                             141 T.C. No. 14



                   UNITED STATES TAX COURT



    VECO CORPORATION AND SUBSIDIARIES, Petitioner v.
    COMMISSIONER OF INTERNAL REVENUE, Respondent



Docket No. 24918-10.                           Filed November 20, 2013.



       On its Federal income tax return for the taxable year ending
Mar. 31, 2005 (TYE 2005), P, an accrual method taxpayer,
implemented a proposed change in accounting method and in so
doing accelerated deductions for parts of certain liabilities
attributable to periods after the close of P’s TYE 2005. R rejected P’s
proposed change in accounting method and denied P’s claimed
accelerated deductions. P claims that it was entitled to accelerate the
deductions under the “all events” test of I.R.C. sec. 461 and/or the
recurring item exception to the economic performance rules of I.R.C.
sec. 461(h)(3). For financial statement purposes petitioner accrued
the liabilities over more than one taxable year. P treated the liabilities
inconsistently for financial statement and tax purposes.

       Held: Because neither the required performances nor the
payment due dates with respect to the majority of the accelerated
deductions occurred before the close of P’s TYE 2005, P failed to
satisfy the first requirement of the all events test of I.R.C. sec. 461;
                                         -2-

      i.e., P failed to prove that all of the events had occurred to establish
      the fact of the liabilities under sec. 1.461-1(a)(2)(i), Income Tax
      Regs.

             Held, further, with respect to the remaining accelerated
      deductions, P did not satisfy all of the requirements for the recurring
      item exception under I.R.C. sec. 461(h)(3) and, consequently, is not
      excepted from the general rule of I.R.C. sec. 461(h)(1) requiring
      economic performance, because the liabilities underlying the
      deductions were prorated over more than one taxable year, were
      treated inconsistently for financial statement and tax purposes, and
      were material items for tax purposes within the meaning of I.R.C. sec.
      461(h)(3)(A)(iv)(I). See sec. 1.461-5(b)(4), Income Tax Regs.



      Christina M. Passard, for petitioner.

      Davis G. Yee and Keith G. Medleau, for respondent.



                                      OPINION


      MARVEL, Judge: On its Federal income tax return for the taxable year

ending (TYE) March 31, 2005, VECO Corp. & Subsidiaries (collectively,

petitioner or affiliated group), which used the accrual method of accounting,

implemented a proposed change in accounting method that accelerated

approximately $5,010,305 of deductions for parts of certain liabilities attributable

to periods after the close of petitioner’s TYE March 31, 2005. Petitioner contends
                                        -3-

it was entitled to accelerate its deductions for these expenses under the “all events”

test of section 4611 and/or the recurring item exception to the economic

performance rules under section 461(h)(3). In a notice of deficiency dated August

17, 2010, respondent disallowed the portions of the deductions attributable to

periods after March 31, 2005, and accordingly determined a $1,919,359 deficiency

in the Federal income tax of petitioner for TYE March 31, 2005.

      After concessions,2 the issues for decision are: (1) whether, under the all

events test of section 461, petitioner properly accelerated and deducted on its

Federal income tax return for TYE March 31, 2005, certain expenses attributable

to periods ending after TYE March 31, 2005; (2) alternatively, whether section



      1
       Unless otherwise indicated, all section references are to the Internal
Revenue Code, as amended and in effect for the year in issue, and all Rule
references are to the Tax Court Rules of Practice and Procedure. Some monetary
amounts have been rounded to the nearest dollar.
      2
        With respect to the economic performance requirement of the all events
test, petitioner concedes that it did not satisfy the 3-1/2-month rule of sec. 1.461-
4(d)(6)(ii), Income Tax Regs., for any of the deductions in issue. With respect to
the recurring item exception to the general rule of economic performance,
petitioner concedes that it did not satisfy the matching requirement (i.e., the fourth
requirement of the recurring item exception) under sec. 1.461-5(b)(1)(iv)(B) and
(5), Income Tax Regs., for any deductions in issue, with the exception of its
deduction for insurance premium expenses. Respondent concedes that petitioner
satisfied the economic performance and matching requirements of the recurring
item exception for petitioner’s claimed deduction for insurance premium expenses.
See sec. 461(h)(3)(A)(ii), (iv); sec. 1.461-5(b)(ii), (iv), Income Tax Regs.
                                         -4-

