VECO Corp. & Subsidiaries v. Commissioner

VECO CORPORATION AND SUBSIDIARIES, PETITIONER

v. COMMISSIONER OF INTERNAL REVENUE,

RESPONDENT

Docket No. 24918–10. Filed November 20, 2013.

On its Federal income tax return for the taxable year

ending Mar. 31, 2005 (TYE 2005), P, an accrual method tax-

payer, implemented a proposed change in accounting method

and in so doing accelerated deductions for parts of certain

liabilities attributable to periods after the close of P’s TYE

2005. R rejected P’s proposed change in accounting method

and denied P’s claimed accelerated deductions. P claims that

it was entitled to accelerate the deductions under the ‘‘all

events’’ test of I.R.C. sec. 461 and/or the recurring item excep-

tion to the economic performance rules of I.R.C. sec. 461(h)(3).

For financial statement purposes petitioner accrued the liabil-

ities over more than one taxable year. P treated the liabilities

inconsistently for financial statement and tax purposes. Held:

Because neither the required performances nor the payment

due dates with respect to the majority of the accelerated

deductions occurred before the close of P’s TYE 2005, P failed

to satisfy the first requirement of the all events test of I.R.C.

sec. 461; i.e., P failed to prove that all of the events had

occurred to establish the fact of the liabilities under sec.

1.461–1(a)(2)(i), Income Tax Regs. Held, further, with respect

to the remaining accelerated deductions, P did not satisfy all

of the requirements for the recurring item exception under

I.R.C. sec. 461(h)(3) and, consequently, is not excepted from

the general rule of I.R.C. sec. 461(h)(1) requiring economic

performance, because the liabilities underlying the deductions

were prorated over more than one taxable year, were treated

inconsistently for financial statement and tax purposes, and

were material items for tax purposes within the meaning of

I.R.C. sec. 461(h)(3)(A)(iv)(I). See sec. 1.461–5(b)(4), Income

Tax Regs.

Christina M. Passard, for petitioner.

Davis G. Yee and Keith G. Medleau, for respondent.

440

VerDate Mar 15 2010 10:01 Feb 03, 2015 Jkt 000000 PO 00000 Frm 00001 Fmt 3857 Sfmt 3857 V:\FILES\BOUNDV~1.WIT\BVACDB~1.141\VECOCO~1 JAMIE

(440) VECO CORP. & SUBS. v. COMMISSIONER 441

OPINION

MARVEL, Judge : On its Federal income tax return for the

taxable year ending (TYE) March 31, 2005, VECO Corp. &

Subsidiaries (collectively, petitioner or affiliated group),

which used the accrual method of accounting, implemented a

proposed change in accounting method that accelerated

approximately $5,010,305 of deductions for parts of certain

liabilities attributable to periods after the close of petitioner’s

TYE March 31, 2005. Petitioner contends it was entitled to

accelerate its deductions for these expenses under the ‘‘all

events’’ test of section 461 1 and/or the recurring item excep-

tion to the economic performance rules under section

461(h)(3). In a notice of deficiency dated August 17, 2010,

respondent disallowed the portions of the deductions attrib-

utable to periods after March 31, 2005, and accordingly

determined a $1,919,359 deficiency in the Federal income tax

of petitioner for TYE March 31, 2005.

After concessions, 2 the issues for decision are: (1) whether,

under the all events test of section 461, petitioner properly

accelerated and deducted on its Federal income tax return

for TYE March 31, 2005, certain expenses attributable to

periods ending after TYE March 31, 2005; (2) alternatively,

whether section 467 prevents petitioner from using the recur-

ring item exception under section 461(h)(3) to accelerate

deductions for expenses attributable to an equipment lease

1 Unless otherwise indicated, all section references are to the Internal

Revenue Code, as amended and in effect for the year in issue, and all Rule

references are to the Tax Court Rules of Practice and Procedure. Some

monetary amounts have been rounded to the nearest dollar.

2 With respect to the economic performance requirement of the all events

test, petitioner concedes that it did not satisfy the 31⁄2-month rule of sec.

1.461–4(d)(6)(ii), Income Tax Regs., for any of the deductions in issue. With

respect to the recurring item exception to the general rule of economic per-

formance, petitioner concedes that it did not satisfy the matching require-

ment (i.e., the fourth requirement of the recurring item exception) under

sec. 1.461–5(b)(1)(iv)(B) and (5), Income Tax Regs., for any deductions in

issue, with the exception of its deduction for insurance premium expenses.

Respondent concedes that petitioner satisfied the economic performance

and matching requirements of the recurring item exception for petitioner’s

claimed deduction for insurance premium expenses. See sec.

461(h)(3)(A)(ii), (iv); sec. 1.461–5(b)(ii), (iv), Income Tax Regs.

VerDate Mar 15 2010 10:01 Feb 03, 2015 Jkt 000000 PO 00000 Frm 00002 Fmt 3857 Sfmt 3857 V:\FILES\BOUNDV~1.WIT\BVACDB~1.141\VECOCO~1 JAMIE

442 141 UNITED STATES TAX COURT REPORTS (440)

and certain real estate leases; 3 and (3) if petitioner properly

claimed deductions for expenses under amendment XIV to

the 949 East 36th Avenue lease and the 949 East 36th

Avenue commercial sublease agreement for the period after

March 31, 2005, whether, under section 1.1502–13(c), Income

Tax Regs., petitioner must include in income the rent peti-

tioner received under those leases for the same period.

Because we conclude that petitioner did not properly deduct

the accelerated expenses attributable to periods after March

31, 2005, on its Federal income tax return for TYE March 31,

2005, we do not reach issues (2) and (3).

Background

The parties submitted this case fully stipulated under Rule

122. We incorporate the stipulated facts, and facts drawn

from stipulated exhibits, into our findings by this reference.

I. Background

VECO Corp. is a corporation organized and existing under

Delaware law with its principal office in Alaska. VECO Corp.

is the common parent of an affiliated group of corporations

that includes VECO Equipment, Inc. (VECO Equipment),

VECO Services, Inc. (VECO Services), VECO Alaska, Inc.

(VECO Alaska), 4 VECO USA, Inc. (VECO USA), 5 VECO

36th Avenue, Inc. (VECO 36th Avenue), VECO Properties,

Inc. (VECO Properties), 6 Norcon, Inc., RTX, Inc., HEBL, Inc.,

and VECO Federal, Inc.

Petitioner is engaged in various business activities

including oil and gas field services, newspaper publishing,

manufacturing, construction, equipment rental, wholesale

sales, leasing, and engineering. During years preceding and

3 These leases include the Frontier Building lease, see infra pp. 452–453,

the 6411 A Street lease, see infra pp. 453–454, amendment XIV to the

949 East 36th Avenue lease, see infra pp. 454–455, and the 949 East

36th Avenue commercial sublease agreement, see infra pp. 455–456.

4 During TYE March 31, 2005, VECO Alaska was a subsidiary of VECO

Services.

5 VECO USA formerly was known as Veco Rocky Mountain, Inc. (Veco

Rocky Mountain), which itself formerly was known as VECO Rapley, Inc.,

and/or Rapley Engineering Services, Inc. (Rapley Engineering Services).

6 During TYE March 31, 2005, VECO Properties was a subsidiary of

VECO Equipment, itself a subsidiary of VECO Corp.

VerDate Mar 15 2010 10:01 Feb 03, 2015 Jkt 000000 PO 00000 Frm 00003 Fmt 3857 Sfmt 3857 V:\FILES\BOUNDV~1.WIT\BVACDB~1.141\VECOCO~1 JAMIE

(440) VECO CORP. & SUBS. v. COMMISSIONER 443

including the taxable year in issue petitioner entered into a

number of service contracts, licensing contracts, insurance

contracts, and real property and equipment leases, described

infra.

Petitioner prepared consolidated financial statements in

accordance with generally accepted accounting principles

(GAAP) for fiscal years ending (FYE) March 31, 2005, 2006,

and 2007. Petitioner maintained general ledgers and working

trial balances for each member of the affiliated group for

FYE March 31, 2005. For Federal income tax purposes, peti-

tioner uses the accrual method of accounting and has a TYE

March 31.

II. Petitioner’s Tax Reporting

Petitioner filed a Form 1120, U.S. Corporation Income Tax

Return, for TYE March 31, 2005, on which it reported total

income of $71,497,738 and claimed total deductions of

$64,608,986. 7 Petitioner attached to its return a Form 3115,

Application for Change in Accounting Method, for TYE

March 31, 2005, requesting an accounting method change

pursuant to Rev. Proc. 2005–9, 2005–1 C.B. 303. 8 Petitioner

reported on an attachment to the Form 3115 that it pres-

ently deducted liabilities as follows: (1) with respect to liabil-

ities for which economic performance was satisfied by pay-

ment, petitioner capitalized the liability and amortized the

payment over the life of the agreement; (2) with respect to

liabilities for which economic performance was not satisfied

by payment, petitioner deducted the liabilities ‘‘in the period

to which they relate.’’ Petitioner proposed a change in its

accounting method to: (1) deduct liabilities in the year

incurred under the all events test, with modifications under

the recurring item exception for insurance and maintenance

7 Petitioner claimed deductions on a consolidated basis and per sub-

sidiary. Petitioner does not have documentation to show the total expenses

attributable to the software license and maintenance contracts, service

contracts, real estate leases, and equipment lease on an entity-specific

basis or a consolidated basis.

8 Rev. Proc. 2005–9, sec. 1, 2005–1 C.B. 303, provides administrative pro-

cedures under which a taxpayer may obtain automatic consent to change

to a method of accounting provided in secs. 1.263(a)–4, 1.263(a)–5, and

1.167(a)–3(b), Income Tax Regs., for the taxpayer’s second taxable year

ending on or after December 31, 2003.

VerDate Mar 15 2010 10:01 Feb 03, 2015 Jkt 000000 PO 00000 Frm 00004 Fmt 3857 Sfmt 3857 V:\FILES\BOUNDV~1.WIT\BVACDB~1.141\VECOCO~1 JAMIE

444 141 UNITED STATES TAX COURT REPORTS (440)

agreement payments; and (2) with respect to rent liabilities

for which economic performance is not satisfied by payment,

deduct the liabilities ‘‘in the year the liabilities are fixed and

determinable with reasonable accuracy, and where economic

performance has occurred’’.

Petitioner implemented its proposed change in accounting

method and prepared its Form 1120 for TYE March 31, 2005,

accordingly. As a result of the change in accounting method,

petitioner claimed deductions for prepaid expenses and

accrued expenses attributable to periods after March 31,

2005, claiming that its tax treatment of the expenses was

permitted under the all events test of section 461 and/or the

recurring item exception under section 461(h)(3). Those accel-

erated deductions are at issue here.

A. Prepaid Expenditures

1. Aspen Technology Agreement

On March 31, 2003, VECO Corp. and Aspen Technology,

Inc. (Aspen Technology), entered into a software license and

service agreement for the period from March 31, 2003,

through March 31, 2009 (Aspen agreement). Under the

Aspen agreement Aspen Technology licensed use of its soft-

ware and agreed to provide software maintenance services to

VECO Corp. VECO Corp. agreed to pay license fees over six

consecutive years as follows: (1) $161,000 on April 30, 2003; 9

(2) $206,000 on March 30, 2004; (3) $212,180 on March 30,

2005; (4) $218,545 on March 30, 2006; (5) $225,102 on March

30, 2007; and (6) $231,855 on March 30, 2008. VECO Corp.

also agreed to pay an annual service fee of $11,945 10 for the

first effective year of the contract and an annual service fee

of $38,000 for each subsequent year.

