In a recent internal legal memorandum (ILM 201442048), the IRS concluded that a taxpayer, a professional moving company, couldn't use the recurring item exception to economic performance for its payments to customers under its contract when the taxpayer damaged items during a move.

The customer contract includes a clause limiting the taxpayer's liability during the move to an agreed-upon amount. A customer could seek replacement or reimbursement for goods that were lost, damaged or stolen during the move by submitting a claim to the taxpayer within a specified time after delivery.

Generally, amounts are deductible only after they meet the all-events test and economic performance occurs. The recurring-item exception, provided in Treas. Reg. Sec. 1.461-5, is an exception to the general economic performance rules. Under the recurring-item exception, a liability is incurred for a taxable year if the following requirements are met:

  • At the end of the year all events have occurred that establish the fact of the liability, and the amount of the liability can be determined with reasonable accuracy.
  • Economic performance related to the liability occurs on or before the earlier of 8 ½ months after year end or by the time the tax return is filed for the year.
  • Either the amount of the liability is not material or the accrual of the liability for that tax year results in better matching.

The recurring-item exception doesn't apply to liabilities classified as "other liabilities" for purposes of determining when economic performance occurs under Treas. Reg. Sec. 1.461-4(g)(7). Other liabilities are those for which economic performance isn't provided elsewhere in the regulations. For other liabilities, economic performance occurs as payment of the liability is made to the person to whom it is owed.

The memorandum concluded that the taxpayer's liability to pay for damaged goods was an "other liability" under Treas. Reg. Sec. 1.461-4(g)(7) because it didn't fit any of the specific liability descriptions enumerated in the regulation. The liability wasn't for insurance because the contract wasn't in the nature of an insurance contract and its purpose was to limit the taxpayer's liability rather than serve as an insurance arrangement. Additionally, the contract wasn't a warranty or service contract because the contract covered property owned by customers, not property bought or leased by the taxpayer. So, the liability fell into the other liability category for which the recurring-item exception isn't allowed, and the taxpayer couldn't deduct such claims until they were paid.

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