New guidance for vendor's income recognition.

• Author: Madden, David

Sec. 451 provides that the amount of any item of gross income has to be accrued in gross income for the tax year in which received by the taxpayer, unless such amount can be properly accounted for as of a different period under the accounting method used in computing taxable income. Generally, Regs. Sec. 1.451-1(a) provides that gains, profits and income have to be included in gross income in the tax year in which they are actually or constructively received by the taxpayer, unless includible in a different year under the accounting method used.

Under the accrual accounting method, income is includible in gross income when all the events have occurred that fix the right to receive such income and the amount thereof can be determined with reasonable accuracy; see Anderson, 269 US 422 (1926), and Regs. Secs. 1.451-1(a) and 1.446-1(c)(1)(ii). "The all-events test is based on the existence or nonexistence of legal rights or obligations at the close of a particular accounting period ..." (Hallmark Cards, Inc., 90 TC 26, 34 (1988)).

Although neither the Code nor the regulations have specific rules for determining when the right to an item of income becomes "fixed" the Service's position is that accrual-method taxpayers have to recognize income at the earliest of when it is paid, due or earned; see Rev. Rul. 74-607 and Schlude, 372 US 128 (1963). Generally, when the taxpayer receives income, it must accrue that amount, unless the receipt is subject to substantial limits or restrictions or is a deposit or loan. A contract or agreement allowing merchandise returns is not a limit or restriction permitting nonaccrual; see Continental Ill. Corp., 998 F2d 513, 520-521 (7th Cir. 1993), cert. den., and J.J. Little & Ives Co., Inc., TC Memo 1966-68.

Income Inclusion

A variety of circumstances affect whether an amount is includible in income in a particular tax year and the adjustments to be made for amounts erroneously included. When revenue from a merchandise sale is otherwise accruable under a taxpayer's accounting method, a contest or dispute prevents accrual of income in the tax year that it would otherwise be includible in income. Although undefined in the Sec. 451 regulations, Regs. Sec. 1.461-2(b)(2) defines "contest" (from the obligor's perspective) as "a bona fide dispute as to the proper evaluation of the law or the facts necessary to determine the existence or correctness of the amount of an asserted liability ... An affirmative act denying the...