Continuing Life, the victory not only means relief from being improperly assessed many millions in tax liability but also sets an important precedent for the entire CCRC industry. The Hanson Bridgett team was led by partner Fred Weil and included partners Paul Gordon, Larry Cirelli and Gary Watt.

Background on the Case

The case focused on the continued use of a Generally Accepted Accounting Principles (GAAP) method which recognizes Deferred Entrance Fees over the life expectancy of residents, rather than reporting all fees as taxable income at specific intervals. The CCRCs contracted with each resident to make a portion of the entrance fees non-repayable at the rate of 5% per year for the first 4+ years of occupancy, but earned and payable only if Continuing Life fulfilled its lifetime care obligations. The remainder would be repayable to residents or their heirs.

The IRS sought to accelerate the recognition of the Deferred Entrance Fees over the first four+ years of residency, arguing that this income should be taxed merely because the amount of the potentially non-repayable Deferred Entrance Fee became known at a fixed date, fully ignoring that the promise of care for life had not yet been fulfilled. However, Continuing Life, adhering to GAAP, recognized income from the Deferred Entrance Fees based on the life expectancy of each resident, even though the fees were not considered earned until the promise to provide lifetime care had been fulfilled.

The Ninth Circuit did not accept the IRS’s argument and instead confirmed that Continuing Life’s method met the “all-events test” for income recognition, complied with GAAP, and thus clearly reflected income. As such, the Tax Court found that the IRS lacked the authority to impose a different method, a decision that the Ninth Circuit has now affirmed.

About Hanson Bridgett LLP

Hanson Bridgett LLP is a full-service AmLaw 200 law firm with more than 200 attorneys across California. Creating a diverse workforce by fostering an atmosphere of belonging and intentional support has been a priority at Hanson Bridgett since its founding in 1958. We are dedicated to creating an environment that provides opportunities for people with varied backgrounds, both for attorneys and administrative professionals. As the first law firm recognized as a certified B Corp, we are committed to the communities where our employees live and work and consider it part of our professional obligation to serve justice by encouraging and supporting pro bono and social impact work.