Page 549 - TaxAdviser_2022

Corporations & Shareholders

M&A transactions: Deducting
accrued liabilities
Determining when accrued liabilities
are deductible is often complicated in
the normal course of business, let alone
during merger-and-acquisition (M&A)
transactions. For cash-method taxpayers,
the rules are straightforward — liabili-
ties are typically deductible in the tax
year in which they are paid. For accrual-
method taxpayers, however, the rules are
a bit more complicated. Under Sec. 461,
the liability is generally deductible in the
tax year in which the three prongs of the determined, this will generally not pre- to) accrued compensation, taxes, servic-
“all events” test have been met: (1) all vent a taxpayer from taking into account es, rent, interest, etc., the determination
the events have occurred that establish that portion of the amount of the liabili- of when economic performance occurs
the fact of the liability; (2) the amount ty that can be computed with reasonable may be governed by other various
of the liability can be determined with accuracy within the tax year. Internal Revenue Code sections and/
reasonable accuracy; and (3) economic or Treasury regulations. These special
performance has occurred with respect Example 1: A renders services to rules are beyond the scope of this dis-
to the liability (Regs. Sec. 1.461-1(a)(2)). B during the tax year, for which A cussion. It is important to note that the
After describing the all-events test charges $10,000. B admits a liability general economic performance rules do
in more detail, this item discusses the to A for $6,000 but contests the not override other Code sections that
rules for deducting accrued liabilities in remainder. B may take into account specifically dictate the timing of when
M&A transactions and then provides an only $6,000 as an expense for the tax certain items may be deductible.
illustration by looking at a recent IRS year in which the services were ren-
technical advice memorandum. dered. (This example is taken from Deducting liabilities in M&A
Regs. Sec. 1.461-1(a)(2)(ii).) transactions
Three-pronged all-events test Turning now to M&A transactions,
In the first prong of the all-events In the third and final prong of the the determination of when accrued
test, the fact of the liability must be all-events test, economic performance liabilities are deductible can be even
established. Generally, this condition must occur with respect to the liability. more delicate because these transac-
is satisfied when (1) the event fixing A detailed analysis of this requirement tions generally have lots of moving
the liability occurs, whether that be the is beyond the scope of this discussion. pieces. Frequently, buyers will assume
required performance or other event, or In general, the determination of when certain liabilities (often, working capital
(2) payment therefore is due, whichever economic performance occurs depends liabilities). In a taxable asset acquisition
happens earlier (Regs. Sec. 1.461-1(a)(2) upon the type of liability at hand, as (or a taxable stock acquisition treated
and Rev. Rul. 2007-3). It is important to there are different rules for different as an asset acquisition for income tax
IMAGE BY MARTIN BARRAUD/GETTY IMAGES the fact of a liability. once payment has been made for li- ties assumed by the buyer, pursuant to
purposes), the purchase price is gener-
types of liabilities. For example, eco-
note that the mere execution of a con-
tract is generally not enough to satisfy
nomic performance generally occurs
ally increased by the amount of liabili-
In the second prong of the all-events
abilities including (but not limited to):
Regs. Sec. 1.1001-2. From the seller’s
workers’ compensation, torts, breaches
perspective, the amount realized is also
test, the amount of the liability must be
increased, which, in turn, increases
of contract, violations of law, rebates
determined with “reasonable accuracy.”
and refunds, awards, prizes, jackpots,
Thus, taxpayers generally do not need
the seller’s taxable gain on the sale of
to establish the exact amount of a li-
assets. Consider the following situa-
insurance, warranties, etc. (Regs. Sec.
1.461-4(g)). For other types of liabili-
tion involving accrued liabilities in an
ability for it to be deductible in a given
tax year. If an exact amount cannot be
www.thetaxadviser.com ties, however, including (but not limited M&A transaction. November 2022 7