VECO Corp. made payments to Aspen Technology as fol-

lows: (1) $172,945 on June 6, 2003; (2) $39,140 on June 29,

2004; and (3) $40,314 on April 27, 2005. In February 2006

VECO Corp. received an invoice dated February 13, 2006,

9 The Aspen agreement provided that VECO Corp. had prepaid the li-

cense fees under a prior agreement by $39,000 and that the amount of the

first license fee payment had been adjusted accordingly.

10 The Aspen agreement provided that VECO Corp. had prepaid service

fees of $26,055 under a prior agreement and that the first service fee pay-

ment had been adjusted accordingly.

VerDate Mar 15 2010 10:01 Feb 03, 2015 Jkt 000000 PO 00000 Frm 00005 Fmt 3857 Sfmt 3857 V:\FILES\BOUNDV~1.WIT\BVACDB~1.141\VECOCO~1 JAMIE

(440) VECO CORP. & SUBS. v. COMMISSIONER 445

from Bank of America Leasing for $218,545 with respect to

the Aspen agreement. VECO Corp. paid the invoice by check

dated February 24, 2006, made payable to Bank of America

Leasing.

Petitioner treated $200,235, 11 which was attributable to

the period April 1 to August 1, 2005, as an FYE March 31,

2006, expense on its financial statements for that year. How-

ever, petitioner deducted the $200,235 on its return for TYE

March 31, 2005.

2. Primavera Agreement

Primavera provided software management services for

VECO Alaska pursuant to a service agreement between

Primavera and VECO Alaska that is not in the record.

Primavera issued an invoice dated December 31, 2004, for

$10,600 to VECO Alaska. VECO Alaska paid the invoice by

check dated April 4, 2005.

Petitioner treated $7,950, 12 which was attributable to the

period April 1 to December 1, 2005, as an FYE March 31,

2006, expense on its financial statements for that year. How-

ever, petitioner deducted the $7,950 on its return for TYE

March 31, 2005.

3. Surveyor’s Exchange Agreement

The record does not contain a copy of the service agree-

ment between Surveyor’s Exchange Co. (Surveyor’s

Exchange) and VECO Alaska.

Surveyor’s Exchange issued an invoice dated March 17,

2005, for $51,895 for Autocad subscription renewals to VECO

Alaska. VECO Alaska paid the invoice by check dated April

14, 2005.

11 The parties stipulated the amount and treatment of this expense for

petitioner’s financial accounting and tax reporting purposes. However, peti-

tioner’s summary analysis of its Schedule M–3, Net Income (Loss) Rec-

onciliation for Corporations With Total Assets of $10 Million or More,

shows that petitioner accelerated expenses attributable to the Aspen agree-

ment of $212,180. Petitioner failed to offer any explanation, and the record

contains no evidence, as to how petitioner calculated the amount of this

particular accelerated deduction.

12 The $7,950 is equal to the portion of the total amount due to

Primavera for services provided during the period April 1 to December 1,

2005.

VerDate Mar 15 2010 10:01 Feb 03, 2015 Jkt 000000 PO 00000 Frm 00006 Fmt 3857 Sfmt 3857 V:\FILES\BOUNDV~1.WIT\BVACDB~1.141\VECOCO~1 JAMIE

446 141 UNITED STATES TAX COURT REPORTS (440)

For financial statement purposes, petitioner recorded the

Autocad expenses on a straight-line basis over the term of its

contract with Surveyor’s Exchange. Petitioner treated the

$51,895, which was attributable to the period April 1, 2005,

to March 1, 2006, as an FYE March 31, 2006, expense on its

financial statements for that year. However, petitioner

deducted the $51,895 on its return for TYE March 31, 2005.

4. Invensys Systems Agreement

In March 2004 VECO USA entered into a computer pro-

gram license agreement with Invensys Systems, Inc.

(Invensys), for the period March 1, 2004, through February

28, 2007 (Invensys agreement), that required VECO USA to

pay total license fees of $156,522 and total maintenance fees

of $23,478. The agreement required VECO USA to pay

annual license and maintenance fees of $52,174 and $7,826,

respectively, on March 1, 2004, 2005, and 2006.

Invensys issued to VECO USA an invoice dated March 22,

2004, for $64,920 covering the period from March 1, 2004, to

February 28, 2007. 13 VECO USA paid the invoice by a check

dated April 28, 2004.

For financial statement purposes, petitioner recorded the

Invensys agreement expenses on a straight-line basis over

the term of the agreement. Petitioner treated $59,420, 14

which was attributable to the period April 1 to December 15,

2005, as an FYE March 31, 2006, expense on its financial

statements for that year. However, petitioner deducted the

$59,420 on its return for TYE March 31, 2005.

B. Expenditures Accrued for Periods After March 31, 2005

1. Service Contracts

a. Marsh Agreement

On January 10, 2005, VECO Corp. entered into an insur-

ance brokerage service agreement with Marsh USA, Inc.

(Marsh), for the period January 10 through December 31,

13 The

difference between the $60,000 specified under the Invensys

agreement and the $64,920 on the invoice is attributable to sales tax.

14 Petitioner failed to offer any explanation, and the record contains no

evidence, as to how petitioner calculated the amount of this particular de-

duction.

VerDate Mar 15 2010 10:01 Feb 03, 2015 Jkt 000000 PO 00000 Frm 00007 Fmt 3857 Sfmt 3857 V:\FILES\BOUNDV~1.WIT\BVACDB~1.141\VECOCO~1 JAMIE

(440) VECO CORP. & SUBS. v. COMMISSIONER 447

2005 (Marsh agreement). Under the Marsh agreement VECO

Corp. agreed to pay Marsh a fixed fee of $300,000 payable as

follows: (1) $75,000 on February 1, 2005; (2) $30,000 on April

1, 2005; (3) $45,000 on June 30, 2005; (4) $75,000 on Sep-

tember 30, 2005; and (5) $75,000 on December 31, 2005.

VECO Corp. made payments to Marsh as follows: (1) $60,000

on March 4, 2005; (2) $120,000 on April 1, 2005; (3) $45,000

on June 17, 2005; and (4) $75,000 on October 3, 2005.

For financial statement purposes petitioner recorded the

expenses under the Marsh agreement on a straight-line basis

over the term of the agreement. Petitioner treated

$225,000, 15 which was attributable to the period April 1 to

December 31, 2005, as an FYE March 31, 2006, expense on

its financial statements for that year. However, petitioner

deducted the $225,000 on its return for TYE March 31, 2005.

b. ACS Agreement

The record does not contain a copy of the service agree-

ment between ACS and VECO Alaska.

For financial statement purposes petitioner recorded the

expenses under the ACS agreement on a straight-line basis

over the term of the agreement. Petitioner treated $14,779, 16

which was attributable to the period April 1 to December 31,

2005, as an FYE March 31, 2006, expense on its financial

statements for that year. However, petitioner deducted the

$14,779 on its return for TYE March 31, 2005.

c. Schwamm & Frampton Agreement

In February 1999 VECO Properties entered into a manage-

ment agreement with Schwamm & Frampton, LLC

(Schwamm & Frampton), for a term of one year, which auto-

matically was renewed in February of each year (Schwamm

& Frampton agreement). Under the agreement Schwamm &

Frampton agreed to provide property management services

for University Plaza, a property owned by VECO Properties,

15 Petitioner calculated this amount by adding the amounts of the four

payments it made during 2005 and then multiplying that total by 75%.

16 Petitioner’s summary analysis of its Schedule M shows that VECO

Alaska was required to make monthly payments to ACS of $1,739. While

petitioner’s accounts payable vendor history distribution to ACS shows

that VECO Alaska made fairly regular payments to ACS, the payments

made during 2004–05 ranged from $1,321 to $1,324 per month.

VerDate Mar 15 2010 10:01 Feb 03, 2015 Jkt 000000 PO 00000 Frm 00008 Fmt 3857 Sfmt 3857 V:\FILES\BOUNDV~1.WIT\BVACDB~1.141\VECOCO~1 JAMIE

448 141 UNITED STATES TAX COURT REPORTS (440)

and to act as agent for VECO Properties. VECO Properties

agreed to make monthly payments equal to the greater of: (1)

$6,250 or (2) 4% of the monthly gross rental receipts, as

VECO Properties received such receipts.

During FYE March 31, 2005, VECO Properties made one

payment of $460 to Schwamm & Frampton. On April 20,

2005, VECO Properties made a payment of $7,500 to

Schwamm & Frampton.

For financial statement purposes petitioner recorded the

expenses under the Schwamm & Frampton agreement on a

straight-line basis over the term of the agreement. Petitioner

treated $6,250, which was attributable to the period April 1

to April 30, 2005, as an FYE March 31, 2006, expense on its

financial statements for that year. However, petitioner

deducted the $6,250 on its return for TYE March 31, 2005.

d. Otis Elevator Agreement

In February 2002 Schwamm & Frampton, as agent for

VECO Properties, entered into a maintenance agreement

with Otis Elevator Co. (Otis Elevator) for the period Feb-

ruary 1, 2002, through January 31, 2007 (Otis Elevator

agreement). Under the agreement Otis Elevator agreed to

provide maintenance services at University Plaza for a fee of

$1,950 per month, and Schwamm & Frampton agreed to

make quarterly payments on or before the last day of the

month before the billing period. 17 Neither VECO Corp. nor

VECO Properties made any direct payments to Otis Elevator.

For financial statement purposes petitioner recorded the

expenses under the Otis Elevator agreement on a straight-

line basis over the term of the agreement. Petitioner treated

$16,575, 18 which was attributable to the period April 1 to

December 15, 2005, as an FYE March 31, 2006, expense on

its financial statements for that year. However, petitioner

deducted the $16,575 on its return for TYE March 31, 2005.

17 The

Otis Elevator agreement further provided that the billing period

would begin on February 1, 2002, the commencement date.

18 The $16,575 is equal to the monthly payment rate for April through

November 2005 plus an additional $975 attributable to the monthly pay-

ment rate for the first half of December 2005.

VerDate Mar 15 2010 10:01 Feb 03, 2015 Jkt 000000 PO 00000 Frm 00009 Fmt 3857 Sfmt 3857 V:\FILES\BOUNDV~1.WIT\BVACDB~1.141\VECOCO~1 JAMIE

(440) VECO CORP. & SUBS. v. COMMISSIONER 449

e. Q–1 Agreement

In September 1999 Schwamm & Frampton, as agent for

VECO Properties, entered into a maintenance agreement

with Q–1 Corp. (Q–1) for the period September 15, 1999,

through September 14, 2000, with automatic renewal each

year (Q–1 agreement). Under the Q–1 agreement VECO

Properties agreed to make monthly payments of $9,984 for

maintenance services, with payment due in arrears on the

10th day of the month following provision of the

services. In November 2005 VECO Properties and Q–1

amended the Q–1 agreement to provide for a monthly fee of

$9,221.

For financial statement purposes, petitioner recorded the

expenses under the Q–1 agreement on a straight-line basis

over the term of the agreement. Petitioner treated $59,940, 19

which was attributable to the period April 1 to October 15,

2005, as an FYE March 31, 2006, expense on its financial

statements for that year. However, petitioner deducted the

$59,940 on its return for TYE March 31, 2005.