467 prevents petitioner from using the recurring item exception under section

461(h)(3) to accelerate deductions for expenses attributable to an equipment lease

and certain real estate leases;3 and (3) if petitioner properly claimed deductions for

expenses under amendment XIV to the 949 East 36th Avenue lease and the 949

East 36th Avenue commercial sublease agreement for the period after March 31,

2005, whether, under section 1.1502-13(c), Income Tax Regs., petitioner must

include in income the rent petitioner received under those leases for the same

period. Because we conclude that petitioner did not properly deduct the

accelerated expenses attributable to periods after March 31, 2005 on its Federal

income tax return for TYE March 31, 2005, we do not reach issues (2) and (3).

                                    Background

      The parties submitted this case fully stipulated under Rule 122. We

incorporate the stipulated facts, and facts drawn from stipulated exhibits, into our

findings by this reference.




      3
       These leases include the Frontier Building lease, see infra pp. 22-23, the
6411 A Street lease, see infra pp. 23-24, amendment XIV to the 949 East 36th
Avenue lease, see infra pp. 25-26, and the 949 East 36th Avenue commercial
sublease agreement, see infra pp. 26-27.
                                        -5-

I.    Background

      VECO Corp. is a corporation organized and existing under Delaware law

with its principal office in Alaska. VECO Corp. is the common parent of an

affiliated group of corporations that includes VECO Equipment, Inc. (VECO

Equipment), VECO Services, Inc. (VECO Services), VECO Alaska, Inc. (VECO

Alaska),4 VECO USA, Inc. (VECO USA),5 VECO 36th Avenue, Inc. (VECO 36th

Avenue), VECO Properties, Inc. (VECO Properties),6 Norcon, Inc., RTX, Inc.,

HEBL, Inc., and VECO Federal, Inc.

      Petitioner is engaged in various business activities including oil and gas

field services, newspaper publishing, manufacturing, construction, equipment

rental, wholesale sales, leasing, and engineering. During years preceding and

including the taxable year in issue petitioner entered into a number of service

contracts, licensing contracts, insurance contracts, and real property and

equipment leases, described infra.


      4
       During TYE March 31, 2005, VECO Alaska was a subsidiary of VECO
Services.
      5
      VECO USA formerly was known as Veco Rocky Mountain, Inc. (Veco
Rocky Mountain), which itself formerly was known as VECO Rapley, Inc., and/or
Rapley Engineering Services, Inc. (Rapley Engineering Services).
      6
      During TYE March 31, 2005, VECO Properties was a subsidiary of VECO
Equipment, itself a subsidiary of VECO Corp.
                                       -6-

      Petitioner prepared consolidated financial statements in accordance with

generally accepted accounting principles (GAAP) for fiscal years ending (FYE)

March 31, 2005, 2006, and 2007. Petitioner maintained general ledgers and

working trial balances for each member of the affiliated group for FYE March 31,

2005. For Federal income tax purposes, petitioner uses the accrual method of

accounting and has a TYE March 31.

II.   Petitioner’s Tax Reporting

      Petitioner filed a Form 1120, U.S. Corporation Income Tax Return, for TYE

March 31, 2005, on which it reported total income of $71,497,738 and claimed

total deductions of $64,608,986.7 Petitioner attached to its return a Form 3115,

Application for Change in Accounting Method, for TYE March 31, 2005,

requesting an accounting method change pursuant to Rev. Proc. 2005-9, 2005-1

C.B. 303.8 Petitioner reported on an attachment to the Form 3115 that it presently



      7
        Petitioner claimed deductions on a consolidated basis and per subsidiary.
Petitioner does not have documentation to show the total expenses attributable to
the software license and maintenance contracts, service contracts, real estate
leases, and equipment lease on an entity-specific basis or a consolidated basis.
      8
        Rev. Proc. 2005-9, sec. 1, 2005-1 C.B. 303, provides administrative
procedures under which a taxpayer may obtain automatic consent to change to a
method of accounting provided in sections 1.263(a)-4, 1.263(a)-5, and 1.167(a)-
3(b), Income Tax Regs., for the taxpayer’s second taxable year ending on or after
December 31, 2003.
                                         -7-

deducted liabilities as follows: (1) with respect to liabilities for which economic

performance was satisfied by payment, petitioner capitalized the liability and

amortized the payment over the life of the agreement; (2) with respect to liabilities

for which economic performance was not satisfied by payment, petitioner

deducted the liabilities “in the period to which they relate.” Petitioner proposed a

change in its accounting method to: (1) deduct liabilities in the year incurred

under the all events test, with modifications under the recurring item exception for

insurance and maintenance agreement payments; and (2) with respect to rent

liabilities for which economic performance is not satisfied by payment, deduct the

liabilities “in the year the liabilities are fixed and determinable with reasonable

accuracy, and where economic performance has occurred”.

