The IRS has concluded that a manufacturer was able to deduct chargeback reimbursements it made to its wholesalers and distributors. 

The IRS said the manufacturer met the “all events test” and further concluded that the recurring-item exception to the economic performance rule allowed the accrual-method manufacturer to deduct chargeback reimbursements actually made in the following year [Legal Advice Issued by Field Attorneys (LAFA) 20121602F]. 

Under the accrual accounting method, a liability is generally deducted in the tax year in which: 

• All the events have occurred that establish the fact of the liability;
• The amount of the liability can be determined with reasonable accuracy; and
• Economic performance has occurred.  

Generally, the all-events test is not met any earlier than when economic performance occurs.  

Under the recurring-item exception to the general rule of economic performance, a liability is deductible if:  

• At the end of the tax year, all events have occurred that establish the fact of the liability, and the amount can be determined with reasonable accuracy;
• Economic performance occurs on or before the earlier of
  • The date that the company files its return for the tax year, or
  • The 15th day of the ninth calendar month after the close of the tax year;
• The liability is recurring in nature; and
• Either the amount of the liability is not material, or accrual of the liability results in better matching of the liability against the income to which it relates.

In the facts presented in the LAFA, a manufacturer negotiated discounted prices with certain preferred customers. Its wholesalers/distributors were required to accept the discounted prices, which were less than their cost for the items.

The wholesalers/distributors then submitted documents and were reimbursed by the manufacturer. The manufacturer deducted an estimate of the chargeback reimbursement liability based upon its historical pricing information and other data.

The IRS concluded that the all-events test was met when a wholesaler/distributor sold to end-user customers. At that time, the wholesaler/distributor’s right to demand a chargeback reimbursement was unconditional.

Whether the manufacturer’s data allowed it to estimate the amount of its liability with reasonable accuracy had to be determined on examination. However, the IRS stated that an estimate based on reliable inputs and reasonable methodology is generally acceptable.

The IRS also concluded that the manufacturer was entitled to use the recurring-item exception and could deduct the accrual for chargeback reimbursements that were paid within the first 8 1/2 months of the following tax year.

Note that, although LAFAs may not be used or cited as precedent, they do provide an insight into the IRS’s own field attorneys’ interpretation of the law.