2. Insurance Premium Agreement

On April 28, 2005, VECO Corp. entered into a commercial

premium finance agreement with Marsh, an insurance

broker, for insurance policies with effective dates of April 1,

2005, for 12 months of coverage (insurance premium agree-

ment). The agreement provided for total premiums of

$3,445,037 and required VECO Corp. to make 10 monthly

payments of $316,714 beginning May 1, 2005.

On its return for TYE March 31, 2005, petitioner deducted

$2,304,165 20 for insurance premium expenses attributable to

the period April 1 to December 15, 2005.

19 Although

the Q–1 agreement was not amended until November 2005,

petitioner’s summary analysis of its Schedule M shows that petitioner cal-

culated the amount of the deduction on the basis of a monthly fee of $9,221

for the 61⁄2-month period from April 1 to October 15, 2005.

20 Petitioner calculated this amount by multiplying the total premium by

81.96%, a figure purportedly equal to the amount of the premium for the

period May 1, 2005, through February 1, 2006, that petitioner had paid by

December 15, 2005.

VerDate Mar 15 2010 10:01 Feb 03, 2015 Jkt 000000 PO 00000 Frm 00010 Fmt 3857 Sfmt 3857 V:\FILES\BOUNDV~1.WIT\BVACDB~1.141\VECOCO~1 JAMIE

450 141 UNITED STATES TAX COURT REPORTS (440)

3. Real Property Leases

a. Arctic Spur Lease

On June 24, 2004, VECO Equipment entered into a lease

agreement with Arctic Spur Investments (Arctic Spur) for

property at 6411 A Street, Anchorage, Alaska (Arctic Spur

lease). The term of the Arctic Spur lease was July 1, 2004,

through June 30, 2005. Under the Arctic Spur lease VECO

Equipment agreed to pay monthly rent of $7,500 on the first

day of each month.

For financial and tax accounting purposes VECO Corp.

allocated $3,674 of the monthly rent to itself and $3,827 to

VECO Alaska. For financial statement purposes petitioner

recorded the expenses under the Arctic Spur lease on a

straight-line basis over the term of the lease.

Petitioner treated $11,022 and $11,480, which were attrib-

utable to the period April 1 to June 30, 2005, as FYE March

31, 2006, expenses on its financial statements for that year.

However, petitioner deducted the $11,021 (paid through

VECO Corp.) and the $11,480 (paid through VECO Alaska)

on its return for TYE March 31, 2005.

b. Wyoming Lease

On September 25, 1996, VECO USA entered into a lease

with Rock Spring Plaza, LLC, for office space at a property

in Wyoming (Wyoming lease). On September 1, 2004, VECO

USA and TRB #3 Owners Corp., owner of the Wyoming prop-

erty, amended the original lease to extend the term for one

year from September 1, 2004, to August 31, 2005. Under the

Wyoming lease as amended VECO USA agreed to make

monthly rent payments of $1,694 on the first day of each

month.

For financial statement purposes petitioner recorded the

expenses under the Wyoming lease on a straight-line basis

over the term of the lease. Petitioner treated $8,468, which

was attributable to the period April 1 through August 31,

2005, as an FYE March 31, 2006, expense on its financial

statements for that year. However, petitioner deducted the

$8,468 on its return for TYE March 31, 2005.

VerDate Mar 15 2010 10:01 Feb 03, 2015 Jkt 000000 PO 00000 Frm 00011 Fmt 3857 Sfmt 3857 V:\FILES\BOUNDV~1.WIT\BVACDB~1.141\VECOCO~1 JAMIE

(440) VECO CORP. & SUBS. v. COMMISSIONER 451

c. Golden Lease

On April 17, 1999, Veco Rocky Mountain entered into a

lease with Gold Office Building for office space at a property

in Golden, Colorado (Golden lease). On February 24, 2005,

VECO USA and Gold Office Building amended the original

lease to extend the term for a period of one year beginning

March 1, 2005, and ending February 28, 2006. Under the

lease as amended VECO USA agreed to pay monthly rent of

$4,410 on the first day of each month.

For financial statement purposes petitioner recorded the

expenses under the Golden lease on a straight-line basis over

the term of the lease. Petitioner treated $34,359, 21 which

was attributable to the period April 1 through December 15,

2005, as an FYE March 31, 2006, expense on its financial

statements for that year. However, petitioner deducted the

$34,359 on its return for TYE March 31, 2005.

d. Durango Lease

On June 1, 2004, VECO USA entered into a lease with

Lunceford Investments for office space in Durango, Colorado

(Durango lease). The term of the Durango lease was June 1,

2004, through May 31, 2005. Under the Durango lease VECO

USA agreed to make monthly rent payments of $2,067 on or

before the first day of the month.

For financial statement purposes petitioner recorded the

expenses under the Durango lease on a straight-line basis

over the term of the lease. Petitioner treated $4,134, which

was attributable to the period April 1 through May 31, 2005,

as an FYE March 31, 2006, expense on its financial state-

ments for that year. However, petitioner deducted the $4,134

on its return for TYE March 31, 2005.

e. Bay Street Lease

On January 1, 2005, VECO USA entered into a lease

agreement with Bay Building LLC (Bay Building) for office

space in Bay Street, Washington (Bay Street lease). The term

of the Bay Street lease was January 1, 2005, through

21 Petitioner’s summary analysis of its Schedule M shows that petitioner

calculated this amount using a monthly rent of $4,042 rather than the

$4,410 provided for under the Golden lease as amended.

VerDate Mar 15 2010 10:01 Feb 03, 2015 Jkt 000000 PO 00000 Frm 00012 Fmt 3857 Sfmt 3857 V:\FILES\BOUNDV~1.WIT\BVACDB~1.141\VECOCO~1 JAMIE

452 141 UNITED STATES TAX COURT REPORTS (440)

December 31, 2009. Under the Bay Street lease, VECO USA

agreed to pay Bay Building monthly rent of $33,990 before

the first day of each month.

For financial statement purposes petitioner recorded the

expenses under the Bay Street lease on a straight-line basis

over the term of the lease. Petitioner treated $294,696, 22

which was attributable to the period April 1 through

December 15, 2005, as an FYE March 31, 2006, expense on

its financial statements for that year. However, petitioner

deducted the $294,696 on its return for TYE March 31, 2005.

f. Englewood Lease

On May 26, 1994, Rapley Engineering Services entered

into a lease agreement with Highland Court LLC for office

space in Englewood, Colorado (Englewood lease). The term of

the lease was July 1, 1994, through June 30, 2000. On

December 16, 2002, Veco Rocky Mountain and Prentiss Prop-

erties amended the Englewood lease to extend the term for

five years, from August 1, 2002, through June 30, 2007.

Under the Englewood lease as amended, Veco Rocky Moun-

tain agreed to pay monthly base rent of $43,450 on or before

the first day of each month.

For financial statement purposes, petitioner recorded the

expenses under the Englewood lease on a straight-line basis

over the term of the lease. Petitioner treated $380,103, 23

which was attributable to the period April 1 through

December 15, 2005, as an FYE March 31, 2006, expense on

its financial statements for that year. However, petitioner

deducted the $380,103 on its return for TYE March 31, 2005.

g. Frontier Building Lease

On March 22, 2000, VECO Corp. entered into a lease

agreement with Frontier Building Limited Partnership for

space at the Frontier Building in Anchorage, Alaska (Fron-

tier Building lease). The term of the Frontier Building lease

22 Petitioner’s summary analysis of its Schedule M shows that petitioner

calculated this amount using a monthly rent rate of $34,670 rather than

the $33,990 provided for under the Bay Street lease.

23 Petitioner’s summary analysis of its Schedule M shows that petitioner

calculated this amount using a monthly rent of $44,718 rather than the

$43,450 provided for under the Englewood lease as amended.

VerDate Mar 15 2010 10:01 Feb 03, 2015 Jkt 000000 PO 00000 Frm 00013 Fmt 3857 Sfmt 3857 V:\FILES\BOUNDV~1.WIT\BVACDB~1.141\VECOCO~1 JAMIE

(440) VECO CORP. & SUBS. v. COMMISSIONER 453

was July 1, 2000, through November 30, 2005. The Frontier

Building lease required VECO Corp. to pay a fixed minimum

monthly rent, subject to increases based on the Anchorage

Consumer Price Index, 24 on the first day of each month. 25

For the period October 1, 2003, to September 30, 2004, the

fixed minimum monthly rent was $17,569. For the period

October 1, 2004, to September 30, 2005, the fixed minimum

monthly rent was $17,939. 26

For financial statement purposes petitioner recorded the

expenses under the Frontier Building lease on a straight-line

basis over the term of the lease. Petitioner treated

$107,637, 27 which was attributable to the period April 1

through September 30, 2005, as an FYE March 31, 2006,

expense on its financial statements for that year. However,

petitioner deducted the $107,637 on its return for TYE

March 31, 2005.

h. 6411 A Street Lease

On December 22, 1999, VECO Equipment entered into a

lease with Carr-Gottstein Foods Co. for property at 6411 A

Street, Anchorage, Alaska (6411 A Street lease). The term of

the lease was March 1, 2000, to December 31, 2010. The

6411 A Street lease required VECO Equipment to pay a fixed

minimum monthly rent on the first day of each month. For

the period March 1, 2004, to February 28, 2005, the fixed

minimum monthly rent was $54,599. For the period March

24 For

2004 the Anchorage Consumer Price Index had a percentage

change of 2.58%. For 2005 the Anchorage Consumer Price Index had a per-

centage change of 3.06%.

25 For the period from October 1, 2003, through September 30, 2004,

VECO Corp. paid the following amounts under the Frontier Building lease:

October 2003—$18,582; November 2003—$18,666; December 2003—

$18,666; January 2004—$19,318; February 2004—$19,318; March 2004—

$19,318; April 2004—$19,318; May 2004—$21,116; June 2004—$19,318;

July 2004—$19,318; August 2004—$19,318; and September 2004—

$19,318.

26 The fixed minimum monthly rent of $17,939 for the period October 1,

2004, to September 30, 2005, was less than a 2.58% increase from the

monthly rent that VECO Corp. paid for the period October 1, 2003, to Sep-

tember 30, 2004.

27 Petitioner’s summary analysis of its Schedule M shows that petitioner

calculated this amount using a monthly payment rate of $17,939.

VerDate Mar 15 2010 10:01 Feb 03, 2015 Jkt 000000 PO 00000 Frm 00014 Fmt 3857 Sfmt 3857 V:\FILES\BOUNDV~1.WIT\BVACDB~1.141\VECOCO~1 JAMIE

454 141 UNITED STATES TAX COURT REPORTS (440)

1, 2005, to February 28, 2006, the fixed minimum monthly

rent was $60,626. 28

For financial statement purposes, petitioner recorded the

expenses under the 6411 A Street lease on a straight-line

basis over the term of the lease. Petitioner treated

$515,324, 29 which was attributable to the period April 1

through December 15, 2005, as an FYE March 31, 2006,

expense on its financial statements for that year. However,

petitioner deducted the $515,324 on its return for TYE

March 31, 2005.

i. 949 East 36th Avenue

On or about August 22, 1995, VECO Engineering entered

into a lease agreement with Alaska Pacific University to rent

property at 949 East 36th Avenue, Anchorage, Alaska (949

East 36th Avenue lease). Under the 949 East 36th Avenue

lease VECO Engineering agreed to make monthly rent pay-

ments on or before the first day of the month. VECO

Engineering and Alaska Pacific University subsequently

entered into a number of agreements amending the lease to

extend the term of the lease and to provide VECO

Engineering with increased space at the 949 East 36th

Avenue property.