      Petitioner implemented its proposed change in accounting method and

prepared its Form 1120 for TYE March 31, 2005, accordingly. As a result of the

change in accounting method, petitioner claimed deductions for prepaid expenses

and accrued expenses attributable to periods after March 31, 2005, claiming that

its tax treatment of the expenses was permitted under the all events test of section

461 and/or the recurring item exception under section 461(h)(3). Those

accelerated deductions are at issue here.
                                         -8-

      A.     Prepaid Expenditures

             1.     Aspen Technology Agreement

      On March 31, 2003, VECO Corp. and Aspen Technology, Inc. (Aspen

Technology) entered into a software license and service agreement for the period

from March 31, 2003, through March 31, 2009 (Aspen agreement). Under the

Aspen agreement Aspen Technology licensed use of its software and agreed to

provide software maintenance services to VECO Corp. VECO Corp. agreed to

pay license fees over six consecutive years as follows: (1) $161,000 on April 30,

2003;9 (2) $206,000 on March 30, 2004; (3) $212,180 on March 30, 2005; (4)

$218,545 on March 30, 2006; (5) $225,102 on March 30, 2007; and (6) $231,855

on March 30, 2008. VECO Corp. also agreed to pay an annual service fee of

$11,94510 for the first effective year of the contract and an annual service fee of

$38,000 for each subsequent year.

      VECO Corp. made payments to Aspen Technology as follows: (1)

$172,945 on June 6, 2003; (2) $39,140 on June 29, 2004; and (3) $40,314 on April


      9
       The Aspen agreement provided that VECO Corp. had prepaid the license
fees under a prior agreement by $39,000 and that the amount of the first license
fee payment had been adjusted accordingly.
      10
        The Aspen agreement provided that VECO Corp. had prepaid service fees
of $26,055 under a prior agreement and that the first service fee payment had been
adjusted accordingly.
                                       -9-

27, 2005. In February 2006 VECO Corp. received an invoice dated February 13,

2006, from Bank of America Leasing for $218,545 with respect to the Aspen

agreement. VECO Corp. paid the invoice by check dated February 24, 2006, made

payable to Bank of America Leasing.

      Petitioner treated $200,235,11 which was attributable to the period April 1 to

August 1, 2005, as an FYE March 31, 2006, expense on its financial statements for

that year. However, petitioner deducted the $200,235 on its return for TYE March

31, 2005.

             2.    Primavera Agreement

      Primavera provided software management services for VECO Alaska

pursuant to a service agreement between Primavera and VECO Alaska that is not

in the record.

      Primavera issued an invoice dated December 31, 2004, for $10,600 to

VECO Alaska. VECO Alaska paid the invoice by check dated April 4, 2005.


      11
         The parties stipulated the amount and treatment of this expense for
petitioner’s financial accounting and tax reporting purposes. However,
petitioner’s summary analysis of its Schedule M-3, Net Income (Loss)
Reconciliation for Corporations With Total Assets of $10 Million or More, shows
that petitioner accelerated expenses attributable to the Aspen agreement of
$212,180. Petitioner failed to offer any explanation, and the record contains no
evidence, as to how petitioner calculated the amount of this particular accelerated
deduction.
                                       - 10 -

      Petitioner treated $7,950,12 which was attributable to the period April 1 to

December 1, 2005, as an FYE March 31, 2006, expense on its financial

statements for that year. However, petitioner deducted the $7,950 on its return for

TYE March 31, 2005.

             3.    Surveyor’s Exchange Agreement

      The record does not contain a copy of the service agreement between

Surveyor’s Exchange Co. (Surveyor’s Exchange) and VECO Alaska.

      Surveyor’s Exchange issued an invoice dated March 17, 2005, for $51,895

for Autocad subscription renewals to VECO Alaska. VECO Alaska paid the

invoice by check dated April 14, 2005.

