Matching Deductions to Payments: Payer/payee Rules Are Not Always Clear

Article excerpt

EXECUTIVE SUMMARY

* The matching concept is often used to test whether a particular accounting method clearly reflects income. However, the IRS's requirement that one taxpayer's revenue match another's expense may not be upheld by the courts unless the situation is governed by a specific statutory or regulatory rule.

* Transactions among corporations that are part of the same consolidated group require the payer and the payee to be treated as one entity.

* IRC section 267(a)(2) prevents related taxpayers that use different accounting methods from taking a current deduction on one hand but deferring income recognition on the other. Related taxpayers include corporate controlled groups with a 50% stock ownership requirement.

* IRC section 404(d) does not permit any deduction for payments to independent contractors until the year the contractor includes the compensation in income. Compensation to such nonemployees deferred more than 2 1/2 months after the close of the payer's taxable year cannot be deducted until the payee recognizes the income.

* An employer that transfers property for services may take a deduction equal to the amount required to be included in the recipient's income. The service provider must include the fair market value of the property in income in the first year the rights are either transferable by the recipient or not subject to substantial risk of forfeiture.

* Section 274(e)(2) now requires an amount match in income in the same period for entertainment expenses for goods, services or facilities provided to officers, directors or 10%-or-greater owners (or parties related to them). But under the Sutherland Lumber-Southwest rule, the company can deduct its actual cost for providing such items to other employees.

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In most situations, as CPAs know, income must be measured by matching revenue and expenses for the same time period. There are a number of instances, however, in which this general rule does not apply for tax purposes--so many, in fact, that CPAs must pay careful attention to the laws and regulations that govern these situations. In addition, new provisions in the American Jobs Creation Act of 2004 and the Gulf Opportunity Zone Act of 2005 affect the rules in some circumstances.

This article analyzes a number of the instances in which the income/deduction matching concept is broadened for tax purposes. (See "Income/Deduction Matching Provisions," page 61, for a list of the provisions discussed in the text.)

THE MATCHING PRINCIPLE

The matching concept is often used to test whether a taxpayer's particular accounting method clearly reflects income. To help protect the tax base, the IRS has broadened tax matching beyond the traditional matching of revenue and expenses to include payer/ payee matches. That is, before one taxpayer can record a deduction, another must report a similar amount of income in the same period. Thus income and expenses are matched--but for different taxpayers.

The IRS's need for special rules is underscored by the fact that the courts have not definitively ruled on requiring payer/ payee matches. Thus it is questionable whether the requirement that one taxpayer's revenue match another's expense will be upheld unless the situation is governed by a specific statutory or regulatory rule. The rules discussed seem to be conditioned on the degree of the relationship between payers and payees. That is, the closer the relationship the greater is the restriction placed on the payer's ability to record a deduction.

INTERCOMPANY TRANSACTIONS AND CONSOLIDATED RETURNS

CPAs who deal with corporate clients or employers must be aware that the most restrictive requirements for payer/payee matching involve transactions among companies that are part of the same consolidated group. In these situations, payer and payee are considered part of the same entity. …