[Federal Register Volume 68, Number 225 (Friday, November 21, 2003)]
[Rules and Regulations]
[Pages 65634-65637]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 03-29161]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[TD 9095]
RIN 1545-BA91


Transfers To Provide for Satisfaction of Contested Liabilities

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final and temporary regulations.

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SUMMARY: This document contains regulations relating to transfers of 
money or other property to provide for the satisfaction of contested 
liabilities. The regulations affect taxpayers that are contesting an 
asserted liability and that transfer their own stock or indebtedness, 
the stock or indebtedness of a related party, or a promise to

[[Page 65635]]

provide services or property in the future, to provide for the 
satisfaction of the liability prior to the resolution of the contest. 
The regulations also affect taxpayers that transfer money or other 
property to a trust, an escrow account, or a court to provide for the 
satisfaction of a liability for which payment is economic performance. 
The text of these temporary regulations also serves as the text of the 
proposed regulations set forth in the notice of proposed rulemaking on 
this subject in the Proposed Rules section in this issue of the Federal 
Register.

DATES: Effective Date: These regulations are effective November 19, 
2003.
    Applicability Dates: For dates of applicability, see Sec.  1.461-
2T(g).

FOR FURTHER INFORMATION CONTACT: Norma Rotunno, (202) 622-7900 (not a 
toll free number).

SUPPLEMENTARY INFORMATION: 

Background

    This document contains amendments to the Income Tax Regulations (26 
CFR part 1) under section 461(f) of the Internal Revenue Code (Code) 
relating to the transfer of money or other property to provide for the 
satisfaction of an asserted liability that a taxpayer is contesting. 
Section 461(f) provides an exception to the general rules of tax 
accounting by allowing a taxpayer to deduct a contested liability in a 
year prior to the resolution of the contest if the following conditions 
are met: (1) The taxpayer contests an asserted liability, (2) the 
taxpayer transfers money or other property to provide for the 
satisfaction of the asserted liability, (3) the contest with respect to 
the asserted liability exists after the time of transfer, and (4) but 
for the fact that the asserted liability is contested, a deduction 
would be allowed for the taxable year of the transfer (or for an 
earlier taxable year) determined after the application of the economic 
performance rules. If these requirements are satisfied, a taxpayer may 
deduct the liability in the taxable year of the transfer.
    Section 461(f)(2) requires the taxpayer to transfer money or other 
property to provide for the satisfaction of the asserted liability. 
Neither the statute nor the regulations specifically define money or 
other property. The examples in the regulations and the legislative 
history involve only transfers of cash.
    Under Sec.  1.461-2(c)(1) of the Income Tax Regulations, a transfer 
for the satisfaction of an asserted liability is a transfer of money or 
other property beyond the taxpayer's control to: (1) The person 
asserting the liability, (2) an escrowee or trustee pursuant to a 
written agreement (among the escrowee or trustee, the taxpayer, and the 
person who is asserting the liability) providing that the money or 
other property be delivered in accordance with the settlement of the 
contest, (3) an escrowee or trustee pursuant to an order of a court or 
government entity providing that the money or other property be 
delivered in accordance with the settlement of the contest, or (4) a 
court with jurisdiction over the contest. The taxpayer must relinquish 
all authority over the money or other property transferred.
    To qualify for a deduction, section 461(f)(4) provides that a 
deduction is allowed in the taxable year of the transfer only if, but 
for the fact that the asserted liability is contested, a deduction 
would be allowed for the taxable year of the transfer (or for an 
earlier taxable year) A determined after application of subsection 
(h).'' Congress added the quoted language to section 461(f)(4) when 
Congress enacted section 461(h), which provides, for amounts with 
respect to which a deduction would be allowable after July 18, 1984, 
that the all events test is not met any earlier than when economic 
performance has occurred with respect to the liability. Section 
461(h)(2)(C) provides that payment to another person is required to 
satisfy economic performance for liabilities arising out of any workers 
compensation act or any tort. The Conference Report accompanying 
enactment of section 461(h) explains the impact of the economic 
performance requirement on trusts established under section 461(f):

    In the case of workers' compensation or tort liabilities of the 
taxpayer requiring payments to another person, economic performance 
occurs as payments are made to that person. Since payment to a 
section 461(f) trust is not a payment to the claimant and does not 
discharge the taxpayer's liability to the claimant, such payment 
does not satisfy the economic performance test.