      For financial statement purposes, petitioner recorded the Autocad expenses

on a straight-line basis over the term of its contract with Surveyor’s Exchange.

Petitioner treated the $51,895, which was attributable to the period April 1, 2005,

to March 1, 2006, as an FYE March 31, 2006, expense on its financial statements

for that year. However, petitioner deducted the $51,895 on its return for TYE

March 31, 2005.




      12
        The $7,950 is equal to the portion of the total amount due to Primavera for
services provided during the period April 1 to December 1, 2005.
                                       - 11 -

             4.    Invensys Systems Agreement

      In March 2004 VECO USA entered into a computer program license

agreement with Invensys Systems, Inc. (Invensys), for the period March 1, 2004,

through February 28, 2007 (Invensys agreement) that required VECO USA to pay

total license fees of $156,522 and total maintenance fees of $23,478. The

agreement required VECO USA to pay annual license and maintenance fees of

$52,174 and $7,826, respectively, on March 1, 2004, 2005, and 2006.

      Invensys issued to VECO USA an invoice dated March 22, 2004, for

$64,920 covering the period from March 1, 2004, to February 28, 2007.13 VECO

USA paid the invoice by a check dated April 28, 2004.

      For financial statement purposes, petitioner recorded the Invensys

agreement expenses on a straight-line basis over the term of the agreement.

Petitioner treated $59,420,14 which was attributable to the period April 1 to

December 15, 2005, as an FYE March 31, 2006, expense on its financial

statements for that year. However, petitioner deducted the $59,420 on its return

for TYE March 31, 2005.


      13
       The difference between the $60,000 specified under the Invensys
agreement and the $64,920 on the invoice is attributable to sales tax.
      14
       Petitioner failed to offer any explanation, and the record contains no
evidence, as to how petitioner calculated the amount of this particular deduction.
                                       - 12 -

      B.     Expenditures Accrued for Periods After March 31, 2005

             1.    Service Contracts

                   a.     Marsh Agreement

      On January 10, 2005, VECO Corp. entered into an insurance brokerage

service agreement with Marsh USA, Inc. (Marsh), for the period January 10

through December 31, 2005 (Marsh agreement). Under the Marsh agreement

VECO Corp. agreed to pay Marsh a fixed fee of $300,000 payable as follows: (1)

$75,000 on February 1, 2005; (2) $30,000 on April 1, 2005; (3) $45,000 on June

30, 2005; (4) $75,000 on September 30, 2005; and (5) $75,000 on December 31,

2005. VECO Corp. made payments to Marsh as follows: (1) $60,000 on March 4,

2005; (2) $120,000 on April 1, 2005; (3) $45,000 on June 17, 2005; and (4)

$75,000 on October 3, 2005.

      For financial statement purposes petitioner recorded the expenses under the

Marsh agreement on a straight-line basis over the term of the agreement.

Petitioner treated $225,000,15 which was attributable to the period April 1 to

December 31, 2005, as an FYE March 31, 2006, expense on its financial




      15
      Petitioner calculated this amount by adding the amounts of the four
payments it made during 2005 and then multiplying that total by 75%.
                                      - 13 -

statements for that year. However, petitioner deducted the $225,000 on its return

for TYE March 31, 2005.

                   b.     ACS Agreement

      The record does not contain a copy of the service agreement between ACS

and VECO Alaska.

      For financial statement purposes petitioner recorded the expenses under the

ACS agreement on a straight-line basis over the term of the agreement. Petitioner

treated $14,779,16 which was attributable to the period April 1 to December 31,

2005, as an FYE March 31, 2006, expense on its financial statements for that year.

However, petitioner deducted the $14,779 on its return for TYE March 31, 2005.

                   c.     Schwamm & Frampton Agreement

      In February 1999 VECO Properties entered into a management agreement

with Schwamm & Frampton, LLC (Schwamm & Frampton), for a term of one

year, which automatically was renewed in February of each year (Schwamm &

Frampton agreement). Under the agreement Schwamm & Frampton agreed to

provide property management services for University Plaza, a property owned by

      16
       Petitioner’s summary analysis of its Schedule M shows that VECO Alaska
was required to make monthly payments to ACS of $1,739. While petitioner’s
accounts payable vendor history distribution to ACS shows that VECO Alaska
made fairly regular payments to ACS, the payments made during 2004-05 ranged
from $1,321 to $1,324 per month.
                                      - 14 -

VECO Properties, and to act as agent for VECO Properties. VECO Properties

agreed to make monthly payments equal to the greater of: (1) $6,250 or (2) 4% of

the monthly gross rental receipts, as VECO Properties received such receipts.

