United States: Deductible Settlement Payments for Subsidiary Wind-up, by Department
In a heavily drafted technical opinion published on April 23, 2021, the IRS examined whether an insolvent liquidating subsidiary could deduct certain liabilities. In TAM 202116012, several entities within a consolidated group, including the company in question and its direct parent company (which was a second-tier subsidiary of the US parent company of the consolidated group) were subject to a number of product liability claims in multi-district litigation. proceed. The entities resolved the claims by entering into several Master Settlement Agreements (MSAs) with the claimants.
- Reg. article 1.461-4 (d) (5) (i)
The company involved, then insolvent, converted from a company C to a limited liability company and checked the box to be treated as an ignored entity, which caused its parent company to acquire all of its assets and assume all its liabilities for tax purposes. The company in question included the fixed and determinable part of the settled liabilities arising from the MSAs in its amount realized on the deemed liquidation and sought to deduct these liabilities from the declaration of its consolidated group for the year which included the conversion and the presumed liquidation.
Section 162 generally allows taxpayers to deduct all ordinary and necessary expenses paid or incurred in a taxable year in carrying on a trade or business. Settlement payments related to a taxpayer’s business are generally deductible under section 162. See Rev. Rul. 80-211, 1980-2 CB 57 (âthe courts and the Service have recognized that payments made in settlement of lawsuits are deductible if the acts which gave rise to the dispute were carried out in the normal conduct of the taxpayer’s business “). However, determining when a deduction is allowed can be just as important (and potentially more complicated as) determining whether a deduction is allowed. Section 461 provides that any permitted deduction must be taken in the appropriate taxation year according to the accounting method used by the taxpayer in calculating taxable income. For taxpayers using the accrual method of accounting, such as the company involved in TAM 202116012, Treas. Reg. Article 1.461-1 (a) (2) (i) provides that the appropriate tax year for recognizing a liability is the tax year in which (1) all events have occurred establishing the made of the liability, (2) the amount of the liability can be reasonably ascertained, and (3) economic performance has occurred in relation to the liability. The rules for determining when economic performance occurs depend largely on the type of liability involved. For liabilities resulting from torts, breaches of contract, and breaches of law, economic performance is generally considered to occur only when liability is paid. Treas. Reg. article 1.461-4 (g) (2). If, in connection with the sale or exchange of a business or business, the assignee expressly assumes an accrued charge arising from that business or business that the assignor would have been entitled to deduct (or otherwise take into account). account for tax purposes) at the time of sale or exchange, but for the economic performance requirement, the economic performance with respect to the liability coincides with the liability being included in the amount realized by the transferor on the transaction. Treas.
Reg. article 1.461-4 (d) (5) (i)
The only question publicly addressed in TAM 202116012 is whether the parent company has assumed the subsidiary’s MSA liabilities so that the economic performance requirement has been met. Quoting Reverend Rul. 2003-125, 2003-2 CB 1243, the IRS explained that since the subsidiary was insolvent at the time of its conversion to an ignored entity, the parent company could not be considered to acquire the assets and liabilities of the subsidiary in exchange for the shares in the subsidiary. Instead, the parent company was to be viewed as buying the assets of the subsidiary in exchange for the parent taking over the subsidiary’s MSA liabilities (either by directly taking on those liabilities or by taking the assets. of the subsidiary subject to these liabilities). Thus, the IRS concluded that the economic performance requirement was met under Treas. Reg. article 1.461-4 (d) (5) (i), and the subsidiary was therefore able to benefit from a deduction under article 162 for its obligations under the MSA.
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