H. R. Rep. No. 861, 98th Cong., 2d Sess. 871, 876 (1984).
    For transfers in taxable years beginning after December 31, 1991, 
Sec.  1.461-4(g)(2)-(7) expands the list of liabilities for which 
payment to the person ``to which the liability is owed'' constitutes 
economic performance (payment liabilities). The additional payment 
liabilities listed in Sec.  1.461-4(g)(2)-(6) include liabilities for 
breach of contract (to the extent of incidental, consequential, and 
liquidated damages) or violation of law, rebates and refunds, awards, 
prizes, jackpots, insurance, warranty and service contracts, and taxes. 
In addition, Sec.  1.461-4(g)(7) characterizes as payment liabilities 
other liabilities for which other specific rules are not provided.
    Section 1.461-4(g)(1)(ii)(A) provides that payment does not include 
the furnishing of a note or other evidence of indebtedness of the 
taxpayer.
    Section 1.461-4(g)(1)(i) provides that, for liabilities for which 
payment is economic performance, economic performance does not occur as 
a taxpayer makes payments in connection with a liability to any other 
person, including a trust, escrow account, court-administered fund, or 
any similar arrangement, unless the payments constitute payment to the 
person to which the liability is owed under paragraph (g)(1)(ii)(B). 
Section 1.461-4(g)(1)(ii)(B) states that payment is accomplished if a 
cash basis taxpayer in the position of the person to which the 
liability is owed would be treated as having actually or constructively 
received the amount of the payment as gross income under section 451.

Explanation of Provisions

Transfers of Property To Provide for the Satisfaction of an Asserted 
Liability

    The regulations remove Sec.  1.461-2(c)(1) and add Sec.  1.461-
2T(c)(1). The temporary regulations restructure the provisions of 
current Sec.  1.461-2(c)(1) for greater clarity but retain all of the 
rules in Sec.  1.461-2(c)(1), including the requirement that the 
taxpayer must transfer money or other property beyond the taxpayer's 
control and relinquish all authority over the money or other property 
transferred. The temporary regulations clarify that the transfer of the 
indebtedness of a taxpayer or of any promise by the taxpayer to provide 
services or property in the future is not a transfer to provide for the 
satisfaction of an asserted liability. See Eckert v. Burnet, 283 U.S. 
140 (1931); Willamette Industries, Inc., v. Commissioner, 92 T.C. 1116 
(1989), aff'd, 149 F. 3d 1057 (9th Cir. 1998). In addition, the 
temporary regulations provide the express rule that a transfer (other 
than to the person asserting the liability) of a taxpayer's stock, or 
the indebtedness or stock of a person related to the taxpayer (as 
defined in section 267(b)), is not a transfer to provide for the 
satisfaction of an asserted liability. These rules are consistent with 
section 468B(d)(1)(B), which excludes as a qualified payment to a 
designated settlement fund the transfer of any stock or indebtedness of 
the taxpayer (or any related person). See Sec.  1.461-4(g)(1)(ii)(A), 
which provides that payment does not include the furnishing of a note 
or other evidence of

[[Page 65636]]

indebtedness of the taxpayer or a promise of the taxpayer to provide 
services or property in the future.

Economic Performance Rules for Payment Liabilities

    Section 1.461-4(g) provides that economic performance occurs in the 
case of a liability requiring payment to another person arising out of 
a workers compensation act, tort, or other designated liability as 
payments are made to the person to which the liability is owed. 
Therefore, the temporary regulations provide in Sec.  1.461-2T(e)(2) 
that, except as provided in section 468B or the regulations thereunder, 
economic performance does not occur when a taxpayer transfers money or 
other property to a trust, escrow account, or court to provide for the 
satisfaction of a contested workers compensation, tort, or other 
liability designated in Sec.  1.461-4(g) unless the trust, escrow 
account, or court is the claimant or the taxpayer's payment to the 
trust, escrow account, or court discharges the taxpayer's liability to 
the claimant. See Maxus Energy Corporation and Subsidiaries v. United 
States, 31 F.3d 1135 (Fed. Cir. 1994). Rather, economic performance 
occurs in the taxable year in which the taxpayer transfers money or 
other property to the person asserting the liability that the taxpayer 
is contesting, or in the taxable year in which payment from the trust, 
escrow account, or court registry is made to the person to which the 
liability is owed.

