Rev. Rul. 57-105

The Internal Revenue Service has been requested to state its position respecting the time for accrual for Federal income tax purposes of additional State income taxes asserted against a taxpayer for prior years.

The general rule applicable to taxpayers who keep their accounts and file their returns on the accrual method is that expenses should be accrued and deducted in the year in which the liability therefor is incurred. The courts have continuously expressed the view that all events must occur to fix a liability of the obligor before an obligation can be recognized by accrual on a taxpayers' books of account. United States v. Chauncey Anderson et al, 269, U. S. 422, T. D. 3839; C. B. V-1, 179 (1926).

Thus, an obligation is considered contingent when the existence of any liability at all is uncertain or when its existence depends upon the happening of a future contingent event. When a taxpayer disagrees with the determination of an additional tax liability, he is in effect disputing or contesting the existence of such additional liability. Therefore, until the contingency disappears and the fact of the additional liability becomes fixed and certain, there can be no accrual for tax purposes of the additional tax liability.

In G. C. M. 25298, C. B. 1947-2, 39, the term "contest" was held to include a contest lodged with the tax authorities as well as a contest in court. Therefore, unpaid amounts asserted against a taxpayer as additional tax liabilities, which amounts are the subject of a bona fide contest, are not accruable items for Federal income tax purposes while they are unsettled as to amount and prior to establishment of the fact of liability.

A "contest" arises any time there is a dispute as to the proper evaluation of the facts necessary to determine the correct tax liability. The soundness of this position is supported by the holding in the case of Great Island Holding Corp. v. Commissioner, 5 T. C. 150, cited with approval in Gunderson Bros. Engineering Corp. v. Commissioner, 16 T. C. 118.

The rationale of Gunderson Bros. Engineering Corp., supra, is that where a taxpayer files with the State taxing authorities a return reflecting only x dollars tax liability, the taxpayer is in effect denying any greater tax liability. At such time as the taxpayer properly recognizes or concedes a liability to the State for taxes in a greater amount than x dollars, the taxpayer is entitled to an accrual for the additional amount. Thus, an agreement between the taxpayer and the Internal Revenue Service with respect to the taxpayer's income for Federal income tax purposes is not necessarily determinative of the taxpayer's income for State tax purposes. It follows that a taxpayer is not entitled to accrue as additional tax liability an amount of State tax until the fact of liability is established and the amount thereof is settled.

Accordingly, in the case of an accrual method taxpayer, an increase in the amount of the State tax accrues and is allowable as a deduction for Federal income tax purposes when the amount is finally determined by litigation or default, or when the taxpayer acknowledges his liability to the State for the amount of such increase.

Pursuant to the authority granted by section 7805(b) of the Internal Revenue Code of 1954, the tax liability for taxable years ended prior to May 1, 1957, shall not be adjusted to apply this Revenue Ruling unless such adjustment is requested by the taxpayer in a timely claim for refund.

When the Federal excise tax on transportation of oil by pipeline is deductible by a carrier whose records are kept on the accrual basis. See Rev. Rul. 57-148, page 409.