Attorney-at-Law

YA GOTTA DO IT TO ACCRUE IT

In Uncategorized on 11/20/2013 at 21:05

Just signing a contract isn’t enough. That’s Judge Marvel’s word to VECO Corporation and Subsidiaries, 141 T. C. 14, filed 11/20/13.

VECO and its bushelbasketful of subsidiaries echo the Beach Boys’ 1964 hit: they get around. From Wyoming to Alaska to Colorado to Washington, VECO was busy with “oil and gas field services, newspaper publishing, manufacturing, construction, equipment rental, wholesale sales, leasing, and engineering.” 141 T. C. 14, at p. 5, and entered into numerous contracts in furtherance of all the foregoing, as the expensive lawyers say.

VECO’s tax problem? They want to shunt the tax incidents of their 2006 contracting into 2005. So VECO attaches to their 2005 return Form 3115, Application for Change in Accounting Method, for their 2005 tax year, requesting an accounting method change pursuant to Rev. Proc. 2005-9, 2005-1 C.B. 303.

Rev. Proc. 2005-9 provides an automatic change of accounting method for the second tax year following 2003, which just happens to be 2005. Except IRS says no.

VECO of course is an accrual basis taxpayer. So it’s “all events”, reasonably ascertainable amount, and economic performance.

Just signing a contract isn’t enough, though. Judge Marvel: “The execution of a contract contemplating payment, without more, is not an event that fixes the payor’s liability. See Spencer, White & Prentis v. Commissioner, 144 F.2d 45, 47 (2d Cir. 1944) (‘It is well settled that deductions may only be taken for the year in which the taxpayer’s liability to pay becomes definite and certain, even though the transactions (such as the contract in the present case) which occasioned the liability, may have taken place in an earlier year.’). In particular, where a contract ‘contains mutually dependent promises, liability under it is contingent upon performance or tendered performance’, and is not fixed by merely entering into the contract. Levin v. Commissioner, 219 F.2d 588, 589 (3d Cir. 1955), aff’g 21 T.C. 996 (1954); see also Gulf Oil Corp. v. Commissioner, 914 F.2d 396, 409 (3d Cir. 1990) (‘Unconditional liability under an executory contract is not created until at least one party performs.’), aff’g 86 T.C. 115 (1986).” 141 T. C. 14, at p. 37.

In simple English, an agreement that you’ll do this if I do that doesn’t establish liability for accrual purposes unless one of us does something.

And the three-and-a-half month test doesn’t help VECO. Forgot the three-and-a half-month test? See my blogpost “Drill, Baby, Drill”, 1/12/12. No way could the contemplated performances be completed within three-and-a-half months after the end of VECO’s tax year.

Finally, VECO wants the recurring item treatment. Now watch this closely:

“Under the recurring item exception, a taxpayer may treat an item as incurred during any taxable year if:

(i)            the all events test with respect to such item is met during such taxable year (determined without regard to * * * [section 461(h)(1)]),

(ii)            economic performance with respect to such item occurs within the shorter of–

(I)            a reasonable period after the close of such taxable year, or

(II)            8 1/2 months after the close of such taxable year,

(iii)            such item is recurring in nature and the taxpayer consistently treats items of such kind as incurred in the taxable year in which the requirements of clause (i) are met, and

(iv) either–

(I)            such item is not a material item, or

(II)            the accrual of such item in the taxable year in which the requirements of clause (i) are met results in a more proper match against income than accruing such item in the taxable year in which economic performance occurs.” 141 T. C. 14, at p. 53.

You can accrue a recurring item. But VECO can’t, because they flunk economic performance on a lot of their deductions, and materiality, as determined under GAAP, goes against them.

Here’s FASB’s take: materiality is “ ‘[t]he magnitude of an omission or misstatement of accounting information that, in the light of surrounding circumstances, makes it probable that the judgment of a reasonable person relying on the information would have been changed or influenced by the omission or misstatement.’ Statement of Financial Accounting Concepts No. 2, “Qualitative Characteristics of Accounting Information” (1980) (SFAC No. 2).” 141 T. C. 14, at p. 55, footnote 53.

Taishoff’s Rule of Footnotes: when there are almost as many footnotes as pages, or more footnotes than pages, someone is in trouble.

Of course, everything is material. VECO was inconsistent in reporting for financial and for tax purposes, and that makes whatever it is material, regardless of size.

I think I deserve at least a small kudo for not referring to Otis Blackwell’s fifth best song of 1956 and 92nd on the all-time list.

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