On March 1, 1999, VECO Properties and VECO

Engineering entered into an agreement to amend the lease

to extend the term to December 31, 2005, effective upon the

closing of the acquisition of the 949 East 36th Avenue prop-

erty by VECO Properties. On or about March 7, 1999, Alaska

Pacific University assigned its interest in the lease to peti-

tioner. As of September 1, 1999, VECO Engineering assigned

its interest in the lease to VECO Alaska.

(i) Amendment XIV to the 949 East 36th Avenue Lease

VECO Properties, as landlord, and VECO Alaska, as ten-

ant, subsequently amended the 949 East 36th Avenue lease

28 The fixed minimum monthly rent of $60,626 for the period March 1,

2005, to February 28, 2006, was less than a 2.58% increase from the

monthly rent that petitioner paid for the period October 1, 2003, to Sep-

tember 30, 2004.

29 Petitioner’s summary analysis of its Schedule M shows that petitioner

calculated this amount using a monthly payment rate of $60,626.

VerDate Mar 15 2010 10:01 Feb 03, 2015 Jkt 000000 PO 00000 Frm 00015 Fmt 3857 Sfmt 3857 V:\FILES\BOUNDV~1.WIT\BVACDB~1.141\VECOCO~1 JAMIE

(440) VECO CORP. & SUBS. v. COMMISSIONER 455

numerous times to provide VECO Alaska with increased

rental space. All of the amendments extended the term of the

lease to December 31, 2005, except for amendment No. XIV

to the 949 East 36th Avenue lease (amendment XIV to the

949 East 36th Avenue lease). Amendment XIV to the 949

East 36th Avenue lease provided for a lease term of April 12,

2004, to April 11, 2006, for 11,971 square feet of space on the

fourth floor of the 949 East 36th Avenue property at a

monthly rent of $25,546 for the first year and $25,890 for the

second year.

For financial statement purposes petitioner recorded the

expenses under amendment XIV to the 949 East 36th

Avenue lease on a straight-line basis over the term of the

amended lease. Petitioner treated $220,066, 30 which was

attributable to the period April 1 through December 15,

2005, as an FYE March 31, 2006, expense on its financial

statements for that year. However, petitioner, through VECO

Alaska, deducted the $220,066 on its return for TYE March

31, 2005. Petitioner did not include the $220,066 as rental

income of VECO Properties on its return for TYE March 31,

2005.

(ii) 949 East 36th Avenue Commercial Sublease Agreement

On June 1, 2005, VECO Corp. entered into a commercial

lease agreement with VECO 36th Avenue regarding the 949

East 36th Street property (949 East 36th Avenue commercial

lease agreement). The term of the lease was June 1, 2005, to

May 31, 2020. Under the 949 East 36th Avenue commercial

lease agreement VECO Corp. agreed to pay monthly rent of

$222,499 on or before the first day of each month, with

increases in the monthly rent based on the Consumer Price

Index.

On June 1, 2005, VECO Corp. entered into a commercial

sublease agreement with VECO Alaska regarding the 949

East 36th Avenue property (949 East 36th Avenue commer-

cial sublease agreement). The term of the sublease was June

1, 2005, to May 31, 2020. Under the 949 East 36th Avenue

commercial sublease agreement VECO Alaska agreed to pay

monthly rent of $224,206 on or before the first day of each

30 Petitioner’s summary analysis of its Schedule M shows that petitioner

calculated this amount using a monthly payment rate of $25,890.

VerDate Mar 15 2010 10:01 Feb 03, 2015 Jkt 000000 PO 00000 Frm 00016 Fmt 3857 Sfmt 3857 V:\FILES\BOUNDV~1.WIT\BVACDB~1.141\VECOCO~1 JAMIE

456 141 UNITED STATES TAX COURT REPORTS (440)

month, with increases in the monthly rent based on the Con-

sumer Price Index.

For financial statement purposes, petitioner recorded the

expenses under the 949 East 36th Avenue commercial sub-

lease agreement on a straight-line basis over the term of the

sublease agreement. Petitioner treated $221,070, 31 which

was attributable to a two-month rental period commencing

after March 31, 2005, as an FYE March 31, 2006, expense on

its financial statements for that year. However, petitioner,

through VECO Alaska, deducted the $221,070 on its return

for TYE March 31, 2005. Petitioner did not include the

$221,070 as rental income on its return for TYE March 31,

2005.

4. IKON Equipment Lease

On May 21, 2004, VECO Services and IKON Financial

Services (IKON) entered into an equipment lease (IKON

equipment lease) for a term of 60 months. Under the IKON

equipment lease and the accompanying product schedule,

VECO Services agreed to make monthly rent payments of

$25,785, with the first payment made on or before the effec-

tive date 32 and the remaining payments made on the same

day each month. On January 14, 2005, VECO Alaska and

IKON amended the IKON equipment lease to provide for an

increased minimum monthly payment of $27,780. On April

13, 2005, VECO Services and IKON amended the IKON

equipment lease to provide for an increased minimum

monthly payment of $28,002. On March 28, 2007, VECO

Services and IKON amended the IKON equipment lease to

provide for an increased minimum monthly payment of

$37,128.

31 Petitioner’s

summary analysis of its Schedule M shows that petitioner

calculated this amount using a monthly payment rate of $110,535. Peti-

tioner failed to offer any explanation, and the record contains no evidence,

as to why petitioner used a monthly payment rate of $110,535 rather than

the amount specified in the 949 East 36th Avenue commercial sublease

agreement.

32 The record does not show the effective date of the IKON equipment

lease. VECO Services entered into the master agreement with respect to

the IKON equipment lease on May 21, 2004, and entered into the product

schedule on July 15, 2004.

VerDate Mar 15 2010 10:01 Feb 03, 2015 Jkt 000000 PO 00000 Frm 00017 Fmt 3857 Sfmt 3857 V:\FILES\BOUNDV~1.WIT\BVACDB~1.141\VECOCO~1 JAMIE

(440) VECO CORP. & SUBS. v. COMMISSIONER 457

Petitioner treated $225,738, 33 which was attributable to

the period April 1 through December 15, 2005, as an FYE

March 31, 2006, expense in its financial statements for that

year. However, petitioner deducted the $255,739 on its

return for TYE March 31, 2005.

III. Notice of Deficiency

Respondent issued to petitioner the notice of deficiency for

TYE March 31, 2005, determining that petitioner was not

permitted to change its method of accounting for its prepaid

and accrued expenditures. Accordingly, respondent dis-

allowed portions of petitioner’s claimed deductions as follows:

(1) $200,235 under the Aspen agreement; (2) $7,950 under

the Primavera agreement; (3) $51,895 under the Surveyor’s

Exchange agreement; (4) $59,420 under the Invensys agree-

ment; (5) $225,000 under the Marsh agreement; (6) $14,779

under the ACS agreement; (7) $16,575 under the Otis

Elevator agreement; (8) $6,250 under the Schwamm &

Frampton agreement; (9) $59,940 under the Q–1 agreement;

(10) $2,304,165 under the insurance premium agreement;

(11) $22,501 under the Arctic Spur lease; (12) $8,468 under

the Wyoming lease; (13) $34,359 under the Golden lease; (14)

$4,134 under the Durango lease; (15) $294,696 under the Bay

Street lease; (16) $380,103 under the Englewood lease; (17)

$107,637 under the Frontier Building lease; (18) $515,324

under the 6411 A Street lease; (19) $220,066 under amend-

ment XIV to the 949 East 36th Avenue lease; (20) $221,070

under the 949 East 36th Avenue commercial sublease agree-

ment; and (21) $255,738 under the IKON equipment lease.

Respondent determined that petitioner was not entitled to

these deductions because: (1) petitioner failed to establish

that it incurred the related expenses during TYE March 31,

2005, 34 and (2) petitioner’s method of claiming the deduc-

tions did not clearly reflect income within the meaning of

section 446(b). Respondent alternatively determined that if

VECO Alaska was entitled to deductions of $220,066 and

33 Petitioner’s summary analysis of its Schedule M shows that petitioner

calculated this amount using a monthly rental rate of $30,087 rather than

the rate provided for under the IKON equipment lease as amended.

34 Respondent also determined that even if petitioner satisfied the all

events test of sec. 461 for the claimed deductions, petitioner was required

to capitalize those amounts under sec. 263(a).

VerDate Mar 15 2010 10:01 Feb 03, 2015 Jkt 000000 PO 00000 Frm 00018 Fmt 3857 Sfmt 3857 V:\FILES\BOUNDV~1.WIT\BVACDB~1.141\VECOCO~1 JAMIE

458 141 UNITED STATES TAX COURT REPORTS (440)

$221,070 for expenses under amendment XIV to the 949 East

36th Avenue lease and the 949 East 36th Avenue commercial

sublease agreement, VECO Properties was required to recog-

nize the receipt of income to that extent under section

1.1502–13, Income Tax Regs.

Discussion

I. Burden of Proof

Generally, the Commissioner’s determinations in a notice

of deficiency are presumed correct, and the taxpayer bears

the burden of proving that the determinations are erro-

neous. 35 See Rule 142(a); Welch v. Helvering, 290 U.S. 111,

115 (1933). However, if a taxpayer produces credible evidence

with respect to a factual issue relevant to ascertaining the

taxpayer’s Federal income tax liability, the burden of proof as

to that issue may shift to the Secretary 36 under section

7491(a)(1) if the taxpayer satisfies certain requirements

under section 7491(a)(2). 37

35 Where a taxpayer has requested the Commissioner’s consent to change

its method of accounting, this Court generally reviews the Commissioner’s

refusal to give consent for abuse of discretion. See Capitol Fed. Sav. &

Loan Ass’n v. Commissioner, 96 T.C. 204, 209–210 (1991). The use of an

abuse of discretion standard is premised on the idea that the Commis-

sioner’s ‘‘determination with respect to the issue of whether income is re-

flected clearly is entitled to more than the usual presumption of correct-

ness.’’ Id. at 209.

In the notice of deficiency respondent rejected petitioner’s attempt to

change its former method of accounting with respect to the disputed deduc-

tions. Respondent explained that petitioner had failed to establish that pe-

titioner incurred the expenses attributable to the disputed deductions in

its TYE March 31, 2005, and in addition, petitioner’s method of claiming

the disputed deductions did not clearly reflect income within the meaning

of sec. 446(b). However, in respondent’s brief respondent argues only that

petitioner failed to establish that it incurred the expenses attributable to

the disputed deductions in its TYE March 31, 2005. Respondent does not

contend that this Court should review respondent’s determinations in the

notice of deficiency for abuse of discretion.

36 The term ‘‘Secretary’’ means ‘‘the Secretary of the Treasury or his del-

egate’’, sec. 7701(a)(11)(B), and the term ‘‘or his delegate’’ means ‘‘any offi-

cer, employee, or agency of the Treasury Department duly authorized by

the Secretary of the Treasury directly, or indirectly by one or more redele-

gations of authority, to perform the function mentioned or described in the

context’’, sec. 7701(a)(12)(A)(i).

37 If the taxpayer is a partnership, a corporation, or a trust (other than

VerDate Mar 15 2010 10:01 Feb 03, 2015 Jkt 000000 PO 00000 Frm 00019 Fmt 3857 Sfmt 3857 V:\FILES\BOUNDV~1.WIT\BVACDB~1.141\VECOCO~1 JAMIE

(440) VECO CORP. & SUBS. v. COMMISSIONER 459

Petitioner does not argue that section 7491(a)(1) shifts the

burden of proof to respondent. In addition, petitioner has not

established (nor do we find) that it satisfied the requirements

of section 7491(a)(2). Petitioner bears the burden of proof.

