When is a rebate liability fixed and eligible for the recurring-item exception?

• Author: Tucker, Natalie

With the passing of April 15, many practitioners will shift their attention to taxpayers under extension, many of which will use the recurring-item exception to deduct expenditures paid subsequent to year end but prior to the filing of the tax return. In recent guidance, the IRS has been scrutinizing the timing of the deduction of rebate payments (expenditures generally eligible for the recurring-item exception) and focusing on whether the related liability is actually fixed by year end and therefore eligible to be deducted even if paid within 8 1/2 months of year end.

Background

Under an accrual method of accounting, a liability is incurred and generally taken into account for federal income tax purposes in the tax year in which:

* All the events have occurred that establish the fact of the liability;

* The amount of the liability can be determined with reasonable accuracy; and

* Economic performance has occurred with respect to the liability (Regs. Sec. 1.461-1(a)(2)(i)).

Economic performance occurs for a rebate liability when the taxpayer makes a payment to the person to whom the liability is owed (Regs. Sec. 1.461-4(g)(3)). Accordingly, taxpayers cannot deduct rebates in any tax year prior to the tax year in which they actually pay the rebate, unless they qualify for the recurring-item exception.

Under the recurring-item exception, economic performance is treated as having been met for the year the rebate liability is fixed and determinable, as long as:

* Payment is made on or before the earlier of the date the taxpayer files a timely tax return (including extensions) for the tax year the rebate liability is fixed and determinable or 8 1/2 months after the close of that tax year; and

* The rebate liability is recurring in nature (Regs. Secs. 1.461-5(b)(1)(ii), (b) (1)(iii), and (b)(3)).

Under the recurring-item exception, the amount of the liability must not be material, or accrual of the liability in the tax year must result in better matching of the liability against the income to which it relates. The matching requirement of the recurring-item exception is deemed satisfied with respect to rebates, and the exception applies to rebate liabilities without regard to materiality (Regs. Secs. 1.461-5(b)(1) (iv) and (b)(5)(ii)).

It is tempting to immediately dismiss the all-events test for rebate payments, move immediately to the economic performance issue, and conclude that since economic performance occurs as rebate payments are made, any...