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TAX CLINIC

before the recurring-item exception can
For passthrough entities on the accrual be utilized. Each imposing jurisdiction’s
elections should be reviewed in detail to
method, the issue arises of whether the determine whether the liability is fixed
deduction must be taken in the year the tax and determinable at year end.
From John Charin, J.D., LL.M. (John.
is paid or whether it is possible to take the Charin@rsmus.com); Ryan Corcoran,
deduction in the preceding year. CPA (Ryan.Corcoran@rsmus.com); and
Kate Abdoo, J.D., LL.M. (Kate.Abdoo@
rsmus.com), Washington, D.C.
acceleration of a deduction for state in- For a state income tax liability, the
come tax payments. A taxpayer utilizing regulations provide that the match-
an accrual method is generally allowed ing requirement of the recurring-item Tax Accounting
a deduction for a liability when all exception is deemed satisfied. Thus,
events occur to establish the fact of the under the recurring-item exception, an Assessing the need for a
liability, the amount of the liability can accrual-basis taxpayer generally may ac- valuation allowance
be determined with reasonable accuracy, celerate the deduction for state income Over the past decade or so, financial
and economic performance occurs with taxes to the year prior to payment, reporting under GAAP has become
respect to the liability. For state income notwithstanding the general economic more mechanical or formulaic, with the
taxes, Regs. Sec. 1.461-4(g)(6) provides performance rules under Sec. 461. goal of increasing consistency among
that economic performance occurs as the While not certain, the notice does financial statement preparers. Yet, pro-
tax is paid to the governmental authority not appear to change any general rules fessional judgment remains a critical
that imposed the tax. or regulations under Sec. 461, so it skill in preparing and auditing financial
Thus, accrual-method taxpayers may stands to reason that, provided the re- statements, even though the trend in
generally deduct state income taxes in the quirements of the recurring-item excep- financial reporting may appear to lessen
year paid, similar to a cash-basis taxpayer. tion are met, an accrual-basis taxpayer the need for it.
However, a special rule exists under Regs. should be able to utilize this exception A key part of accounting for income
Sec. 1.461-5 for accrual-basis taxpayers to deduct a specified income tax pay- taxes under FASB Accounting Stan-
regarding the timing of a deduction for ment in the tax year accrued, even if dards Codification (ASC) Topic 740,
certain recurring items, such as state payment is made in the subsequent year. Income Taxes, that requires significant
income taxes. This is known as the There are some important consid- professional judgment is evaluating the
recurring-item exception. erations to keep in mind if a taxpayer need for a valuation allowance. The
wishes to use the recurring-item excep- valuation allowance reduces a com-
The recurring-item exception tion for these specified income tax pany’s deferred tax assets (DTAs) to the
Under this special method of accounting, payments. First, the recurring-item amount more likely than not to be real-
an accrual-basis taxpayer may deduct a exception is a method of accounting. ized. This analysis requires thoroughly
qualified item in the tax year preceding the Passthrough entity taxpayers should evaluating all positive and negative evi-
actual year of payment, provided that at the review their prior income tax return dence available and includes objective,
end of that tax year: filings and determine if a method subjective, and mechanical elements.
■ All events have occurred that establish of accounting has been established A general starting point in the valu-
the fact of the liability and the amount for the deduction of state income ation allowance assessment is to look
of the liability can be determined with taxes. If not, taxpayers can adopt the at the company’s three-year cumula-
reasonable accuracy; recurring-item exception the first time tive pretax book losses or earnings.
■ Payment occurs on or before 8½ they incur the item. If a “deduct when Companies that show a strong his-
months after the end of the tax year; paid” method has been established for tory of earnings demonstrate positive
■ The liability is recurring in nature; and income taxes, taxpayers may be able to evidence that a valuation allowance is
■ Either the amount of the liability make an automatic accounting method not needed. Likewise, the guidance in
is not material or the accrual of the change to begin applying the recurring- ASC Paragraph 740-10-30-23 states:
liability for that tax year results in item exception. “A cumulative loss in recent years is a
better matching of the liability with Second, the fixed and determinable significant piece of negative evidence
the income to which it relates. prongs of the all-events test must be met that is difficult to overcome.” While

24 April 2023 The Tax Adviser