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TAX CLINIC

liabilities (such as accounts payable), product liabilities as part of a deemed
Determining the who is entitled to claim this deduc- acquisition by its parent company.
An insolvent corporation that was
tion — the buyer or Company A as
deductibility and the seller? In the original example, the part of a consolidated group had con-
timing of accrued buyer did not assume the liabilities. verted to a limited liability company
liability deductions Thus, when Company A receives $10 of (LLC) by making a “check the box” elec-
cash from the sale of its assets, it would
tion. Upon the conversion, the company
in M&A transactions presumably pay off the $4 of liabilities was classified for U.S. federal income
can be complicated, and receive a deduction for this amount. tax purposes as a disregarded entity, and,
therefore, all of its assets and liabilities
In the modified example, however, the
depending upon the buyer assumed the $4 of liabilities. Even were deemed to be acquired by its par-
nature of liabilities at in this instance, the seller would nor- ent (the sole owner of the company).
At the time of the conversion, the
mally receive this deduction pursuant to
hand, the application Sec. 461. This is because, although the company had entered into master settle-
of the all-events test, seller does not actually satisfy the liabili- ment agreements (MSAs) with various
and other factors. ties by making direct payments to the groups of claimants to resolve certain
product claims. Upon converting to an
ultimate obligees, by accepting less cash
than it otherwise would have received in LLC, the company included the fixed
exchange for assumption of liabilities, it and determinable portion of the settled
Example 2: Company A has assets effectively paid the liabilities at the time MSA liabilities in its amount realized
with a fair market value (FMV) of of sale (see Commercial Security Bank, 77 on the deemed liquidation event and de-
$10 and liabilities of $4 as of the T.C. 145 (1981)). ducted these amounts under Regs. Sec.
most recent balance sheet date. If a Though this may seem straightfor- 1.461-4(d)(5).
buyer acquires all the assets of Com- ward at first, in practice, determinations The case focused on whether the
pany A without assuming Company in M&A transactions involving accrued parent company had assumed the com-
A’s liabilities, then the buyer would liabilities can be much more compli- pany’s liabilities such that the economic
have a basis in the assets acquired cated. The nature of specific liabilities performance standard was met for the
of $10 (the FMV of Company A’s being assumed by buyers should be subsidiary to deduct the liabilities. The
assets), and Company A, as the seller, carefully reviewed as well as the applica- IRS held that since the company was
would have an amount realized of tion of the all-events test and economic insolvent at the time of the check-the-
$10. Company A would use $4 of the performance rules pursuant to Sec. 461 box election, the parent must be treated
$10 to pay off its liabilities, resulting to determine the timing of these types as purchasing the company’s assets and
in ending cash of $6. of deductions and whether these items either assuming the liabilities (the case
can be deducted by buyers or sellers. In if the shareholder is directly liable to the
Continuing with the above example some cases, the economic performance claimants) or taking the assets subject
and modifying the facts, if the buyer ac- requirement may not be met until to the liabilities (where the shareholder
quires all the assets of Company A while sometime in the future, and, therefore, is not directly liable to the claimants).
also assuming Company A’s liabilities, the buyer may not be able to benefit As such, the company could deduct the
the result would generally be the same. from increased basis until economic amount of product liabilities because
The purchase price in this case would performance occurs. Every M&A trans- economic performance was satisfied
be $6 (since the buyer is assuming $4 action will have its own set of facts and under Regs. Sec. 1.461-4(d)(5).
of liabilities); however, for income tax circumstances that should be carefully Determining the deductibility and
purposes, the purchase price would be reviewed to ensure proper tax account- timing of accrued liability deductions in
adjusted to $10 ($6 of cash paid by the ing treatment. M&A transactions can be complicated,
buyer to the seller, plus $4 of liabilities depending upon the nature of liabilities
assumed by the buyer). Company A as TAM 202116012 at hand, the application of the all-events
the seller would have an amount realized A recent technical advice memorandum test, and other factors. It is often prudent
of $10 and ending cash of $6, which is (TAM) illustrates the type of issues that to have the purchase/sale agreement
the same as in the original example. can arise in the M&A context. In TAM identify such liabilities and the parties’
The question of note is: Assum- 202116012, the IRS considered whether intended tax treatment with respect to
ing the $4 of liabilities are deductible a subsidiary company could deduct the assumption of liabilities. This, along

8 November 2022 The Tax Adviser