See Rule 142(a).

II. The All Events Test

A. Introduction

Section 461(a) provides that a deduction must be taken for

the proper taxable year under the taxpayer’s method of

accounting. Accrual method taxpayers generally are allowed

a deduction for the year in which the taxpayer incurred the

expense, regardless of the actual date of payment. Sec.

461(h)(4); sec. 1.461–1(a)(2), Income Tax Regs.; see also

Interex, Inc. v. Commissioner, 321 F.3d 55, 58 (1st Cir. 2003)

(‘‘Accrual method taxpayers may deduct expenses when they

are incurred even if they have not yet been paid[.]’’), aff ’g

T.C. Memo. 2002–57. 38

Whether an accrual method taxpayer has incurred an

expense is determined under the ‘‘all events test’’. See sec.

1.461–1(a)(2)(i), Income Tax Regs. Under the all events test,

‘‘a liability * * * is incurred, and generally is taken into

account for Federal income tax purposes, in the taxable year

in which all the events have occurred that establish the fact

of the liability, the amount of the liability can be determined

with reasonable accuracy, and economic performance has

occurred with respect to the liability.’’ Id.; see also United

States v. Gen. Dynamics Corp., 481 U.S. 239, 242–243 (1987);

United States v. Anderson, 269 U.S. 422, 441 (1926); Caltex

a qualified revocable trust as defined in sec. 645(b)(1)), sec. 7491(a)(2) re-

quires the taxpayer to establish, among other things, that it meets the re-

quirements of sec. 7430(c)(4)(A)(ii) (which in turn references the net worth

requirements of 28 U.S.C. sec. 2412(d)(2)(B)).

38 Conversely, a taxpayer may not deduct either a prepaid amount or an

amount paid without a legal obligation to do so any earlier than the tax-

able year in which such amount is incurred. Sec. 1.446–1(c)(ii)(B), Income

Tax Regs. Accordingly, we need not consider the amount and timing of

payments petitioner actually made with respect to each of the liabilities

because even if petitioner made such payment during TYE March 31,

2005, petitioner is not entitled to a deduction for the related expense un-

less petitioner also incurred a liability for that expense during TYE March

31, 2005.

VerDate Mar 15 2010 10:01 Feb 03, 2015 Jkt 000000 PO 00000 Frm 00020 Fmt 3857 Sfmt 3857 V:\FILES\BOUNDV~1.WIT\BVACDB~1.141\VECOCO~1 JAMIE

460 141 UNITED STATES TAX COURT REPORTS (440)

Oil Venture v. Commissioner, 138 T.C. 18, 23 (2012). An

accrual basis taxpayer claiming that it incurred a liability for

Federal income tax purposes must satisfy each of the three

requirements under the all events test in order to claim a

deduction for the liability.

Respondent does not dispute that the second requirement

of the all events test (i.e., that the amount of the liability

was determinable with reasonable accuracy) was satisfied

with respect to the disputed deductions. Rather, respondent

disputes whether the first and third requirements were satis-

fied. With respect to the disputed deductions attributable to

the Marsh, ACS, Schwamm & Frampton, Otis Elevator, and

Q–1 agreements, as well as the insurance premium expense

deduction and the real property and equipment lease expense

deductions, respondent contends that the first requirement of

the all events test was not satisfied because all the events

had not occurred to establish the fact of these liabilities as

of March 31, 2005. With respect to all of the deductions

except the insurance premium expense deduction, respondent

contends that the third requirement (economic performance)

of the all events test was not satisfied because: (1) the 31⁄2-

month rule of section 1.461–4(d)(6)(ii), Income Tax Regs.,

does not apply and (2) petitioner is not entitled to rely on the

recurring item exception to the economic performance

requirement.

Petitioner contends that it satisfied each requirement of

the all events test. Petitioner argues that it satisfied the first

requirement because its execution of the relevant agree-

ments, and assumption of binding legal obligations there-

under, fixed the fact of the liabilities underlying the disputed

deductions. Petitioner also argues that it satisfied the eco-

nomic performance requirement because the recurring item

exception of section 461(h)(3) applies.

We first address respondent’s contention that the fact of

petitioner’s liabilities under the Marsh, ACS, Schwamm &

Frampton, Otis Elevator, and Q–1 agreements, the insurance

premium agreement, and the real property and equipment

rental agreements was not fixed as of the close of the taxable

year in issue. We then analyze whether there was economic

performance with respect to the disputed deductions. If peti-

tioner was entitled to rely on the recurring item exception

VerDate Mar 15 2010 10:01 Feb 03, 2015 Jkt 000000 PO 00000 Frm 00021 Fmt 3857 Sfmt 3857 V:\FILES\BOUNDV~1.WIT\BVACDB~1.141\VECOCO~1 JAMIE

(440) VECO CORP. & SUBS. v. COMMISSIONER 461

with respect to the disputed deductions, then the economic

performance requirement of the all events test is satisfied.

B. Fact of the Liability

The term ‘‘liability’’ refers to ‘‘any item allowable as a

deduction, cost, or expense for Federal income tax purposes.’’

Sec. 1.446–1(c)(ii)(B), Income Tax Regs. Generally, the fact of

a liability is established on the earlier of: (1) the event fixing

the liability, such as the required performance or (2) the date

the payment is unconditionally due. See Rev. Rul. 2007–3,

2007–1 C.B. 350; Rev. Rul. 80–230, 1980–2 C.B. 169; Rev.

Rul. 79–410, 1979–2 C.B. 213.

Petitioner argues that actual payment of an expense is not

required to establish the fact of the liability. 39 As discussed

supra, an accrual method taxpayer may deduct an expense

for a taxable year before the year in which the taxpayer actu-

ally remits payment provided that the taxpayer incurred the

expense during the taxable year for which it claimed the

deduction. Sec. 461(h)(4); sec. 1.461–1(a)(2), Income Tax

Regs.; see also United States v. Hughes Props. Inc., 476 U.S.

593, 599 (1986); Interex, Inc. v. Commissioner, 321 F.3d at

57–58. ‘‘[A]lthough expenses may be deductible before they

have become due and payable, liability must first be firmly

established.’’ Gen. Dynamics Corp., 481 U.S. at 243. Accord-

ingly, we agree with petitioner that actual payment is not

necessarily required to establish that petitioner’s liability for

an expense is fixed under the all events test.

Petitioner argues that upon its entering into the various

agreements, its liabilities under those agreements became

fixed by virtue of its assumption of the contractual obliga-

tions. Although petitioner and respondent agree that a

39 Petitioner

also argues that ‘‘courts have repeatedly rejected the Re-

spondent’s arguments that a liability is not fixed until the time has come

for payment of the obligation.’’ Petitioner, however, overstates respondent’s

argument. Respondent contends that all events have occurred to establish

the fact of a taxpayer’s liability upon the earlier of the event fixing the li-

ability or the payment due date. Accordingly, respondent contends that a

liability may be fixed before the payment due date provided that the event

fixing the liability already occurred. Furthermore, in respondent’s answer-

ing brief, respondent specifically acknowledges that ‘‘actual payment is not

required to fix the liability.’’

VerDate Mar 15 2010 10:01 Feb 03, 2015 Jkt 000000 PO 00000 Frm 00022 Fmt 3857 Sfmt 3857 V:\FILES\BOUNDV~1.WIT\BVACDB~1.141\VECOCO~1 JAMIE

462 141 UNITED STATES TAX COURT REPORTS (440)

statute 40 or regulation sometimes may operate to fix a tax-

payer’s liability, the parties disagree regarding whether peti-

tioner’s execution of each agreement constituted an event

that fixed petitioner’s liability for the entire obligation under

the agreement.

The execution of a contract contemplating payment, with-

out more, is not an event that fixes the payor’s liability. See

Spencer, White & Prentis v. Commissioner, 144 F.2d 45, 47

(2d Cir. 1944) (‘‘It is well settled that deductions may only

be taken for the year in which the taxpayer’s liability to pay

becomes definite and certain, even though the transactions

(such as the contract in the present case) which occasioned

the liability, may have taken place in an earlier year.’’). In

particular, where a contract ‘‘contains mutually dependent

promises, liability under it is contingent upon performance or

tendered performance’’, and is not fixed by merely entering

into the contract. Levin v. Commissioner, 219 F.2d 588, 589

(3d Cir. 1955), aff ’g 21 T.C. 996 (1954); see also Gulf Oil

Corp. v. Commissioner, 914 F.2d 396, 409 (3d Cir. 1990)

(‘‘Unconditional liability under an executory contract is not

created until at least one party performs.’’), aff ’g 86 T.C. 115

(1986). For example, this Court has held that taxpayers who

entered into a contract in year 1 for the provision of services

in years 1 and 2 were not entitled to deduct the entire

amount of the contract price in year 1 because they had not

incurred the entire amount of the liability in year 1. Levin

v. Commissioner, 21 T.C. 996. 41 In so holding, this Court

40 Furthermore,

this Court has held that the fact that a liability is fixed

by statute does not control whether the liability is fixed for purposes of the

all events test. See Chrysler Corp. v. Commissioner, T.C. Memo. 2000–283,

aff ’d, 436 F.3d 644 (6th Cir. 2006).

41 In Levin v. Commissioner, 21 T.C. 996 (1954), aff ’d, 219 F.2d 588 (3d

Cir. 1955), the taxpayers were partners in a business that manufactured,

produced, and sold food products. On December 12, 1946, the business en-

tered into an advertising contract with a two-year term. Id. at 996–997.

Under the terms of the contract, the taxpayers were to pay the advertising

agent $733 per month in exchange for the advertisement of their food

products. Id. On December 17, 1946, the advertising agent sent to the tax-

payers an invoice for services rendered from December 5, 1946, to Decem-

ber 4, 1947. Id. at 997. The partnership, which used an accrual method

of accounting, accrued the entire amount of the invoice on its books for the

TYE December 31, 1946, although the partnership did not begin making

payments on the invoice until February 10, 1947. Id.

VerDate Mar 15 2010 10:01 Feb 03, 2015 Jkt 000000 PO 00000 Frm 00023 Fmt 3857 Sfmt 3857 V:\FILES\BOUNDV~1.WIT\BVACDB~1.141\VECOCO~1 JAMIE

(440) VECO CORP. & SUBS. v. COMMISSIONER 463

stated that ‘‘it has been well established that the accrual

method of accounting does not permit the anticipation in the

taxable year of future expenses in other years prior to the

rendition of the services fixing the liability for which the pay-

ment is to be made.’’ Id. at 999.

Petitioner cites numerous cases that it claims stand for the

proposition that the execution of a contract fixes a taxpayer’s

liability for the entire amount of the contract price. 42 None

of the cases, however, stand for the proposition that the

execution of a contract, without more, establishes the fact of

the taxpayer’s liability for the entire amount due under the

contract. Rather, in each of the cited cases, the court exam-

ined the relevant contract to decide when the liability

became fixed. See Commissioner v. H.B. Ives Co., 297 F.2d

229 (2d Cir. 1961), rev’g T.C. Memo. 1959–187; Willoughby

Camera Stores, Inc. v. Commissioner, 125 F.2d 607, 608–609

(2d Cir. 1942), rev’g 44 B.T.A. 520 (1941); Helvering v. Rus-

The Court held that the partnership was not entitled to accrue the en-

tire amount of the invoice for Federal income tax purposes. Id. at 998–999.

