On August 22, 2008, the IRS released Chief Counsel Advice (CCA) 200834019, addressing whether a retailer could use the recurring-item exception of Sec. 461(h)(3) to treat its cash rebate liability as incurred in the year of the sale of the rebate-eligible product.
In a nutshell, the Office of Chief Counsel concluded that the taxpayer may not do so, because the rebate liability was not fixed until the customer complied with the rebate requirements and thus did not meet the required all-events test. As a result, the question of the recurring-item exception's applicability was moot.
Incidentally, this CCA is apparently related to CCA 200826006, in which the IRS advised that a retailer's method of accounting for its cash rebate liabilities was not permitted under the regulations. In that case, the taxpayer did not record the full purchase price as income at the time of the sale, even though it received full price at that time. Instead, it reduced its gross receipts by the amount of its estimated rebate payment. Later, if a particular rebate expired, it reversed the prior reduction from gross receipts by bringing back into income the amount of its previously estimated rebate payment. The Service stated that this method did not follow Regs. Sec. 1.461-4(g)(3), which provides that economic performance for rebates occurs as payment is made to the person to whom the liability is owed.
Note: Various sources differ as to whether the economic performance rules are part of the all-events test. Even the IRS seems to treat it both ways: In Publication 538, Accounting Periods and Methods, it seems to view economic performance as separate from the all-events test, whereas in CCA 200834019 it treats economic performance as a third prong in the allevents test. Practically speaking, there is no real difference, since Sec. 461(h)(1) provides that "the all events test shall not be treated as met any earlier than when economic performance with respect to such item occurs." Nevertheless, for purposes of this discussion, the all-events test will be treated as a two-prong test.
BackgroundAn accrual-basis taxpayer is generally entitled to deduct an item in a particular year (assuming it is otherwise deductible in the first place) only to the extent that:
- It meets the all-events test (i.e., all the events have occurred that establish the fact of the liability, and the amount of the liability can be determined with reasonable accuracy); and
- Economic performance has occurred with respect to the liability.
In addition, Regs. Sec. 1.461-5(b)(1) provides a limited exception to the economic performance rules, allowing taxpayers who adopt it to accelerate the time at which economic performance is deemed met. This recurring-item exception allows a taxpayer to treat a liability as incurred for a tax year if:
- At the end of the tax year, all events have occurred that establish the fact of the liability and the amount can be determined with reasonable accuracy;
- Economic performance occurs on or before the earlier of (a) the date that the taxpayer files a return (including extensions) for the tax year or (b) the fifteenth day of the ninth calendar month after the close of the tax year;
- The liability is recurring in nature; and
- Either the amount of the liability is not material, or accrual of the liability in the tax year results in better matching of the liability against the income to which it relates than would result from accrual of the liability in the tax year in which economic performance occurs.
Note, however, that this exception to the usual economic performance rules does not override the all-events test and does not accelerate the deduction for items that are not fixed and determinable. Unfortunately, as in the case of the taxpayer in CCA 200834019, taxpayers often misunderstand this aspect of the recurring-item exception.
Details of CCA 200834019The chief counsel advice addressed the case of a consumer products retailer using the accrual method of accounting. Like many retailers, the taxpayer had a cash rebate program that involved issuing cash payments to buyers that met specified conditions. Under the program, a thirdparty administrator handled the taxpayer's rebate plan, processing rebate claims and issuing checks if the purchasers met all applicable conditions.
The conditions of the rebate were as follows: After purchasing the product, the buyer would have to:
- Fill out the rebate form provided when the merchandise was purchased;
- Cut out and attach a copy of the UPC code from the merchandise;
- Attach a copy of the sales receipt; and
- Send these items by mail to the thirdparty administrator within 30 days of the purchase date.
Query from the field to the Office of Chief Counsel: The IRS field agent examining the taxpayer asked the Office of Chief Counsel for advice on whether all the events occurred that establish the fact of the taxpayer's liability for the cash rebates at the time of the issuance of the offers (at the time of the sale of a product), allowing it to treat the liability as incurred in the year of issuance, as long as the rebates were paid within the period permitted under the recurring-item exception.
Chief counsel's opinion: The Office of Chief Counsel began its analysis by discussing the all-events and economic performance tests (which it collectively labeled the "all-events test"). It then moved into the issue of when the rebate liability became fixed, which was a prerequisite to the use of the recurring-item exception.
Citing several revenue rulings, as well as General Dynamics Corp., 481 U.S. 239 (1987), and Hughes Properties, Inc., 476 U.S. 593 (1986), the IRS pointed out that the rebate liability was not unconditionally due until the customer mailed a properly completed rebate form with attachments. It based its rationale on the premise that the taxpayer's situation in the CCA was similar to that in General Dynamics, where the liabilities associated with the taxpayer's self-insured medical plan were not fixed until the employee-patient submitted properly completed claim forms.
Moreover, the Service distinguished the taxpayer's situation in the CCA from that of the Nevada casino operator in Hughes Properties, in which the taxpayer was required by state law to pay out a jackpot based on amounts gambled in progressive slot machines and was required to keep a cash reserve sufficient to pay the guaranteed jackpots when won. Because the amount of the casino's liability was fixed by the slot machine payout indicators, the last event necessary to fix liability was the last play of the slot machine before the end of the casino's tax year.
ConclusionUltimately, the IRS found the recurring- item exception question to be moot because the rebate liability was not fixed until the customer complied with the rebate requirements. Because the liability was not fixed, the taxpayer did not meet the all-events test with respect to that liability and was not entitled to a deduction for the estimated rebate liability at year end.
Even though the CCA may not be cited
or used as precedent, it does persuasively rely on
authoritative Supreme Court case law. CCA 200834019
demonstrates the importance of a careful analysis of the facts
and circumstances associated with any potential deductions of
Michael Koppel is with Gray, Gray & Gray, LLP, in Westwood, MA.
The Tax Adviser would
like to acknowledge the special contribution to the December
Tax Clinic of Singer Lewak LLP; Mark G. Cook, tax partner in
the Irvine, CA, office; and Steve Cupingood, the partner in
charge of that firm's tax practice.
For additional information about these items, contact Mr. Koppel at (781) 407-0300 or firstname.lastname@example.org.