## Facts

- A calendar-year corporation (X) uses the accrual method of accounting and has elected the recurring item exception under Treas. Reg. § 1.461-5.
- On December 15, 2006, X enters into a contract with Y for services to be performed from January 15 through January 31, 2007.
- The services contract requires payment on January 15, 2007, and X pays on that date.
- On December 15, 2006, X enters into an insurance contract with W (a state-regulated insurance company) for coverage from January 15, 2007, through December 31, 2007.
- The insurance premium is due January 15, 2007, and X pays on that date.
- In both situations, no services are performed and no insurance coverage is provided in 2006, and no payment is due in 2006.

## Issues

1. When does an accrual-method taxpayer incur a liability for services under I.R.C. § 461 and the related regulations?
2. When does an accrual-method taxpayer incur a liability for insurance under I.R.C. § 461 and the related regulations?
3. Whether an executory contract plus the recurring item exception permits deduction in the year the contract is executed when performance and payment are in the following year.

## Decision

- X does not incur either liability in 2006 merely by signing the executory contracts.
- The liabilities are incurred in 2007, no earlier than the earlier of (i) when the services/coverage begins or (ii) when payment becomes due (January 15, 2007).
- Because the “fact of the liability” is not established in 2006, the recurring item exception does not permit a 2006 deduction.

## Legal Principles

- Under the accrual method, a deduction generally is allowed only when (1) all events establish the fact of the liability, (2) the amount is reasonably determinable, and (3) economic performance has occurred. I.R.C. § 461; Treas. Reg. § 1.461-1(a)(2)(i).
- An executory contract, by itself, does not establish the fact of a liability for § 461 purposes; the liability must be firmly established rather than contingent on future performance.
- For services, economic performance occurs as the services are provided; for insurance, economic performance occurs as coverage is provided. Treas. Reg. § 1.461-4.
- The “fact of the liability” is established no earlier than the earlier of (i) the event fixing liability (such as performance or provision of coverage) or (ii) when payment is due.
- The recurring item exception may accelerate deduction only after the fact of liability and reasonable accuracy requirements are satisfied; it cannot treat a liability as incurred in a year when the only support is an executory contract.

## Conclusion

For accrual-method taxpayers, signing a contract in one tax year for services or insurance coverage beginning the next year does not, by itself, fix liability under § 461; the deduction is not available until the next year when payment becomes due or performance/coverage begins, and the recurring item exception cannot change that result.


Rev. Rul. 2007-3, 2007-1 C.B. 350 (2007)