      During FYE March 31, 2005, VECO Properties made one payment of $460

to Schwamm & Frampton. On April 20, 2005, VECO Properties made a payment

of $7,500 to Schwamm & Frampton.

      For financial statement purposes petitioner recorded the expenses under the

Schwamm & Frampton agreement on a straight-line basis over the term of the

agreement. Petitioner treated $6,250, which was attributable to the period April 1

to April 30, 2005, as an FYE March 31, 2006, expense on its financial statements

for that year. However, petitioner deducted the $6,250 on its return for TYE

March 31, 2005.

                   d.    Otis Elevator Agreement

      In February 2002 Schwamm & Frampton, as agent for VECO Properties,

entered into a maintenance agreement with Otis Elevator Co. (Otis Elevator) for

the period February 1, 2002, through January 31, 2007 (Otis Elevator agreement).

Under the agreement Otis Elevator agreed to provide maintenance services at

University Plaza for a fee of $1,950 per month, and Schwamm & Frampton agreed

to make quarterly payments on or before the last day of the month before the
                                       - 15 -

billing period.17 Neither VECO Corp. nor VECO Properties made any direct

payments to Otis Elevator.

      For financial statement purposes petitioner recorded the expenses under the

Otis Elevator agreement on a straight-line basis over the term of the agreement.

Petitioner treated $16,575,18 which was attributable to the period April 1 to

December 15, 2005, as an FYE March 31, 2006, expense on its financial

statements for that year. However, petitioner deducted the $16,575 on its return

for TYE March 31, 2005.

                   e.     Q-1 Agreement

      In September 1999 Schwamm & Frampton, as agent for VECO Properties,

entered into a maintenance agreement with Q-1 Corp. (Q-1) for the period

September 15, 1999, through September 14, 2000, with automatic renewal each

year (Q-1 agreement). Under the Q-1 agreement VECO Properties agreed to make

monthly payments of $9,984 for maintenance services, with payment due in

arrears on the 10th day of the month following provision of the services. In



      17
       The Otis Elevator agreement further provided that the billing period would
begin on February 1, 2002, the commencement date.
      18
         The $16,575 is equal to the monthly payment rate for April through
November 2005 plus an additional $975 attributable to the monthly payment rate
for the first half of December 2005.
                                       - 16 -

November 2005 VECO Properties and Q-1 amended the Q-1 agreement to provide

for a monthly fee of $9,221.

      For financial statement purposes, petitioner recorded the expenses under the

Q-1 agreement on a straight-line basis over the term of the agreement. Petitioner

treated $59,940,19 which was attributable to the period April 1 to October 15,

2005, as an FYE March 31, 2006, expense on its financial statements for that year.

However, petitioner deducted the $59,940 on its return for TYE March 31, 2005.

            2.     Insurance Premium Agreement

      On April 28, 2005, VECO Corp. entered into a commercial premium

finance agreement with Marsh, an insurance broker, for insurance policies with

effective dates of April 1, 2005, for 12 months of coverage (insurance premium

agreement). The agreement provided for total premiums of $3,445,037 and

required VECO Corp. to make 10 monthly payments of $316,714 beginning May

1, 2005.




      19
        Although the Q-1 agreement was not amended until November 2005,
petitioner’s summary analysis of its Schedule M shows that petitioner calculated
the amount of the deduction on the basis of a monthly fee of $9,221 for the 6-1/2-
month period from April 1 to October 15, 2005.
                                         - 17 -

        On its return for TYE March 31, 2005, petitioner deducted $2,304,16520 for

insurance premium expenses attributable to the period April 1 to December 15,

2005.

              3.    Real Property Leases

                    a.     Arctic Spur Lease

        On June 24, 2004, VECO Equipment entered into a lease agreement with

Arctic Spur Investments (Arctic Spur) for property at 6411 A Street, Anchorage,

Alaska (Arctic Spur lease). The term of the Arctic Spur lease was July 1, 2004,

through June 30, 2005. Under the Arctic Spur lease VECO Equipment agreed to

pay monthly rent of $7,500 on the first day of each month.

