Rev. Rul. 72-34

Advice has been requested whether the Internal Revenue Service will follow the decision of the Court of Appeals for the Third Circuit in Commissioner v. Lukens Steel Co., 442 F.2d 1131, affirming 52 T.C. 764 (1969).

The issue in the Lukens case was whether an accrual method taxpayer may deduct currently amounts recorded on its books as a "Contingent Liability", computed on an amount per hour of man-hours of labor, under a union-management negotiated supplemental unemployment benefit plan where payment of the amounts is contingent upon the occurrence of one of the following events: (1) the balance in the cash supplemental unemployment benefits plan trust drops below a designated level; (2) the plan is terminated by agreement of the parties; or (3) the taxpayer ceases business operations.

The Plan provided for contributions by the taxpayer of an amount per man hour of labor performed, up to a maximum funding limitation. The Plan was designed to reach maximum funding limitation within a few years from its outset. Additional contributions were computed only to the extent needed to restore maximum funding. Annual "contributions" computed under the per man hour of labor formula were split between the portion paid directly to the trust and the portion attributed to the taxpayer's contingent liability account. All payments for supplemental unemployment benefits were to be made first out of amounts on hand in the trust and then by the taxpayer to the extent recorded in the taxpayer's contingent liability account. In this fashion when the amounts paid directly to the trust fund for the Plan were substantially exhausted then the amounts represented by the taxpayer's contingent liabiilty account were used to satisfy the maximum funding limitations. After reaching maximum funding limitation there was a very significant decrease in the annual required direct and contingent "contributions" to the Plan by the taxpayer.

The court held that the above-described contingencies only affected the timing of the cash payout, and not the taxpayer's liability under the plan. Thus, the court concluded that the liability was fixed in the year recorded under the taxpayer's method of accounting, and therefore satisfied the requirements of section 162 and 461 of the Internal Revenue Code of 1954. In particular, the court held that the "all events" test prescribed in section 1.461-1(a)(2) of the Income Tax Regulations was satisfied, and that the taxpayer's liability was fixed at the time the employees performed the required man-hours of labor.

The "all-events" test set forth in section 1.461-1(a)(2) of the regulations is that an expense is deductible by an accrual method taxpayer for the taxable year in which all the events have occurred which determine the fact of the liability, and the amount thereof can be determined with reasonable accuracy. See also United States v. Anderson, 269 U.S. 422 (1926), T.D. 3839, C.B. V-1, 179 (1926). If there is any doubt that the liability will occur, it may not be deducted until the liability becomes absolute. See Brown v. Helvering, 291 U.S. 193, 201 (1934), Ct. D. 786, C.B. XIII-1, 223 (1934). It is the position of the Internal Revenue Service that where there exists a contingency as to payment of an obligation, and such contingency relates to other than the ability of the obligor to pay, it cannot be said that the obligation is fixed within the meaning of section 1.461-1(a)(2) of the regulations. In such cases it cannot be said that all the events have occurred that fix the taxpayer's liability and obligation to pay, and, therefore, no deduction is currently allowable for Federal income tax purposes. Furthermore, in cases such as Commissioner v. Lukens Steel Company, where a contingency as to payment of an obligation is created at the same time and in the same instrument establishing the debt, or where they are otherwise concurrently created in a related transaction, that contingency invades liability as well as timing of payment. Accordingly, in such cases, for that portion of the "liability" not paid out by the taxpayer but rather retained for use in the business, no deduction will be allowed until that time when the taxpayer becomes currently obligated to make an actual cash payment under the supplemental unemployment benefit plan.

In view of the foregoing, the Service will not follow the Lukens Steel Co. case as a precedent in the disposition of similar cases.