In so holding, the Court stated that under the contract the taxpayers ‘‘in-

curred no liability but merely agreed to become liable to pay in the event

the future services called for were performed.’’ Id. at 998. The Court fur-

ther acknowledged that the measure of an obligation to pay for future

services was not the contract price but rather ‘‘a contingent response in

damages’’ for breach of the contract. Id. at 998–999. The U.S. Court of Ap-

peals for the Third Circuit affirmed the decision of this Court, stating that

‘‘[r]endition of the services was a condition precedent to any obligation of

the partnership to pay.’’ Levin v. Commissioner, 219 F.2d at 589.

42 Petitioner also cites Amalgamated Hous. Corp. v. Commissioner, 37

B.T.A. 817 (1938), aff ’d, 108 F.2d 1010 (2d Cir. 1940), in support of this

contention. In particular, petitioner contends that in Amalgamated Hous.

Corp., the Court held that the taxpayer’s liability for service payments was

not fixed because the taxpayer had not entered into a binding contract

with a service provider and the services were not yet required under State

housing law. In Amalgamated Hous. Corp. v. Commissioner, 37 B.T.A. at

829, the taxpayers were required under State law to make renovations at

the end of particular periods of months and accordingly ‘‘set up a reserve

from the rent received during that period sufficient to pay for’’ the renova-

tions. The Court held the taxpayers could not accrue the renovation costs

as expenses before the end of the relevant period, as defined by State law,

or the time that renovation services were rendered. Id. The Court did not

discuss the effect, if any, of the taxpayers’ lack of a service contract under

which a third party agreed to provide renovation services. Amalgamated

Hous. Corp. does not stand for the proposition for which it is cited by peti-

tioner.

VerDate Mar 15 2010 10:01 Feb 03, 2015 Jkt 000000 PO 00000 Frm 00024 Fmt 3857 Sfmt 3857 V:\FILES\BOUNDV~1.WIT\BVACDB~1.141\VECOCO~1 JAMIE

464 141 UNITED STATES TAX COURT REPORTS (440)

sian Fin. & Constr. Corp., 77 F.2d 324, 327 (2d Cir. 1935);

Wash. Post Co. v. United States, 405 F.2d 1279, 1283 (Ct. Cl.

1969); Burnham Corp. v. Commissioner, 90 T.C. 953, 957–

958 (1988), aff ’d, 878 F.2d 86 (2d Cir. 1989); Ill. Power Co.

v. Commissioner, 87 T.C. 1417, 1443–1447 (1986); Champion

Spark Plug Co. v. Commissioner, 30 T.C. 295, 298 (1958),

aff ’d, 266 F.2d 347 (6th Cir. 1959). The cited cases are

distinguishable as explained below.

Two of the cases address the treatment of payments made

under a unilateral contract. See Burnham Corp. v. Commis-

sioner, 90 T.C. 953; 43 Champion Spark Plug Co. v. Commis-

sioner, 30 T.C. 295. 44 The agreements at issue here are not

unilateral; each party is obligated to perform the under-

takings specified therein, and petitioner is required to make

payments over the term of the contract in exchange for goods

or services to be provided.

Three of the cases involve situations where the required

performance from one of the contracting parties occurred in

one taxable year but the other contracting party did not actu-

ally make the associated payment until the following taxable

year. Willoughby Camera Stores, Inc. v. Commissioner, 125

F.2d at 608–609; Helvering v. Russian Fin. & Constr. Corp.,

77 F.2d at 327; Wash. Post Co., 405 F.2d at 1283. In contrast,

the required performance under the agreements to which the

disputed deductions relate was not supposed to occur, and in

fact did not occur, until after the close of petitioner’s TYE

March 31, 2005.

One of the cases, Commissioner v. H.B. Ives Co., 297 F.2d

at 229–230, is not relevant to the issues before the Court as

43 BurnhamCorp. v. Commissioner, 90 T.C. 953 (1988), aff ’d, 878 F.2d

86 (2d Cir. 1989), involved a contract under which the taxpayer agreed to

make monthly payments for the remainder of an individual’s life. The

Court held that the taxpayer was entitled to deduct the present value of

the payments for the entirety of the contract term in the taxable year in

which the taxpayer entered into the contract. Id. at 957–958.

44 Champion Spark Plug Co. v. Commissioner, 30 T.C. 295, 297 (1958),

aff ’d, 266 F.2d 347 (6th Cir. 1959), involved a unilateral contract under

which the taxpayer agreed to make semimonthly payments to a disabled

former employee for a multiyear period. The Court found that the taxpayer

was entitled to deduct the value of the payments to be made over the en-

tire period in the taxable year in which the taxpayer entered into the con-

tract. Id. at 298.

VerDate Mar 15 2010 10:01 Feb 03, 2015 Jkt 000000 PO 00000 Frm 00025 Fmt 3857 Sfmt 3857 V:\FILES\BOUNDV~1.WIT\BVACDB~1.141\VECOCO~1 JAMIE

(440) VECO CORP. & SUBS. v. COMMISSIONER 465

it involves a deduction claimed for year 1 under a contract

that was not executed until year 2.

The other case petitioner cites, Ill. Power Co. v. Commis-

sioner, 87 T.C. at 1443–1447, actually supports respondent’s

argument that the fact of the liability is established upon the

occurrence of either the required performance or the payment

due date. Ill. Power Co. v. Commissioner, 87 T.C. at 1445,

involved a lease agreement under which the taxpayer agreed

to make lease payments either monthly, as the taxpayer’s

nuclear power plant became operational, or at the termi-

nation of the lease agreement, which would occur in 40

years. Id. The taxpayer elected to defer its lease payments

for 1981 until the plant became operational; however, the

taxpayer accrued an amount equal to its monthly lease

obligation for 1981 and deducted the amount on its 1981

return. Id. at 1428, 1445. This Court upheld the claimed

deduction, stating:

Whether the lease payments are made as Monthly Lease Charges, as

the plant becomes operational, or as of the termination of the Lease

Agreement, it is clear that in all events, the payments must be made.

That petitioner elected to defer payments of the charges until the plant

becomes operational is of no significance. The election merely affects the

timing and not the certainty of payment of the accrued charge. * * * [Id.

at 1445.]

Because the lease agreement provided that the taxpayer had

an unconditional liability to pay the lease obligations as they

accrued each month, the Court held that the taxpayer was

entitled to deduct those obligations as they accrued even if

the taxpayer did not pay the lease obligations until later. The

holding is consistent with the general proposition that a tax-

payer may deduct a liability as an expense before payment

is made so long as the event fixing the liability (in Ill. Power

Co., performance under the lease agreement) has occurred.

See also Eastman Kodak Co. v. United States, 534 F.2d 252,

259–260 (Ct. Cl. 1976).

Although petitioner’s execution of the agreements in issue

does not establish the fact of the liabilities, the terms of the

agreements are relevant in deciding whether and when the

liabilities became fixed under the all events test. See supra

pp. 462–463; see also Decision, Inc. v. Commissioner, 47 T.C.

58 (1966). We analyze each of the relevant agreements to

VerDate Mar 15 2010 10:01 Feb 03, 2015 Jkt 000000 PO 00000 Frm 00026 Fmt 3857 Sfmt 3857 V:\FILES\BOUNDV~1.WIT\BVACDB~1.141\VECOCO~1 JAMIE

466 141 UNITED STATES TAX COURT REPORTS (440)

identify the earlier of when the required performance

occurred or when petitioner’s payment was unconditionally

due.

1. Service Contracts

An accrual method taxpayer may not deduct an expense

attributable to a bilateral service contract before performance

of the services under the contract occurs. Nat’l Bread Wrap-

ping Mach. Co. v. Commissioner, 30 T.C. 550, 556 (1958)

(‘‘The accrual method does not permit the anticipation of

future expenses prior to the rendition of the services for

which the payment is due.’’); Levin v. Commissioner, 21 T.C.

at 998; Amalgamated Hous. Corp. v. Commissioner, 37 B.T.A.

817, 829 (1938), aff ’d, 108 F.2d 1010 (2d Cir. 1940); see also

Levert v. Commissioner, T.C. Memo. 1989–333; Rev. Rul. 80–

182, 1980–2 C.B. 167.

a. Marsh Agreement

The event fixing a liability under a service contract is the

performance of the services. See, e.g., Levin v. Commissioner,

21 T.C. at 998. As relevant here, under the agreement Marsh

agreed to provide VECO Corp. with various insurance

brokerage and consulting services during the period from

January 10 through December 31, 2005, in exchange for the

payment by VECO Corp. of an annual fixed fee of $300,000.

The $300,000 fee was payable in installments with $75,000

due on February 1, 2005, and four additional payments,

totaling $225,000, due on dates either on or after April 1,

2005. 45

The portion of the fee in dispute, $225,000, was not due

under the agreement until on or after April 1, 2005. Accord-

ingly, the $225,000 qualifies as an established liability

during petitioner’s TYE March 31, 2005, only if Marsh per-

formed the required services under the agreement on or

before March 31, 2005. Petitioner has failed to prove that

45 The Marsh agreement does not provide for VECO Corp. to make pay-

ments in equal amounts. However, the payment schedule shows that

VECO Corp. was to make payments of $75,000, or multiple amounts equal

to $75,000, for each quarter. We infer from this payment schedule that

VECO Corp. was to make payments to Marsh as the services were pro-

vided.

VerDate Mar 15 2010 10:01 Feb 03, 2015 Jkt 000000 PO 00000 Frm 00027 Fmt 3857 Sfmt 3857 V:\FILES\BOUNDV~1.WIT\BVACDB~1.141\VECOCO~1 JAMIE

(440) VECO CORP. & SUBS. v. COMMISSIONER 467

Marsh provided all of the contracted-for services to VECO

Corp. by March 31, 2005.

VECO Corp. was required to make a $75,000 payment for

services rendered during the period January 10 to March 31,

2005, which petitioner properly deducted. However, VECO

Corp. was not required to pay the $225,000 amount by

March 31, 2005. As there is no credible evidence that either

(i) the services required under the contract for the period

after March 31, 2005, had been provided by March 31, 2005,

or (ii) petitioner had an obligation to pay the $225,000 before

March 31, 2005, the fact of the liability for the $225,000 peti-

tioner deducted was not established by the close of peti-

tioner’s TYE March 31, 2005.

b. ACS Agreement

Petitioner failed to introduce a copy of the service agree-

ment between ACS and VECO Alaska or any other evidence

to show the performance required of ACS under the contract.

While we infer from the record that ACS provided services

to VECO Alaska, we are unable to make a finding as to

whether performance under the ACS agreement had occurred

by the close of TYE March 31, 2005.

We also infer from the record that VECO Alaska made

monthly payments to ACS. See supra note 16. The parties

agree that the disputed deduction is attributable to monthly

expenses under the agreement for the period April 1 to

December 31, 2005. At best, payment of the expense gener-

ating the disputed deduction was not due until the beginning

of each month and accordingly, was not unconditionally due

until after March 31, 2005. Petitioner has failed to show that

the fact of the liability was established by the close of peti-

tioner’s TYE March 31, 2005.

c. Schwamm & Frampton Agreement

Under the agreement Schwamm & Frampton agreed to

provide property management services and to act as agent

for VECO Properties, in exchange for monthly payments by

VECO Properties that were due when it received rent for the

month. The disputed deduction is attributable to expenses of

$6,250 for services provided by Schwamm & Frampton in

VerDate Mar 15 2010 10:01 Feb 03, 2015 Jkt 000000 PO 00000 Frm 00028 Fmt 3857 Sfmt 3857 V:\FILES\BOUNDV~1.WIT\BVACDB~1.141\VECOCO~1 JAMIE

468 141 UNITED STATES TAX COURT REPORTS (440)

April 2005. VECO Properties’ payment of $6,250 was not

unconditionally due until on or after April 1, 2005.