        For financial and tax accounting purposes VECO Corp. allocated $3,674 of

the monthly rent to itself and $3,827 to VECO Alaska. For financial statement

purposes petitioner recorded the expenses under the Arctic Spur lease on a

straight-line basis over the term of the lease.

        Petitioner treated $11,022 and $11,480, which were attributable to the

period April 1 to June 30, 2005, as FYE March 31, 2006, expenses on its financial


        20
       Petitioner calculated this amount by multiplying the total premium by
81.96%, a figure purportedly equal to the amount of the premium for the period
May 1, 2005, through February 1, 2006, that petitioner had paid by December 15,
2005.
                                       - 18 -

statements for that year. However, petitioner deducted the $11,021 (paid through

VECO Corp.) and the $11,480 (paid through VECO Alaska) on its return for TYE

March 31, 2005.

                         b.     Wyoming Lease

      On September 25, 1996, VECO USA entered into a lease with Rock Spring

Plaza, LLC, for office space at a property in Wyoming (Wyoming lease). On

September 1, 2004, VECO USA and TRB #3 Owners Corp., owner of the

Wyoming property, amended the original lease to extend the term for one year

from September 1, 2004, to August 31, 2005. Under the Wyoming lease as

amended VECO USA agreed to make monthly rent payments of $1,694 on the first

day of each month.

      For financial statement purposes petitioner recorded the expenses under the

Wyoming lease on a straight-line basis over the term of the lease. Petitioner

treated $8,468, which was attributable to the period April 1 through August 31,

2005, as an FYE March 31, 2006, expense on its financial statements for that year.

However, petitioner deducted the $8,468 on its return for TYE March 31, 2005.
                                        - 19 -

                   c.     Golden Lease

      On April 17, 1999, Veco Rocky Mountain entered into a lease with Gold

Office Building for office space at a property in Golden, Colorado (Golden lease).

On February 24, 2005, VECO USA and Gold Office Building amended the

original lease to extend the term for a period of one year beginning March 1, 2005,

and ending February 28, 2006. Under the lease as amended VECO USA agreed to

pay monthly rent of $4,410 on the first day of each month.

      For financial statement purposes petitioner recorded the expenses under the

Golden lease on a straight-line basis over the term of the lease. Petitioner treated

$34,359,21 which was attributable to the period April 1 through December 15,

2005, as an FYE March 31, 2006, expense on its financial statements for that year.

However, petitioner deducted the $34,359 on its return for TYE March 31, 2005.

                   d.     Durango Lease

      On June 1, 2004, VECO USA entered into a lease with Lunceford

Investments for office space in Durango, Colorado (Durango lease). The term of

the Durango lease was June 1, 2004, through May 31, 2005. Under the Durango




      21
        Petitioner’s summary analysis of its Schedule M shows that petitioner
calculated this amount using a monthly rent of $4,042 rather than the $4,410
provided for under the Golden lease as amended.
                                        - 20 -

lease VECO USA agreed to make monthly rent payments of $2,067 on or before

the first day of the month.

      For financial statement purposes petitioner recorded the expenses under the

Durango lease on a straight-line basis over the term of the lease. Petitioner treated

$4,134, which was attributable to the period April 1 through May 31, 2005, as an

FYE March 31, 2006, expense on its financial statements for that year. However,

petitioner deducted the $4,134 on its return for TYE March 31, 2005.

                   e.     Bay Street Lease

      On January 1, 2005, VECO USA entered into a lease agreement with Bay

Building LLC (Bay Building) for office space in Bay Street, Washington (Bay

Street lease). The term of the Bay Street lease was January 1, 2005, through

December 31, 2009. Under the Bay Street lease, VECO USA agreed to pay Bay

Building monthly rent of $33,990 before the first day of each month.

      For financial statement purposes petitioner recorded the expenses under the

Bay Street lease on a straight-line basis over the term of the lease. Petitioner

treated $294,696,22 which was attributable to the period April 1 through December

15, 2005, as an FYE March 31, 2006, expense on its financial statements for that

      22
        Petitioner’s summary analysis of its Schedule M shows that petitioner
calculated this amount using a monthly rent rate of $34,670 rather than the
$33,990 provided for under the Bay Street lease.
                                        - 21 -

year. However, petitioner deducted the $294,696 on its return for TYE March 31,

2005.

                     f.    Englewood Lease

        On May 26, 1994, Rapley Engineering Services entered into a lease

agreement with Highland Court LLC for office space in Englewood, Colorado

(Englewood lease). The term of the lease was July 1, 1994, through June 30,

2000. On December 16, 2002, Veco Rocky Mountain and Prentiss Properties

amended the Englewood lease to extend the term for five years, from August 1,

2002, through June 30, 2007. Under the Englewood lease as amended, Veco

Rocky Mountain agreed to pay monthly base rent of $43,450 on or before the first

day of each month.

