Recurring-item exception: can economic performance be accelerated?

• Author: Van Leuven, Mary

On Dec. 13, 2011, the IRS released Rev. Rul. 2012-1, which addresses the application of the economic performance rules and whether the recurring-item exception may be applied to accelerate economic performance with respect to liabilities for the lease of equipment and a related maintenance agreement. The determination of when economic performance occurs is a key factor in determining when a liability is properly taken into account under Sec. 461 and Regs. Sec. 1.461-1(a) (2)(i).

Background

In general, an accrual-basis taxpayer is allowed a deduction for an otherwise deductible expense in the period in which the following three-prong test (the first two prongs of which are referred to collectively as the "all-events test") is met:

* All events have occurred that determine 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)).

The all-events test is met when (1) the event fixing the liability occurs (whether the event is the required performance or another event) or (2) payment is due, whichever happens earlier (see, e.g., Rev. Rul. 2007-3).

In general, economic performance occurs for a liability arising out of the provision of property or services to the taxpayer by another person, as the property or services are provided (Regs. Sec. 1.461-4(d)(2)). If the liability arises out of the use of property by the taxpayer (e.g., rent), economic performance generally occurs ratably over the period the taxpayer is entitled to the use of the property (Regs. Sec. 1.461-4(d)(3)). For liabilities arising out of the provision to the taxpayer of insurance or a warranty or service contract, economic performance occurs as payment is made to the person to whom the liability is owed (Regs. Sec. 1.461-4(g)(5)). For this purpose, a "warranty or service contract" is a contract that a taxpayer enters into in connection with property bought or leased by the taxpayer, under which the other party to the contract promises to replace or repair the property in specified circumstances.

The recurring-item exception of Sec. 461(h) and Regs. Sec. 1.461-5 provides an exception to the general rules of economic performance. If a taxpayer is eligible to use the recurring-item exception for a particular liability, then economic performance will be deemed to occur at year end. The recurring-item exception may be used if (I) the all-events test has been met; (2) the liability is recurring in nature; (3) economic performance occurs within 8 1/2 months of year end; and (4) either the amount of the liability is not material or the accrual of the liability in the earlier year results in a better matching...