Deductibility of contested liabilities.

• Author: Tovig, Barry A.

Recently, in Varied Investments, Inc., 8/2/94, the Eighth Circuit held that a contested liability was deductible under Sec. 461(f) when the taxpayer filed a bond collateralized by a pledge of U.S. government securities with an escrow agent. As part of an appeal of a state court judgment entered against Varied, a surety company issued a bond; Varied secured the bond by pledging U.S. government securities to a trust company as the escrow agent. In disallowing the deduction, the Service had argued that a transfer under Sec. 461(f)(2) did not occur because the escrow agreement was not signed by the claimant, even though the agreement expressly provided that the claimant was the beneficiary.

In reaching its holding that the entire amount of the contested liability was deductible, the court first concluded that the amount of the judgment, if it had not been appealed, would have been deductible in 1986 as an ordinary and necessary business expense under Sec. 162, thereby meeting the Sec. 461(f)(4) requirement. In addition, with respect to the Sec. 461(f)(2) requirement (dealing with the transfer of money or other property to provide for the satisfaction of an asserted liability), the court agreed with Varied that the escrow agreement did not need to be signed by the claimant to qualify under Sec. 461(f)(2). The court looked to Regs. Sec. 1.461 2(c)(1), and to two other circuit courts that had reached opposite conclusions on the issue dealing with a claimant's signature on a trust or escrow agreement. The language in Regs. Sec. 1.461-2(c) (preceded by the words "In general," lists three possible means of achieving a transfer. one effective means is a transfer of money or other property beyond the...