The IRS ruled in a technical advice memorandum (TAM 202121010
) that a taxpayer’s promise to pay a guaranteed minimum sales incentive to its distributors was not deductible under the all-events test in the year the promise was made because the guaranteed payment was contingent on the distributors selling at least one of the taxpayer’s units in a subsequent year.
Section 461(h) and Treas. Reg. Sec. 1.461-1(a)(2)(i) provide that, for an accrual method taxpayer, a liability is incurred, and is generally taken into account in the year in which all events have occurred that (1) establish the fact of the liability, (2) the amount of the liability can be determined with reasonable accuracy, and (3) economic performance has occurred with respect to the liability. Collectively, this rule is referred to as the all-events test.
A taxpayer may not deduct a contingent liability (Brown v. Helvering
, 13 AFTR 851). The all-events test is based on the existence or nonexistence of legal rights or obligations at the close of a particular accounting period, not on the probability – or even absolute certainty – that such right or obligation will arise at some point in the future (Hallmark Cards, Inc. v. Commissioner
, 90 T.C. 26, 34).
The taxpayer addressed by the technical advice memorandum sold its products through third-party distributors that were paid commissions based on their sales of the taxpayer’s product. The taxpayer, in an effort to encourage additional purchases by its distributors, made an irrevocable promise to pay a guaranteed minimum sales incentive if (among other requirements) a distributor sold at least one unit of the taxpayer’s product in the year subsequent to the year in which the taxpayer made the irrevocable promise.
The taxpayer was not under a fixed obligation to pay the guaranteed minimum incentive amount in the year in which the irrevocable promise was made by the taxpayer. The taxpayer’s obligation was not fixed because it was contingent upon the sales activity of the distributor in the year subsequent to the year of promise. Accordingly, taxpayer did not meet the all-events test, and consequently, the guaranteed minimum incentive amounts were not deductible in the year the taxpayer made the irrevocable promise.
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