Washington Tax Alert October 22, 2015 (accrual of expenses)

Washington Tax Alert from Don Barnes, [email protected]

October 22, 2015

An accrual method taxpayer incurs an expense in the taxable year in which the fact of liability is established, the amount of the liability can be determined with reasonable accuracy, and economic performance occurs with respect to the liability. IRC § 461(h); Treas. Reg. § 1.461-1(a)(2)(i).

Although all events establishing the fact of liability must occur, there is no requirement that the taxpayer must be legally obligated to make the expenditure. Treas. Reg. § 1.162-1(a) provides that taxpayers are allowed deductions for all ordinary and necessary expenses directly connected with or pertaining to their trade or business. In Champion Spark Plug Co. v. Commissioner, 30 T.C. 295 (1958), aff’d per curiam, 266 F.2d 347 (6th Cir. 1959), the Tax Court held a taxpayer need not have a legal liability to make an expenditure in order for the item to qualify as an ordinary and necessary business expense.

The Service nonacquiesced in Champion and has taken the position in numerous examinations and court cases that taxpayers are not entitled to a deduction if they are not legally obligated to make the expenditure.

In a recent field service advice, however, the Service acknowledged the holding in Champion that a taxpayer’s lack of an underlying legal liability does not necessarily preclude a deduction. FAA 20150701F.

This issue of lack of legal liability arises in several different contexts, including situations where a parent company contracts with a third party for goods or services provided to its subsidiary, and the subsidiary accrues the liability.

Law Offices of Donald A. Barnes, PLLC
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