        For financial statement purposes, petitioner recorded the expenses under the

Englewood lease on a straight-line basis over the term of the lease. Petitioner

treated $380,103,23 which was attributable to the period April 1 through December

15, 2005, as an FYE March 31, 2006, expense on its financial statements for that

year. However, petitioner deducted the $380,103 on its return for TYE March 31,

2005.

        23
        Petitioner’s summary analysis of its Schedule M shows that petitioner
calculated this amount using a monthly rent of $44,718 rather than the $43,450
provided for under the Englewood lease as amended.
                                       - 22 -

                   g.    Frontier Building Lease

      On March 22, 2000, VECO Corp. entered into a lease agreement with

Frontier Building Limited Partnership for space at the Frontier Building in

Anchorage, Alaska (Frontier Building lease). The term of the Frontier Building

lease was July 1, 2000, through November 30, 2005. The Frontier Building lease

required VECO Corp. to pay a fixed minimum monthly rent, subject to increases

based on the Anchorage Consumer Price Index,24 on the first day of each month.25

For the period October 1, 2003, to September 30, 2004, the fixed minimum

monthly rent was $17,569. For the period October 1, 2004, to September 30,

2005, the fixed minimum monthly rent was $17,939.26




      24
       For 2004 the Anchorage Consumer Price Index had a percentage change of
2.58%. For 2005 the Anchorage Consumer Price Index had a percentage change
of 3.06%.
      25
       For the period from October 1, 2003, through September 30, 2004, VECO
Corp. paid the following amounts under the Frontier Building lease: October
2003--$18,582; November 2003--$18,666; December 2003--$18,666; January
2004--$19,318; February 2004--$19,318; March 2004--$19,318; April 2004--
$19,318; May 2004--$21,116; June 2004--$19,318; July 2004--$19,318; August
2004--$19,318; and September 2004--$19,318.
      26
        The fixed minimum monthly rent of $17,939 for the period October 1,
2004, to September 30, 2005, was less than a 2.58% increase from the monthly
rent that VECO Corp. paid for the period October 1, 2003, to September 30, 2004.
                                        - 23 -

      For financial statement purposes petitioner recorded the expenses under the

Frontier Building lease on a straight-line basis over the term of the lease.

Petitioner treated $107,637,27 which was attributable to the period April 1 through

September 30, 2005, as an FYE March 31, 2006, expense on its financial

statements for that year. However, petitioner deducted the $107,637 on its return

for TYE March 31, 2005.

                   h.     6411 A Street Lease

      On December 22, 1999, VECO Equipment entered into a lease with Carr-

Gottstein Foods Co. for property at 6411 A Street, Anchorage, Alaska (6411 A

Street lease). The term of the lease was March 1, 2000, to December 31, 2010.

The 6411 A Street lease required VECO Equipment to pay a fixed minimum

monthly rent on the first day of each month. For the period March 1, 2004, to

February 28, 2005, the fixed minimum monthly rent was $54,599. For the period

March 1, 2005, to February 28, 2006, the fixed minimum monthly rent was

$60,626.28



      27
        Petitioner’s summary analysis of its Schedule M shows that petitioner
calculated this amount using a monthly payment rate of $17,939.
      28
        The fixed minimum monthly rent of $60,626 for the period March 1, 2005,
to February 28, 2006, was less than a 2.58% increase from the monthly rent that
petitioner paid for the period October 1, 2003, to September 30, 2004.
                                        - 24 -

        For financial statement purposes, petitioner recorded the expenses under the

6411 A Street lease on a straight-line basis over the term of the lease. Petitioner

treated $515,324,29 which was attributable to the period April 1 through December

15, 2005, as an FYE March 31, 2006, expense on its financial statements for that

year. However, petitioner deducted the $515,324 on its return for TYE March 31,

2005.

                    i.     949 East 36th Avenue

        On or about August 22, 1995, VECO Engineering entered into a lease

agreement with Alaska Pacific University to rent property at 949 East 36th

Avenue, Anchorage, Alaska (949 East 36th Avenue lease). Under the 949 East

36th Avenue lease VECO Engineering agreed to make monthly rent payments on

or before the first day of the month. VECO Engineering and Alaska Pacific

University subsequently entered into a number of agreements amending the lease

to extend the term of the lease and to provide VECO Engineering with increased

space at the 949 East 36th Avenue property.