Neither the performance of the services nor the payment

due date occurred before March 31, 2005. Accordingly, the

fact of the liability was not established by the close of peti-

tioner’s TYE March 31, 2005.

d. Otis Elevator Agreement

Under the agreement Schwamm & Frampton, as agent for

VECO Properties, agreed to pay Otis Elevator a monthly

service fee of $1,950. 46 The terms of the agreement provided

that payments would be made quarterly, with each quarterly

payment made ‘‘on or before the last day of the month prior

to the billing period, beginning on the Commencement Date.’’

The agreement further provided for a commencement date of

February 1, 2002.

The disputed deduction, $16,575, was attributable to

expenses under the Otis Elevator agreement for the period

April 1 to December 15, 2005. Therefore, petitioner’s liability

for the amount was fixed only if payment of that amount was

unconditionally due on or before March 31, 2005.

Under the agreement VECO Properties was required to

make quarterly payments on or before January 31, April 30,

July 31, and October 31. The advance payment due on or

before January 31, 2005, was for services to be rendered

during February, March, and April 2005. VECO Properties

was not required to make another payment until April 30,

2005, at which time VECO Properties would pay for services

to be rendered during May, June, and July 2005.

46 Respondent

contends that petitioner is not entitled to a deduction for

expenses under the Otis Elevator agreement because: (1) neither VECO

Corp. nor VECO Properties made any direct payments to Otis Elevator

and (2) neither VECO Corp. nor VECO Properties was a party to the con-

tract with Otis Elevator. Although neither VECO Corp. nor VECO Prop-

erties made any direct payments to Otis Elevator, petitioner is entitled to

deduct expenses attributable to liabilities incurred during TYE March 31,

2005, such as the Otis Elevator monthly service fees. See, e.g., United

States v. Gen. Dynamics Corp., 481 U.S. 239, 243 (1987); United States v.

Hughes Props., Inc., 476 U.S. 593, 599 (1986). In addition, while neither

VECO Corp. nor VECO Properties was a party to the Otis Elevator agree-

ment, Schwamm & Frampton, the agent of VECO Properties, entered into

the Otis Elevator agreement at the direction of VECO Properties.

VerDate Mar 15 2010 10:01 Feb 03, 2015 Jkt 000000 PO 00000 Frm 00029 Fmt 3857 Sfmt 3857 V:\FILES\BOUNDV~1.WIT\BVACDB~1.141\VECOCO~1 JAMIE

(440) VECO CORP. & SUBS. v. COMMISSIONER 469

Because the obligation to pay for the services to be ren-

dered during April 2005 was unconditionally due on January

31, 2005, 47 $1,950 of the disputed deduction, attributable to

services provided in April 2005, was fixed during petitioner’s

TYE March 31, 2005. See, e.g., sec. 1.446–1(c)(ii)(B), Income

Tax Regs. The remaining disputed amount attributable to

services provided from May 1 to December 15, 2005, how-

ever, was not fixed during TYE March 31, 2005, because pay-

ment for such services was not unconditionally due until

after March 31, 2005.

e. Q–1 Agreement

Under the agreement Q–1 agreed to provide maintenance

services to VECO Properties and VECO Properties agreed to

pay Q–1 a monthly fee of $9,984 ‘‘in arrears, on the tenth

day of the following month.’’ The disputed deduction,

$59,940, relates to expenses incurred under the Q–1 agree-

ment for services provided during the period April 1 to

October 15, 2005. Neither the performance of the services nor

the payment due date occurred before the close of petitioner’s

taxable year. Accordingly, the fact of the liability was not

established by the close of petitioner’s TYE March 31, 2005.

2. Insurance Premium Agreement

For purposes of the all events test, the deductibility of

expenses under an insurance contract generally is reviewed

in the same manner as the deductibility of expenses under

a service contract. See, e.g., Rev. Rul. 2007–3, supra. Under

VECO Corp.’s commercial premium finance agreement with

Marsh, VECO Corp. agreed to make monthly premium pay-

ments beginning May 1, 2005, for coverage during the period

April 1, 2005, to March 31, 2006. 48 Performance of the serv-

47 Petitioner

is not entitled to treat this liability as incurred any earlier

than the taxable year in which economic performance occurs. See sec.

461(h)(1); sec. 1.461–4(a)(1), Income Tax Regs. We discuss the economic

performance requirement with respect to this liability infra part II.C.

48 As noted supra pp. 461–462, the mere execution of a contract is insuf-

ficient to establish the fact of the taxpayer’s liability. Accordingly, peti-

tioner may not rely on the existence of the insurance premium contract to

support its claimed deduction. Furthermore, VECO Corp. did not enter

into the insurance premium contract until April 28, 2005, after the close

Continued

VerDate Mar 15 2010 10:01 Feb 03, 2015 Jkt 000000 PO 00000 Frm 00030 Fmt 3857 Sfmt 3857 V:\FILES\BOUNDV~1.WIT\BVACDB~1.141\VECOCO~1 JAMIE

470 141 UNITED STATES TAX COURT REPORTS (440)

ices did not occur and payment for the services was not due

before March 31, 2005. Accordingly, the fact of the liability

was not established by the close of petitioner’s TYE March

31, 2005.

3. Equipment and Real Estate Rental Agreements

The fact of the liability of a rental expense is established

as each rent payment becomes due. Consol. Foods Corp. v.

Commissioner, 66 T.C. 436, 443 (1976); see also Rod Realty

Co. v. Commissioner, T.C. Memo. 1967–49. Under all of the

real estate rental leases, with the exception of the Bay Street

lease, VECO Corp. or its subsidiaries agreed to make a rent

payment for each monthly rental period either: (1) on the

first day of that month or (2) ‘‘on or before’’ the first day of

that month. The disputed deductions attributable to these

leases relate to the rental of property on or after April 1,

2005. Under the lease agreements the rent payments for

April 2005 were not unconditionally due until April 1, 2005,

and the rent payments for the remainder of 2005 were not

due until after April 1, 2005. Accordingly, the fact of these

liabilities was not established by the close of petitioner’s TYE

March 31, 2005.

Under the Bay Street lease VECO USA agreed to make

monthly rental payments in advance of the first day of each

month. The disputed deduction, $294,696, is attributable to

the rental period April 1 to December 15, 2005. VECO USA’s

rent payment for April 2005 was due on or before March 31,

2005. Accordingly, the fact of the liability for the $33,990

rent payment for the period April 2005 was established

before the close of petitioner’s TYE March 31, 2005, because

the rent payment was unconditionally due on March 31,

2005. 49 See, e.g., sec. 1.446–1(c)(ii)(B), Income Tax Regs.

Petitioner is not entitled to deduct any amount attributable

to rent for the period May 1 to December 15, 2005, because

the rent payments were not due until after the close of peti-

tioner’s TYE March 31, 2005. Therefore, the fact of peti-

of petitioner’s TYE March 31, 2005.

49 Petitioner is not entitled to treat the amount of this liability as in-

curred any earlier than the taxable year in which economic performance

occurs. See sec. 461(h)(1); sec. 1.461–4(a)(1), Income Tax Regs. We discuss

the economic performance requirement with respect to this liability infra

part II.C.

VerDate Mar 15 2010 10:01 Feb 03, 2015 Jkt 000000 PO 00000 Frm 00031 Fmt 3857 Sfmt 3857 V:\FILES\BOUNDV~1.WIT\BVACDB~1.141\VECOCO~1 JAMIE

(440) VECO CORP. & SUBS. v. COMMISSIONER 471

tioner’s liability for these payments was not established

during petitioner’s TYE March 31, 2005.

Under the IKON equipment lease VECO Services agreed to

make monthly rent payments of $25,785, with the first pay-

ment due on or before the effective date and the remaining

payments due on the same day each month thereafter. Peti-

tioner has failed to introduce evidence to prove the effective

date of the IKON equipment lease. See supra note 32.

Accordingly, we are unable to find that the rent payments for

which the disputed deduction was claimed were due on or

before March 31, 2005. Petitioner has failed to prove that the

fact of its liability under the IKON equipment lease was

established by the close of petitioner’s TYE March 31, 2005.

C. Economic Performance and the Recurring Item Excep-

tion

1. Introduction

Section 461(h)(1) provides that ‘‘in determining whether an

amount has been incurred with respect to any item during

any taxable year, the all events test shall not be treated as

met any earlier than when economic performance with

respect to such item occurs.’’ 50 If the liability is attributable

to the provision of services or property to the taxpayer by

another person, economic performance occurs as the person

provides such services or property. Sec. 461(h)(2)(A)(i) and

(ii); see also sec. 1.461–4(d)(2), Income Tax Regs. If the

liability is attributable to ‘‘the use of property by the tax-

payer, economic performance occurs as the taxpayer uses

such property.’’ 51 Sec. 461(h)(2)(A)(iii); see also sec. 1.461–

4(d)(3), Income Tax Regs. However, ‘‘a taxpayer is permitted

to treat services or property as provided to the taxpayer as

the taxpayer makes payment to the person providing the

services or property * * * if the taxpayer can reasonably

50 Sec. 1.461–1(a)(2)(iii)(B), Income Tax Regs., provides examples of li-

abilities that are not subject to the economic performance requirement,

none of which is relevant here. See sec. 1.461–4(b), Income Tax Regs.

51 The economic performance principles relating to the provision of serv-

ices or property to the taxpayer, or the use of property by the taxpayer,

do not apply to certain liabilities, including, among other things, interest

expenses and liabilities arising under a worker’s compensation act or out

of any tort or breach of contract claim. See sec. 1.461–4(d)(1), Income Tax

Regs.

VerDate Mar 15 2010 10:01 Feb 03, 2015 Jkt 000000 PO 00000 Frm 00032 Fmt 3857 Sfmt 3857 V:\FILES\BOUNDV~1.WIT\BVACDB~1.141\VECOCO~1 JAMIE

472 141 UNITED STATES TAX COURT REPORTS (440)

expect the person to provide the services or property within

31⁄2 months after the date of payment.’’ Sec. 1.461–4(d)(6)(ii),

Income Tax Regs. Petitioner has conceded that it did not sat-

isfy the 31⁄2-month rule of section 1.461–4(d)(6)(ii), Income

Tax Regs., for any of the deductions in issue. 52

Section 461(h)(3) provides an exception (the recurring item

exception) to the general rule requiring economic perform-

ance. Under the recurring item exception, a taxpayer may

treat an item as incurred during any taxable year if:

(i) the all events test with respect to such item is met during such tax-

able year (determined without regard to * * * [section 461(h)(1)]),

(ii) economic performance with respect to such item occurs within the

shorter of—

(I) a reasonable period after the close of such taxable year, or

(II) 81⁄2 months after the close of such taxable year,

(iii) such item is recurring in nature and the taxpayer consistently

treats items of such kind as incurred in the taxable year in which the

requirements of clause (i) are met, and

(iv) either—

(I) such item is not a material item, or

(II) the accrual of such item in the taxable year in which the

requirements of clause (i) are met results in a more proper match

against income than accruing such item in the taxable year in which

economic performance occurs.

[Sec. 461(h)(3)(A).]

See also sec. 1.461–5, Income Tax Regs.

