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TAX CLINIC

of the liability and the amount can be manufacturer’s deduction for sales incen-
determined with reasonable accuracy; tive payments to third-party distribu- Before a liability
2. Economic performance with respect tors of its products. The manufacturer
to the liability occurs on or before the contended that its written promise to is considered as
earlier of (a) the date the taxpayer files pay the distributors a sales incentive of incurred, the ‘last
a timely (including extensions) return a guaranteed minimum amount acceler-
for that tax year, or (b) the 15th day ated the time when it incurred the liabil- event’ necessary
to establish the
of the ninth calendar month after the ity for purposes of the Sec. 461 all-events
close of that tax year; test. Disagreeing, the IRS concluded that
3. The liability is recurring in na- the liability was incurred only in the tax existence of the
taxpayer’s liability
ture; and year the distributors earned the sales in-
4. Either the amount of the liability centive, because the guaranteed payment must have happened,
is not material or the accrual of the was contingent on the distributors’ sell-
liability results in better matching to ing at least one of the taxpayer’s units in and the liability
the income it relates to. a subsequent year and not earning incen- cannot be contingent.
In the case of the manufacturing and tives exceeding the guaranteed minimum.
distribution company being discussed,
all incentives were paid during the first Background distributor opened or viewed the an-
8½ months of year 2. Therefore, the eco- The taxpayer manufactured and distrib- nouncement letters, and the taxpayer
nomic performance requirement would uted products to third-party distributors received no inquiries or communication
be met under the recurring-item excep- for resale to retail customers. In year 1, from distributors regarding the an-
tion if the liability was fixed at the end to encourage additional purchases of nouncement letters.
of year 1. However, since the distributor its products, the taxpayer made an ir- The taxpayer had been taking the
was required to sell at least one unit revocable promise to pay participating amount of the guaranteed minimum pay-
during year 2, the liability was not fixed distributors a guaranteed minimum sales ment as a deduction in the tax year when
and, therefore, the third prong of the all- incentive if a distributor sold at least the taxpayer issued the announcement
events test was not met. one unit of the taxpayer’s product in the letters (year 1).
Reviewing the facts and circum- qualifying period (date 1 of year 1 to date
stances of the company’s sales incentive 2 of year 2) and did not earn sales incen- Analysis
offer along with the provisions of the tives exceeding that guaranteed minimum Under an accrual method of accounting,
all-events test provides clarity into the payment. The taxpayer announced the a liability is incurred, and is generally
IRS’s decision to disallow the accelera- incentive payment in letters posted to a taken into account for federal income
tion of the liability to the year the offer distributor-used portal website near the tax purposes, in the tax year in which
was made. The company’s mere promise end of year 1. (1) all the events have occurred that
to pay was not sufficient to consider the The taxpayer did not provide details establish the fact of the liability; (2) the
liability fixed since all of the events to in the announcement letters on how the amount of the liability can be deter-
establish the fact of the liability did not individual incentives would be calculated mined with reasonable accuracy; and
occur during the year the offer was made. or develop a mechanism to allocate (3) economic performance has occurred
The IRS concluded that the taxpayer the guaranteed minimum payment with respect to the liability (collectively,
must deduct the sales incentive payments among distributors for any of the tax the all-events test) (Sec. 461(h) and
in the tax year they were earned by the years at issue, because the participating Regs. Sec. 1.461-1(a)(2)(i)). Regarding
distributors under the all-events test. distributors always qualified to receive the first requirement, all the events have
From Christa Zumach, CPA, sales incentive payments in excess of the occurred that establish the fact of the
Albany, Ore. guaranteed amount. liability when (1) the event fixing the li-
For the tax years at issue, there is no ability occurs or (2) payment therefore is
All-events test for sales evidence indicating that participating dis- due, whichever happens earlier (Rev. Rul.
incentives — another tributors relied upon the announcement 2007-3).
perspective letters to purchase additional units of the So, the key here in determining when
In Technical Advice Memorandum taxpayer’s products prior to the end of the manufacturer was entitled to take the
202121010, also discussed immediately year 1. The taxpayer was unable to con- deduction is to find out if its liability for
above, the IRS addressed the timing of a firm or track whether any participating the minimum payments was fixed as of

24 November 2022 The Tax Adviser