Effective Date

    In general, the temporary regulations apply to transfers made in 
taxable years beginning after December 31, 1953, and ending after 
August 16, 1954. However, the temporary regulations apply to transfers 
of any stock of the taxpayer or any stock or indebtedness of a related 
person on or after November 19, 2003. Section 1.461-2T(e)(2)(i) applies 
to transfers of money or other property after July 18, 1984, the 
effective date of section 461(h). Similarly, Sec.  1.461-2T(e)(2)(ii) 
applies to transfers of money or other property after July 18, 1984, to 
satisfy workers compensation or tort liabilities, and applies to 
transfers of money or other property in taxable years beginning after 
December 31, 1991, the effective date of Sec.  1.461-4(g), to satisfy 
payment liabilities designated under Sec.  1.461-4(g) (other than 
liabilities for workers compensation or tort).

Special Analyses

    It has been determined that this Treasury decision is not a 
significant regulatory action as defined in Executive Order 12866. 
Therefore, a regulatory assessment is not required. It also has been 
determined that section 553(b) of the Administrative Procedure Act (5 
U.S.C. chapter 5) does not apply to these regulations. Please refer to 
the cross-referenced notice of proposed rulemaking published elsewhere 
in this issue of the Federal Register for applicability of the 
Regulatory Flexibility Act (5 U.S.C. chapter 6). Pursuant to section 
7805(f) of the Code, these temporary regulations will be submitted to 
the Chief Counsel for Advocacy of the Small Business Administration for 
comment on their impact on small business.

Drafting Information

    The principal author of these regulations is Norma Rotunno of the 
Office of the Associate Chief Counsel (Income Tax & Accounting). 
However, other personnel from the IRS and Treasury participated in 
their development.

List of Subjects in 26 CFR Part 1

    Income taxes, Reporting and recordkeeping requirements.

Amendments to the Regulations

0
Accordingly, 26 CFR part 1 is amended as follows:

PART 1--INCOME TAXES

0
1. The authority citation for part 1 continues to read in part as 
follows:

    Authority: 26 U.S.C. 7805 * * *

0
2. Section 1.461-2 is amended by:
0
1. Removing paragraph (a)(5).
0
2. Revising paragraph (c)(1).
0
3. Redesignating paragraph (e)(2) as paragraph (e)(3) and revising it.
0
4. Adding new paragraph (e)(2).
    The addition and revisions read as follows:


Sec.  1.461-2  Contested liabilities.

* * * * *
    (c) * * *
    (1) [Reserved]. For further guidance, see Sec.  1.461-2T(c)(1).
* * * * *
    (e) * * *
    (2) [Reserved]. For further guidance, see Sec.  1.461-2T(e)(2).
    (3) Examples. The provisions of this paragraph are illustrated by 
the following examples:

    Example 1. A, an individual, makes a gift of certain property to 
B, an individual. A pays the entire amount of gift tax assessed 
against him but contests his liability for the tax. Section 
275(a)(3) provides that gift taxes are not deductible. A does not 
satisfy the requirement of paragraph (a)(1)(iv) of this section 
because a deduction would not be allowed for the taxable year of the 
transfer even if A did not contest his liability to the tax.

    Example 2. [Reserved]. For further guidance, see Sec.  1.461-
2T(e)(3), Example 2.
* * * * *

0
4. Section 1.461-2T is added to read as follows:


Sec.  1.461-2T  Contested liabilities (temporary).

