Tax regulations discussion questions Do not write over a page, 2/3 of the page is limit. Revenue Ruling 2007–3 2007-1 Cum. Bull. 350. ISSUES taxpayer using

Tax regulations discussion questions Do not write over a page, 2/3 of the page is limit. Revenue Ruling 2007–3
2007-1 Cum. Bull. 350.
ISSUES
taxpayer using an accrual method of accounting incur a liability for
(1) Under $ 461 of the Internal Revenue Code, when does
services?
FACTS
X is a corporation that uses an accrual method of accounting an
files its federal income tax returns on a calendar year basis.
Situation 1. On December 15, 2006, X executes a contract with Yi
the provision of services. The contract provides for services to begin a
January 15, 2007, and end on January 31, 2007. Under the terms of the
contract, payment for the services is due to Y on January 15, 2007, and
X pays Y for the services on January 15, 2007. ***.
LAW
Section 461(a) provides that the amount of any deduction or cred
must
be taken for the taxable year that is the proper taxable year unde
37 I.R.C. § 471(c)(1)(B)(i); Reg. $ 1.162–3(a).
38 I.R.C. $ 471(c)(1)(B)(ii).
39 The example is adapted from Rev. Proc. 2002–28, 2002-1 C.B. 815, Example 15.
FUNDAMENTAL TIMING PRINCIPLES
635
CHAPTER 19
income.
veria
has
test
Of
1(e)(1)(ii)(A).
the method of accounting used by the taxpayer in computing taxable
Section 1.461-1(a)(2)(i) of the Income Tax Regulations provides that,
under an accrual method of accounting, a liability is incurred, and is
generally taken into account for federal income tax purposes, in the
faxable year in which (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 (the “all events test”). See also $1.446–
The first prong of the all events test requires that all the events have
occurred that establish the fact of the liability. Therefore, it is
fundamental to the all events test that although expenses may be
deductible before they become due and payable, liability first must be
firmly established. United States v. General Dynamics Corp., 481 U.S.
239, 243-4 (1987).
Generally, under $ 1.461–1(a)(2), all the events have occurred that
establish the fact of the liability when((1) the event fixing the fiability,
whether that be the required performance or other event, occurs, or (2)
payment therefore is due, whichever happens earliest. Rev. Rul. 80-230,
1980-2 C.B. 169; Rev. Rul. 79-410, 1979-2 C.B. 213, amplified by Rev.
Rul. 2003-90, 2003-2 C.B. 353. The terms of a contract are relevant in
determining the events that establish the fact of a taxpayer’s liability.
See, e.g., Decision, Inc. v. Commissioner, 47 T.C. 58 (1966), acq., 1967–2
C.B. 2.
Section 461(h) and $ 1.461-4 provide that, for purposes of
determining whether an accrual basis taxpayer can treat the amount of
any liability as incurred, the all events test is not treated as met any
earlier than the taxable year in which economic performance occurs with
respect to the liability.
Section 1.461-4(d)(2) provides that if a liability of a taxpayer arises
out of the providing of services or property to the taxpayer by another
person, economic performance occurs as the services or property is
provided.
***
ANALYSIS
Situation 1. In Situation 1, the first event that occurs to establish
the fact of X’s liability for services is that payment is due under the
contract on January 15, 2007. See Rev. Rul. 80-230; Rev. Rul. 79-410.
Thus
, for purposes of $ 461, the fact of the liability is established on
January 15, 2007. At that time, the amount can be determined with
reasonable accuracy. Economic performance with respect to the liability
occurs as the services are provided, from January 15, 2007, through
636
PARTS
CH
T!
res
THE YEAR OF INCLUSION OR DEDUCTION
January 31, 2007. See $ 1.461-4(d)(2). Therefore, X incurs a liability for
services in 2007.
The fact of the liability is not established in 2006, even though X
executed the service contract on December 15, 2006. It is well established
that an accrual basis obligor is not permitted to deduct an expense
stemming from a bilateral contractual arrangement, that is, mutual
promises, prior to the performance of the contracted for services by the
obligee. Rev. Rul. 80-182, 1980-2 C.B. 167, citing Levin v. Commissioner,
21 T.C. 996 (1954), affd, 219 F.2d 588 (3d Cir. 1955) (an agreement for
services to be performed in the next year did not establish the fact of the
taxpayer’s liability but was simply an agreement under
which a liability
would be incurred in the future) and Amalgamated Housing Corp.
Cir. 1940) (an agreement to renovate property in the future did not
Commissioner, 37 B.T.A. 817 (1938), affd per curium, 108 F.2d 1010 (24
establish the fact of the taxpayer’s liability, the accrual was for services
in renovating, not the duty to renovate). Thus, the mere execution of the
contract by X in 2006 is not sufficient, by itself, to establish the fact of
the liability.
ba:
w1
fu
W
t
***
HOLDINGS
(1) Under $ 461, all the events have occurred that establish the fact
of the liability for services provided to the taxpayer when (1) the event
fixing the liability, whether that be the required performance or other
event, occurs, or (2) payment is due, whichever happens earliest. The
mere execution of a contract, without more, does not establish the fact of
a taxpayer’s liability for services.
* * *
NOTE
Suppose the contract for services in Revenue Ruling 2007–3 had also
required payment in 2006? Would that change in the contract terms have
allowed the taxpayer a 2006 deduction under the accrual method? Under the
first prong of the all-events test, the fact of liability would have been
established because payment would be unconditionally due in 2006. But, the
all-events test has three prongs which have to be satisfied in order to accrue
a deduction. Would there have been economic performance in 2006? The
ruling notes that if a liability arises out of the providing of services to the
taxpayer by another person, economic performance occurs as the services are
provided. So again a 2006 deduction would be denied, but the denial would
be based on a failure to satisfy the third prong of the all-events test. The
Schuessler case introduces the concern that prompted Congress to enact the
economic performance requirement in Section 461(h).

Purchase answer to see full
attachment