denied the deduction, the U.S. Court of
Claims overruled the IRS, and the U.S.
Court of Appeals for the Federal Circuit
affirmed the Court of Claims. The Supreme Court reversed that decision and
backed the IRS. The Supreme Court reasoned that the claimed deduction failed
the all-events test, finding that the last
event determining the liability was the
actual filing of a claim with the plan, not
the underlying medical service.
Has anything changed today that might
persuade a court that General Dynamics
shouldn’t govern similar facts? Perhaps
IBNR calculation can be taken beyond
mere estimate by including a professional actuarial certification. Or you might
argue that modern claims processing is
much different from what it was in 1972,
with electronic transmission at the point
of service making modern estimates more
accurate and presumably lower. Either
would be aggressive, however, ignoring the
court’s statement that the event isn’t the
medical service but the filing of the claim.
Prudence would dictate following
General Dynamics and assuming that
the IRS successfully would challenge
such IBNR deductions if it found them.
(At least this is what we would have concluded before Sept. 8, 2008, the date that
the IRS issued Revenue Procedure 2008-
52, which we will discuss farther down.)
The economic performance Test
Did the concept of economic performance
change anything? Or did it only make it
harder to accrue and deduct IBNR?
This new, third prong of deductible
accrual can be found in Section 461(h).
As stated, it stipulates that “all events”
cannot occur earlier than “economic
performance.” To avoid the General Dynamics rule, however, taxpayers need
to meet the all-events test earlier, not
later. It’s apparent that economic performance only can delay satisfaction of
the all-events test, leaving the accrual
camp’s position hollow. (Again, before
Sept. 8, 2008—after this, it rings virtually true except for Section 263A.)
We examined how the IRS interprets
Section 461(h) as it applies to employee
benefit plans. IRS Reg. Section 1.461-
4(d)( 2)(i) outlines the parameters of
economic performance as follows: “(i)
In general… if the liability of a taxpayer
arises out of the providing of services
or property to the taxpayer by another
person, economic performance occurs
as the services or property is provided.”
This general rule can be interpreted
as meaning that economic performance
can occur by the end of the taxable year
to which it pertains, since the IBNR will
relate to and be employee compensation
(generally tax-free) for services performed in that year. That reading gives
partial support to an accrual-basis employer who decides to deduct IBNR for
a year without actually contributing to it
(assuming General Dynamics presents no
bar to meeting “all events” by that date).
Subparagraph (d)( 2)(iii), however,
clouds things: “…Except as otherwise
provided in any Internal Revenue regu-
lation, revenue procedure, or revenue
ruling, the economic performance re-
quirement is satisfied to the extent that
any amount is otherwise deductible un-
der § 404 (employer contributions to a
plan of deferred compensation), § 404A
(certain foreign deferred compensation
plans), and § 419 (welfare benefit funds).
See § 1.461-1(a) ( 2) (iii) (D).”
Is this special rule meant to override
the general rule for economic perfor-
mance? Section 404 and Section 404A
clearly address deferred compensation
plans and have no relevance to IBNR.
The only other “otherwise deductible” authorization is Section 419, which
places all taxpayers on a cash basis for
welfare plan funding.
So, is the IRS trying to say that
whether an accrual taxpayer’s plan is
self-funded or funded, its deduction for
any plan cost (not just IBNR) is available
only in the year in which it’s paid or con-
tributed? Or is it addressing only funded
plans, with self-funded or partially self-
funded plans being under the general
rule for the self-funded portion?
The astonishing Rev.
proc. 2008-52
At least before Sept. 8, 2008, when IRS
issued Rev. Proc. 2008-52, the favorable
reading sought by accrual taxpayers would
have done nothing to satisfy the all-events
test as interpreted in General Dynamics.
The court clearly defines the “event” as
submission of the claim, not the underly-
ing medical service. That can occur in the
year after the year IBNR is accrued. This
was the flaw we saw in the pro-accrual
argument. Such arguments, viewed most
favorably, at best get only two-thirds of
the way there (reasonably ascertainable in
amount with economic performance hav-
ing occurred). In this area, however, two
out of three isn’t good enough.
