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jgordosea, Enrolled Agent
Category: Tax
Satisfied Customers: 3161
Experience:  I've prepared all types of taxes since 1987.
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Can a corporation deduct a contingent liability

Customer Question

If an accrual basis corporate taxpayer is involved in a $50,000 lawsuit, is it allowed to deduct the amount of this contingent liability on its Schedule C? If so, when can the deduction be taken?
Submitted: 9 years ago.
Category: Tax
Expert:  jgordosea replied 9 years ago.


Generally, the entity should be entitled to a deduction as soon as it meets the all-events test (the fact of the liability is fixed and the amount is determinable).

Section 461(h) and § 1.461-1(a)(2)(i) provide that, under the accrual method of accounting, a liability is incurred, and is generally taken into account for federal income tax purposes, in the taxable year in which (1) all the events have occurred that establish the fact of the liability, (2) the amount of the liability can be determined with reasonable accuracy, and (3) economic performance has occurred with respect to the liability.

I hope this is the information that you need. Please let me know if you need clarification.

jgordosea and other Tax Specialists are ready to help you
Customer: replied 9 years ago.
What is meant by "economic performance has ocurred"?
Expert:  jgordosea replied 9 years ago.

Hello again,

Section 461(h)(2)(A)(i) provides that, if the liability of the taxpayer arises out of the providing of services to the taxpayer by another person, economic performance occurs as that person provides the services. Generally, in a transaction where one taxpayer is accruing a liability to pay another taxpayer, the last event necessary to establish the fact of liability under the all events test of § 1.461-1(a)(2)(i) is the same event that fixes the right to receive income under the all events test of § 1.451-1(a).

In the case of a lawsuit there usually are no services to be performed and economic performance need not be considered.

I hope that helps to clarify the general rules.