Category: Corporations/Accounting
Periods and Methods Copyright 1998, The Tax Resource Group. All rights reserved. Telephone 800-578-3498. Internet: www.taxresourcegroup.com Background Taxpayer is the acquired corporation in a tax-free merger. As of the acquisition date, July 31, the taxpayer had an accrual for real property taxes. The lien date in the jurisdiction in question was January 1 prior to the reorganization. Accordingly, as of the date of acquisition, the taxpayer had met the all events test without consideration of Section 461(h). The taxpayer has a valid recurring item exception election in effect. There was no election to ratably accrue property taxes under Section 461(c). The taxes in question were actually paid by the acquiring corporation in September following the acquisition. Issue Does payment by the acquiring corporation constitute economic performance under the recurring item exception? Answer No, payment by the acquiring corporation does not constitute economic performance. Note: For a discussion of this same issue with respect to the parties in a stock-for-stock reorganization, see Corporate Reorganization; Deduction of Target's Accrued Expenses (Part B); Sections: 461(h). Discussion IRC Section 461(h) provides that the all events test is not deemed met prior to the time economic performance occurs. In the case of taxes and certain other items, Regulation Section 1.461-4(g) provides that economic performance occurs when the taxes are paid to the taxing authority. Regulation Section 1.461-5 provides an exception to the general economic performance rules for certain recurring items if economic performance occurs within a short period after the close of the taxable year in which the deduction for the item is to be claimed. The taxpayer in this case has made a valid election under these regulations that would have allowed a deduction for the property taxes in question if the taxpayer (the acquired corporation in a merger) had paid the taxes itself. Instead, the acquiring corporation paid the taxes after the effective date of the merger. It is clear that the acquiring corporation in the merger is a legal and tax entity which is completely separate from the taxpayer. The regulations as Section 1.461-4(d)(5) provides for treatment of expenses paid by a successor entity when a trade or business is sold. Although the regulation is not absolutely explicit on this point, it very strongly appears to apply only to taxable sales. In this case, of course, the acquisition is a tax-free reorganization. I see no indication within Reg. Section 1.461-4 or elsewhere in the tax literature that payment by a successor taxpayer is sufficient to satisfy the payment requirement under the recurring item exception rule. Clearly in drafting the regulations, Treasury actively considered payment of an accrued expense item by a successor taxpayer. For whatever reason, however, Treasury chose to write a rule applicable only to taxable transactions. Deductions are a matter of legislative grace, and the taxpayer bears the burden of proving entitlement to any deduction claimed. Deputy v. Du Pont [40-1 USTC ¶9161], 308 U.S. 488 (1940); New Colonial Ice Co. v. Helvering [4 USTC¶1292], 292 U.S. 435; (1934); Welch v. Helvering, 3 USTC ¶1164, 290 U.S. 111 (1933). It seems clear to me that absent some indication that Congress or Treasury (pursuant to its authority to draft regulations) intended to create an exception for payment by a successor entity in a tax-free reorganization, the taxpayer in this case is not entitled to a deduction for the accrued property taxes. I can find no such indication. Although you did not specifically raise this issue, I strongly suspect the reason Treasury drafted the regulations in this manner is as follows. It seems fairly clear that the successor entity is entitled to deduct the item in question either under the auspices of Section 381(c)(16) or 381(c)(4). I would be happy to discuss this with you in greater depth if you desire. |
