Comments on economic performance and the accrual of state and local property taxes, February 27, 1990.
On February 27, 1990, Tax Executives Institute filed comments with the Internal Revenue Service concerning forthcoming regulations under section 461(h) of the Internal Revenue Code. Section 461(h), which was enacted in 1984, provides that a liability otherwise subject to accrual under the "all events" test may not be taken into account for tax purposes until "economic performance" in respect of that item occurs. (For example, with respect to a liability arising out of services provided to the taxpayer, economic performance occurs as the services are provided.) On February 13, 1990, Ralph J. Weiland of Abbott Laboratories and Timothy J. McCormally, TEI Tax Counsel, attended a meeting at the IRS on section 461(h). TEI's comments, prepared under the aegis of the Federal Tax Committee, are reprinted below.
Tax Executives Institute appreciates the opportunity it had to participate in your February 13, 1990, meeting on section 461(h) of the Internal Revenue Code. (TEI was represented at the meeting by Ralph Weiland and Timothy McCormally.) This letter follows up on one of the issues discussed during that meeting - the proper treatment of state and local property taxes under the economic performance standard.
Stated simply, TEI does not believe the statutory provision (or its legislative history) mandates an abandonment of published rulings providing that such expenses are accrued as of the lien (or personal liability) date or the assessment date. Consequently, we believe that the retroactive application of regulations overturning such rulings would not only be at odds with the general principles underlying section 7805(b) of the Code, but would also be inconsistent with the legislative history of section 461(h).
In addressing this question, we believe it is important to keep in mind that the premature accrual provisions of the Deficit Reduction Act of 1984 were not promoted by general concern over the tax treatment of myriad routine, recurring business transactions under the accrual method of accounting. Rather, they were the result of congressional concern over the treatment of special expense items such as mine reclamation and nuclear decommissioning expenses, workers compensation claims, and tort liabilities. Ironically, under the final legislation, these items are governed not by the general rules of section 461(h) but by more targeted provisions of the Code.(*)
In discussions with representatives of the Internal Revenue Service (including Commissioner Roscoe Egger and then-Chief Counsel Fred Goldberg) shortly after the 1984 Act became law, it was acknowledged that section 461(h) should properly not affect the majority of routine business transactions. Although more than five years have elapsed since that time, we remain convinced that the IRS's forthcoming economic performance regulations should confirm that conclusion. As a general matter, therefore, we urge the IRS to adopt a balanced and reasoned approach to section 461(h) and to fashion regulations that, consistent with the legislative history of the 1984 Act, neither disrupt normal business and accounting practices nor impose undue burdens on taxpayers. See H.R. Rep. No. 98-861, 98th Cong, 2d Sess. 873 (1984) (Conference Report on the Deficit Reduction Act of 1984).
Treatment of State and
Local Property Taxes
Clearly, state and local property taxes are not the type of expenses that prompted Congress to enact section 461(h). Thus, we believe the grafting of the economic performance standard on the "all events" test does not require a deferral of the deduction beyond the date on which the deduction would otherwise accrue. Rather, regulations under section 461(h)(2)(D) could properly provide that economic performance occurs at the time the tax lien attaches or the tax is assessed. Such a rule would be consistent with legislative history of the statute. Specifically, it would comport with the following statement from the report of the Senate Committee on Finance:
The committee expects that
these regulations will provide
that economic performance
might be considered to occur
earlier than indicated by the
above principles where existing
regulations or rulings permit
earlier accruals and the taxpayer
accounts for such items
consistently from year to year.
For example, in the case of state
and local property taxes, the
regulations could provide that
economic performance may be
treated as having occurred at
the time the tax lien attaches or
the time the tax is assessed.
Thus, the expenses could continue
to be accrued at the same
time as under present law.
S. Print No. 98-169, 98th Cong., 2d Sess. 268 (1984).
The IRS's Authority to Issue
TEI appreciates that the IRS does not share its view of continuing validity of "lien date" or "assessment date" accruals under the economic performance test. What particularly concerns us, however, is not so much the prospect of a rule deferring the accrual of the deduction for state and local property taxes, but rather the possibility that the IRS might seek to impose such a rule retroactively to July 18, 1984. In this regard, we were taken aback by your comments about the scope of the IRS's authority to issue retroactive regulations under section 461(h).
It is true that interpretative regulations are generally applicable on a retroactive basis and, thus, that regulations under section 461(h) would generally relate back to the provision's effective date. The legislative history makes clear, however, that taxpayers are entitled to rely on extant rulings until the issuance of economic performance regulations (or, alternatively, the revocation or modification of the rulings). Specifically, the Conference Report states:
Until new regulations are issued
under these provisions or
the existing rulings are revoked
or clarified, taxpayers may
continue to rely on these rulings
to the extent they are not
inconsistent with the general
principles of economic performance
or the generic exception for
H.R. Rep. No. 98-861, supra, at 876 (emphasis added).
