Tax Court clarifies the all-events test for prepaid and accrued liabilities.

• Author: Meade, Kathleen

The Tax Court recently held in VECO Corp., 141 T.C. No. 14 (2013), that an accrual-method corporation was not permitted to change its method of accounting to accelerate the timing of various deductions because the items failed to satisfy all the requirements of the all-events test in Sec. 461.

Background

VECO Corp. was an accrual-method taxpayer engaged in various business activities, including oil and gas field services, manufacturing, construction, and equipment leasing. For the fiscal year ended March 31, 2005, VECO attached a Form 3115, Application for Change in Accounting Method, to its federal income tax return proposing to change its accounting method to accelerate deductions for prepaid and accrued expense liabilities attributable to periods after the close of its fiscal year that were incurred in connection with service contracts, insurance premiums, and real property and equipment leases. The IRS rejected the taxpayer's proposed accounting method change and denied the majority of the accelerated deductions, contending that the amounts did not meet the requirements of the all-events test outlined in Sec. 461. The taxpayer challenged the IRS's determination in Tax Court.

All-Events Test and Recurring-Item Exception

Under the three-part all-events test, a liability is generally taken into account by an accrual-basis taxpayer in the tax 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.

Sec. 461(h)(3) allows an exception, called the recurring-item exception, to the economic performance requirement of the all-events test where (1) the item meets the all-events test during the tax year without regard to economic performance; (2) economic performance occurs within the shorter of a reasonable period after the close of the tax year or 8 Vi months after the close of the tax year; (3) the item is recurring in nature, and the taxpayer consistently treats such items as incurred in the tax year in which the all-events test is met without regard to economic performance; and (4) either the item is not material or the item's accrual in the tax year results in a more proper match against income than in the year in which economic performance occurs.

The IRS agreed that VECO met the second part of the all-events test with regard to the accelerated deductions at issue...