    (a) and (b) [Reserved]. For further guidance, see Sec.  1.461-2(a) 
and (b).
    (c) Transfer to provide for the satisfaction of an asserted 
liability--(1) In general. (i) A taxpayer may provide for the 
satisfaction of an asserted liability by transferring money or other 
property beyond his control to--
    (A) The person who is asserting the liability;
    (B) An escrowee or trustee pursuant to a written agreement (among 
the escrowee or trustee, the taxpayer, and the person who is asserting 
the liability) that the money or other property be delivered in 
accordance with the settlement of the contest;
    (C) An escrowee or trustee pursuant to an order of the United 
States or of any State or political subdivision thereof or any agency 
or instrumentality of the foregoing, or of a court, that the money or 
other property be delivered in accordance with the settlement of the 
contest; or
    (D) A court with jurisdiction over the contest.
    (ii) In order for money or other property to be beyond the control 
of a taxpayer, the taxpayer must relinquish all authority over the 
money or other property.
    (iii) The following are not transfers to provide for the 
satisfaction of an asserted liability--
    (A) Purchasing a bond to guarantee payment of the asserted 
liability;
    (B) An entry on the taxpayer's books of account;
    (C) A transfer to an account that is within the control of the 
taxpayer;
    (D) A transfer of any indebtedness of the taxpayer or of any 
promise by the taxpayer to provide services or property in the future; 
and
    (E) A transfer to a person (other than the person asserting the 
liability) of any stock of the taxpayer or of any stock or indebtedness 
of a person related to the taxpayer (as defined in section 267(b)).
    (c)(2) through (d) [Reserved]. For further guidance, see Sec.  
1.461-2(c)(2) through (d).
    (e) Deduction otherwise allowed--(1) [Reserved]. For further 
guidance, see--Sec.  1.461-2(e)(1).
    (2) Application of economic performance rules to transfers under

[[Page 65637]]

section 461(f). (i) A taxpayer using an accrual method of accounting is 
not allowed a deduction under section 461(f) in the taxable year of the 
transfer unless economic performance has occurred.
    (ii) Economic performance occurs for liabilities requiring payment 
to another person arising out of any workers compensation act or any 
tort, or any other liability designated in Sec.  1.461-4(g), as 
payments are made to the person to which the liability is owed. Except 
as provided in section 468B or the regulations thereunder, economic 
performance does not occur when a taxpayer transfers money or other 
property to a trust, an escrow account, or a court to provide for the 
satisfaction of an asserted workers compensation, tort, or other 
liability designated under Sec.  1.461-4(g) that the taxpayer is 
contesting unless the trust, escrow account, or court is the person to 
which the liability is owed or the taxpayer's payment to the trust, 
escrow account, or court discharges the taxpayer's liability to the 
claimant. Rather, economic performance occurs in the taxable year the 
taxpayer transfers money or other property to the person that is 
asserting the workers compensation, tort, or other liability designated 
under ``Sec.  1.461-4(g) that the taxpayer is contesting or in the 
taxable year that payment is made from a trust, an escrow account, or a 
court registry funded by the taxpayer to the person to which the 
liability is owed.
    (3) Examples. The provisions of this paragraph (e) are illustrated 
by the following examples:

    Example 1. [Reserved]. For further guidance, see Sec.  1.461-
2(e)(3), Example 1.

    Example 2. Corporation X is a defendant in a class action suit 
for tort liabilities. In 2002, X establishes a trust for the purpose 
of satisfying the asserted liability and transfers $10,000,000 to 
the trust. The trust does not satisfy the requirements of section 
468B or the regulations thereunder. In 2004, the trustee pays 
$10,000,000 to the plaintiffs in settlement of the litigation. Under 
paragraph (e)(2) of this section, economic performance with respect 
to X's liability to the plaintiffs occurs in 2004. X may deduct the 
$10,000,000 payment to the plaintiffs in 2004.

    (f) [Reserved]. For further guidance, see Sec.  1.461-2(f).
    (g) Effective date. (1) Except as otherwise provided, this section 
applies to transfers of money or other property in taxable years 
beginning after December 31, 1953, and ending after August 16, 1954.
    (2) Paragraph (c)(1)(iii)(E) of this section applies to transfers 
of any stock of the taxpayer or any stock or indebtedness of a person 
related to the taxpayer on or after November 19, 2003.
    (3) Paragraph (e)(2)(i) of this section applies to transfers of 
money or other property after July 18, 1984.
    (4) Paragraphs (e)(2)(ii) and (e)(3) of this section apply to--
    (i) Transfers after July 18, 1984, of money or other property to 
provide for the satisfaction of an asserted workers compensation or 
tort liability; and
    (ii) Transfers in taxable years beginning after December 31, 1991, 
of money or other property to provide for the satisfaction of asserted 
liabilities designated in Sec.  1.461-4(g) (other than liabilities for 
workers compensation or tort).

    Approved: November 12, 2003.
Mark E. Matthews,
Deputy Commissioner for Services and Enforcement.
    Approved: November 12, 2003.
Pamela F. Olson,
Assistant Secretary of the Treasury.
[FR Doc. 03-29161 Filed 11-19-03; 8:45 am]
BILLING CODE 4830-01-P