During our February 13 meeting, you expressed the view that "lien date" and "assessment date" accruals are inconsistent with the principles of economic performance and, consequently, that taxpayers could not rely on outstanding rulings that sanctioned such accruals. TEI respectfully disagrees. First, the Senate Committee on Finance expressly anticipated the issuance of regulations deeming economic performance to occur in respect of state and local property taxes "at the time the tax lien attaches or the time the tax is assessed." Indeed, in light of the statement in the Senate Report that regulations could interpret the economic performance standard to "provide that expenses [state and local property taxes] could continue to be accrued at the same time as under present law," we suggest it is somewhat disingenuous to contend that "lien date" or "assessment date" accruals are inconsistent with "the general principles of economic performance." S. Print No. 98-169, supra, at 268. We further suggest that such accruals are "not inconsistent with ... the generic exception for recurring items."
Secondly, even if the legislative history of section 461(h) did not directly sanction taxpayers' continuing reliance on outstanding rulings (at least until the issuance of contrary regulations), we do not believe the IRS can support a claim that "lien date" or "assessment date" accruals are clearly inconsistent with the principles of economic performance.
* If such accruals are patently
inconsistent with the economic
performance test, why did the
IRS not issue an announcement
(or other form of guidance)
sometime during the
nearly five-year interregnum,
alerting taxpayers of that inconsistency
and advising them
of their inability to rely on outstanding
* If "lien date" or "assessment
date" accruals were patently inconsistent
with the economic
performance test, then what is
the "proper" treatment of state
and local property taxes? From
our discussion on February 13,
it appears that no decision has
been made on whether the accrual
date in respect of state
property taxes should turn on
the payment of such taxes, on
the taxable year of the taxing
jurisdiction, or on some other
* If the IRS still does not know
what treatment is consistent
with the economic performance
standard, how could taxpayers
have divined that the treatment
sanctioned in outstanding
revenue rulings was clearly
inconsistent with such a standard?
Finally, if the foregoing argument reads too much into the IRS's failure to act (even in light of the statement in the Conference Report confirming taxpayers' right to rely on outstanding rulings in the absence of IRS action), then how are taxpayers to interpret the IRS's express approval of "lien date" or "assessment date" accruals following the enactment of section 461(h)? Specifically, the IRS has approved taxpayer requests for permission to change to the "lien date" and "assessment date" accounting methods (from the ratable accrual method under section 461(c)) for taxable years beginning after the effective date of section 461(h). Although other taxpayers may not formally rely on such IRS actions under section 6110(j)(3), we submit they could reasonably conclude that the IRS did not believe "lien date" and "assessment date" accruals were inconsistent with the general principles of economic performance.
In summary, taxpayers could reasonably have concluded that "lien date" and "assessment date" accruals were consistent with the economic performance test based on -
* language in the committee reports;
* the IRS's failure to notify taxpayers that it disagreed with that conclusion
(by revoking or modifying outstanding rulings); and
* the IRS's express sanctioning of such accruals by granting permission
to change accounting methods.
Consequently, we submit that the Conference Report's injunction that taxpayers should be permitted to rely on outstanding rulings must be followed and, thus, any regulations issued under section 461(h) in respect of the accrual of state and local property taxes should be applied on a prospective-only basis.
The "Wisdom" of Invoking
On February 13, it was acknowledged that the retroactivity issue has two components: (i) whether the IRS has authority to issue retroactive regulations (which is discussed in the preceding section), and (ii) whether, notwithstanding any such authority, the IRS should prudently decide not to apply its regulations on a retroactive basis. TEI believes that even if the IRS has the authority to apply the section 461(h) regulations in respect of state property taxes retroactively (back to July 18, 1984), it should choose not to do so. Rather, under section 7805(b), the regulations should be applied on a prospective-only basis.
Section 7805(b) has been properly referred to as the tax system's "safety valve" - as a mechanism by which changes in longstanding rules can be made tolerable if not palatable. We submit it should be used where, notwithstanding the IRS's legal authority to apply a rule retroactively, such a decision would undermine the integrity of the tax system and, concomitantly, taxpayer confidence in the fairness of the system.
We acknowledge that the situation in respect of section 461(h) - a new Code provision - differs from those cases where the IRS changes its position in the absence of any statutory change (such as is the case, for example, in respect of package design costs). Nevertheless, we submit that in light of the legislative history of section 461(h), as well as the long period of time that has elapsed since the passage of the provision, the principles underlying section 7805(b) should prompt the IRS to apply the regulations on a prospective-only basis.
Tax Executives Institute appreciates this opportunity to provide our comments on the application of the Internal Revenue Code's economic performance test to state and local property taxes. If you should have any questions about the Institute's views, please do not hesitate to call either Lester D. Ezrati, chair of TEI's Federal Tax Committee, at (415) 857-2089, or the Institute's professional staff (Timothy McCormally or Mary Lou Fahey) at (202) 638-5601.
(*) Thus, the accrual of mining and solid waste reclamation and closing costs is governed by section 468, and nuclear decommissioning costs are addressed by section 468A. Workers compensation and tort liabilities are specially treated by section 461(h)(2)(C), which provides that economic performance in respect of such expense items occurs as payment is made.
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|Date:||Mar 1, 1990|
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