Respondent contends that petitioner failed to satisfy the

economic performance requirement and the materiality or

matching requirement of the recurring item exception for all

of the disputed deductions. Petitioner disagrees. In par-

ticular, petitioner contends that economic performance with

respect to each expense item occurred within 81⁄2 months

after the close of its TYE March 31, 2005, as specified in sec-

52 Sec. 461(h) also provides a general rule for economic performance, de-

scribed supra p. 458. Under the general rule, petitioner is entitled to de-

duct for TYE March 31, 2005, the payments it made during that year for

services actually performed and property actually received during that

year. See, e.g., Caltex Oil Venture v. Commissioner, 138 T.C. 18, 38 (2012).

The only amounts in dispute are those attributable to deductions peti-

tioner claimed on its TYE March 31, 2005, return for services performed

and property received after March 31, 2005. Accordingly, economic per-

formance with respect to the portions of the deductions in dispute did not

occur until after the close of petitioner’s TYE March 31, 2005. See sec.

461(h)(2)(A).

VerDate Mar 15 2010 10:01 Feb 03, 2015 Jkt 000000 PO 00000 Frm 00033 Fmt 3857 Sfmt 3857 V:\FILES\BOUNDV~1.WIT\BVACDB~1.141\VECOCO~1 JAMIE

(440) VECO CORP. & SUBS. v. COMMISSIONER 473

tion 461(h)(3)(A)(ii)(II), and that each expense item is not

material within the meaning of section 461(h)(3)(A)(iv)(I).

Petitioner concedes that it did not satisfy the matching

requirement for any of the disputed deductions, with the

exception of its insurance premium expense deduction.

The deductions remaining at issue are the deductions

claimed with respect to the Aspen, Primavera, Surveyor’s

Exchange, and Invensys agreements, and the deductions

claimed with respect to services and property provided to

petitioner during April 2005 under the Otis Elevator agree-

ment and the Bay Street lease. We examine the record to see

whether petitioner has proven that: (1) each item in dispute

is not material, see sec. 461(h)(3)(A)(iv)(I), and/or (2) eco-

nomic performance with respect to each item in dispute

occurred within the shorter of a reasonable period after the

close of petitioner’s TYE March 31, 2005, or within 81⁄2

months after the close of petitioner’s TYE March 31, 2005,

see sec. 461(h)(3)(A)(ii).

2. Materiality Requirement

In making a determination regarding the materiality of an

item under section 461(h)(3)(A)(iv), the treatment of an item

on financial statements shall be taken into account. Sec.

461(h)(3)(B). Section 1.461–5(b)(4), Income Tax Regs., also

addresses the materiality requirement 53 and provides the

following general principles:

(i) In determining whether a liability is material, consideration shall

be given to the amount of the liability in absolute terms and in relation

to the amount of other items of income and expense attributable to the

same activity.

(ii) A liability is material if it is material for financial statement pur-

poses under generally accepted accounting principles.

(iii) A liability that is immaterial for financial statement purposes

under generally accepted accounting principles may be material for pur-

poses of this paragraph * * *

53 The Financial Standards Accounting Board (FASB) defines materiality

as ‘‘[t]he magnitude of an omission or misstatement of accounting informa-

tion that, in the light of surrounding circumstances, makes it probable that

the judgment of a reasonable person relying on the information would have

been changed or influenced by the omission or misstatement.’’ Statement

of Financial Accounting Concepts No. 2, ‘‘Qualitative Characteristics of Ac-

counting Information’’ (1980) (SFAC No. 2).

VerDate Mar 15 2010 10:01 Feb 03, 2015 Jkt 000000 PO 00000 Frm 00034 Fmt 3857 Sfmt 3857 V:\FILES\BOUNDV~1.WIT\BVACDB~1.141\VECOCO~1 JAMIE

474 141 UNITED STATES TAX COURT REPORTS (440)

We glean from these principles that although a liability is

material for purposes of the recurring item exception if it is

material for financial statement purposes, a liability that is

not material for financial statement purposes may still be

material for purposes of the recurring item exception. See,

e.g., United States v. Stover, 731 F. Supp. 2d 887, 892 (W.D.

Mo. 2010), aff ’d, 650 F.3d 1099 (8th Cir. 2011). 54

Section 461 does not define when an item is material

under the recurring item exception; it simply provides that

in determining materiality, an item’s treatment on financial

statements must be taken into account. Sec. 461(h)(3)(B).

The legislative history accompanying the enactment of the

recurring item exception, however, provides an example of

how the materiality of an item should be analyzed:

For example, assume that a calendar-year taxpayer enters into a one-

year maintenance contract on July 1, 1985. If the amount of the expense

is prorated between 1985 and 1986 for financial statement purposes, it

also should be prorated for tax purposes. If, however, the full amount is

deducted in 1985 for financial statement purposes because it is not

material under generally accepted accounting principles, it may (or may

not) be considered an immaterial item for purposes of this exception.

[H.R. Conf. Rept. No. 98–861, at 874 (1984), 1984–3 C.B. (Vol. 2) 1, 128.]

See also Staff of J. Comm. on Taxation, General Explanation

of the Revenue Provisions of the Deficit Reduction Act of

1984, at 263 (J. Comm. Print 1984). We draw from section

461(h)(3)(B) and from the example a conclusion: If a taxpayer

prorates a liability arising under a contract over two or more

taxable years for financial statement purposes but takes an

inconsistent position on its tax returns, the liability is mate-

rial.

Petitioner prepared its financial statements in accordance

with GAAP. On its financial statements petitioner accrued

54 A

liability also is material if it is significant in amount. See sec. 1.461–

5(b)(4)(i), Income Tax Regs.; see also United States v. Stover, 731 F. Supp.

2d 887, 892 (W.D. Mo. 2010) (analyzing the amount of the expense, the re-

lationship between the expense and the taxpayer’s revenue, and the mate-

riality of the amount and nature of the expense for financial statement

purposes in deciding whether an expense was material under sec.

461(h)(3)(A)(iv)(I)), aff ’d, 650 F.3d 1099 (8th Cir. 2011); Rev. Rul. 2012–

1, 2012–2 I.R.B. 255. However, the FASB has stated that ‘‘[m]agnitude by

itself, without regard to the nature of the item and the circumstances in

which the judgment has to be made, will not generally be a sufficient basis

for a materiality judgment.’’ SFAC No. 2.

VerDate Mar 15 2010 10:01 Feb 03, 2015 Jkt 000000 PO 00000 Frm 00035 Fmt 3857 Sfmt 3857 V:\FILES\BOUNDV~1.WIT\BVACDB~1.141\VECOCO~1 JAMIE

(440) VECO CORP. & SUBS. v. COMMISSIONER 475

its liabilities under the Aspen, Primavera, Surveyor’s

Exchange, Invensys, and Otis Elevator agreements and the

Bay Street lease over more than one year for financial state-

ment purposes. On its FYE March 31, 2006, financial

statement, petitioner treated the disputed deductions as

expenses for that year but deducted the expenses on its tax

return for TYE March 31, 2005. Guided by section

461(h)(3)(B) and the example in the conference report, we

conclude that the liabilities giving rise to the disputed deduc-

tions are material because petitioner prorated the liabilities

between two years on its financial statements and took an

inconsistent position with respect to the liabilities for finan-

cial statement and tax reporting purposes.

Petitioner bears the burden of showing that the liabilities

attributable to the disputed deductions are not material

under section 1.461–5(b)(4), Income Tax Regs. Although peti-

tioner contends that the liabilities were not material in

amount for financial statement purposes, petitioner only

introduced calculations that compare the disputed deductions

to gross receipts. Petitioner neither offered any analysis

regarding how the liabilities at issue compared in amount or

relative importance to similar types of expenses nor

addressed the fact that the disputed deductions resulted from

a requested change in accounting method. 55

Even if we were to find that the amount of the liabilities

was immaterial for financial statement purposes, ‘‘[a]

liability that is immaterial for financial statement purposes

under generally accepted accounting principles may be mate-

rial’’ for purposes of the recurring item exception. See sec.

1.461–5(b)(4)(iii), Income Tax Regs. The disputed items

resulted from a change of accounting method, which was dis-

55 Additionally, the FASB has noted that an item that is too small in

amount to be considered material may be material if it arises in abnormal

circumstances. SFAC No. 2. The liabilities in dispute arose in abnormal

circumstances, i.e., during the year in which petitioner proposed a change

in its accounting method. Petitioner’s treatment of the liabilities for tax

purposes also shows abnormal circumstances given that: (1) petitioner did

not treat the liabilities the same way for financial statement purposes and

(2) petitioner’s treatment of the liabilities as expenses for its TYE March

31, 2005, does not result in a matching of income and expenses since peti-

tioner did not accelerate the income attributable to the accelerated ex-

penses.

VerDate Mar 15 2010 10:01 Feb 03, 2015 Jkt 000000 PO 00000 Frm 00036 Fmt 3857 Sfmt 3857 V:\FILES\BOUNDV~1.WIT\BVACDB~1.141\VECOCO~1 JAMIE

476 141 UNITED STATES TAX COURT REPORTS (440)

closed on petitioner’s financial statement, and the disputed

items were treated inconsistently for financial accounting

and tax reporting purposes. In addition, the liabilities giving

rise to the deductions were accrued over more than one tax-

able year. Under these circumstances, the liabilities gener-

ating the accelerated deductions were material for tax pur-

poses.

Petitioner had the burden of proving that the disputed

items were not material within the meaning of section

461(h)(3)(A)(iv)(I) and section 1.461–5(b)(4), Income Tax

Regs., and it did not do so. Accordingly, we hold that peti-

tioner may not use the recurring item exception to accrue

and deduct its liabilities under the Aspen, Primavera, Sur-

veyor’s, Invensys, and Otis Elevator agreements, or its

liability under the Bay Street lease, for periods after March

31, 2005, on petitioner’s income tax return for TYE March

31, 2005. In the light of our holding, we need not consider

whether the other requirements of the recurring item excep-

tion described in section 461(h)(3)(A) have been met.

III. Conclusion

Because neither the required performances nor the pay-

ment due dates with respect to the majority of the acceler-

ated deductions occurred before the close of petitioner’s TYE

March 31, 2005, petitioner failed to satisfy the first require-

ment of the all events test of section 461; i.e., petitioner

failed to prove that all of the events had occurred to establish

the fact of the liabilities under section 1.461–1(a)(2)(i),

Income Tax Regs. With respect to the remaining accelerated

deductions, petitioner did not satisfy all of the requirements

for the recurring item exception under section 461(h)(3) and,

consequently, is not excepted from the general rule of section

461(h)(1) requiring economic performance, because the liabil-

ities underlying the deductions were prorated over more than

one taxable year, were treated inconsistently for financial

statement and tax purposes, and were material items for tax

purposes within the meaning of section 461(h)(3)(A)(iv)(I).

See sec. 1.461–5(b)(4), Income Tax Regs.

VerDate Mar 15 2010 10:01 Feb 03, 2015 Jkt 000000 PO 00000 Frm 00037 Fmt 3857 Sfmt 3857 V:\FILES\BOUNDV~1.WIT\BVACDB~1.141\VECOCO~1 JAMIE

(440) VECO CORP. & SUBS. v. COMMISSIONER 477

To reflect the foregoing,

Decision will be entered for respondent.

f

VerDate Mar 15 2010 10:01 Feb 03, 2015 Jkt 000000 PO 00000 Frm 00038 Fmt 3857 Sfmt 3857 V:\FILES\BOUNDV~1.WIT\BVACDB~1.141\VECOCO~1 JAMIE