        On March 1, 1999, VECO Properties and VECO Engineering entered into

an agreement to amend the lease to extend the term to December 31, 2005,


        29
        Petitioner’s summary analysis of its Schedule M shows that petitioner
calculated this amount using a monthly payment rate of $60,626.
                                       - 25 -

effective upon the closing of the acquisition of the 949 East 36th Avenue property

by VECO Properties. On or about March 7, 1999, Alaska Pacific University

assigned its interest in the lease to petitioner. As of September 1, 1999, VECO

Engineering assigned its interest in the lease to VECO Alaska.

                          (i)   Amendment XIV to the 949 East 36th Avenue
                                Lease

      VECO Properties, as landlord, and VECO Alaska, as tenant, subsequently

amended the 949 East 36th Avenue lease numerous times to provide VECO

Alaska with increased rental space. All of the amendments extended the term of

the lease to December 31, 2005, except for amendment No. XIV to the 949 East

36th Avenue lease (amendment XIV to the 949 East 36th Avenue lease).

Amendment XIV to the 949 East 36th Avenue lease provided for a lease term of

April 12, 2004, to April 11, 2006, for 11,971 square feet of space on the fourth

floor of the 949 East 36th Avenue property at a monthly rent of $25,546 for the

first year and $25,890 for the second year.

      For financial statement purposes petitioner recorded the expenses under

amendment XIV to the 949 East 36th Avenue lease on a straight-line basis over
                                       - 26 -

the term of the amended lease. Petitioner treated $220,066,30 which was

attributable to the period April 1 through December 15, 2005, as an FYE March

31, 2006, expense on its financial statements for that year. However, petitioner,

through VECO Alaska, deducted the $220,066 on its return for TYE March 31,

2005. Petitioner did not include the $220,066 as rental income of VECO

Properties on its return for TYE March 31, 2005.

                         (ii)   949 East 36th Avenue Commercial Sublease
                                Agreement

      On June 1, 2005, VECO Corp. entered into a commercial lease agreement

with VECO 36th Avenue regarding the 949 East 36th Street property (949 East

36th Avenue commercial lease agreement). The term of the lease was June 1,

2005, to May 31, 2020. Under the 949 East 36th Avenue commercial lease

agreement VECO Corp. agreed to pay monthly rent of $222,499 on or before the

first day of each month, with increases in the monthly rent based on the Consumer

Price Index.

      On June 1, 2005, VECO Corp. entered into a commercial sublease

agreement with VECO Alaska regarding the 949 East 36th Avenue property (949

East 36th Avenue commercial sublease agreement). The term of the sublease was

      30
        Petitioner’s summary analysis of its Schedule M shows that petitioner
calculated this amount using a monthly payment rate of $25,890.
                                       - 27 -

June 1, 2005, to May 31, 2020. Under the 949 East 36th Avenue commercial

sublease agreement VECO Alaska agreed to pay monthly rent of $224,206 on or

before the first day of each month, with increases in the monthly rent based on the

Consumer Price Index.

      For financial statement purposes, petitioner recorded the expenses under the

949 East 36th Avenue commercial sublease agreement on a straight-line basis over

the term of the sublease agreement. Petitioner treated $221,070,31 which was

attributable to a two-month rental period commencing after March 31, 2005, as an

FYE March 31, 2006, expense on its financial statements for that year. However,

petitioner, through VECO Alaska, deducted the $221,070 on its return for TYE

March 31, 2005. Petitioner did not include the $221,070 as rental income on its

return for TYE March 31, 2005.

            4.     IKON Equipment Lease

      On May 21, 2004, VECO Services and IKON Financial Services (IKON)

entered into an equipment lease (IKON equipment lease) for a term of 60 months.

Under the IKON equipment lease and the accompanying product schedule, VECO

      31
         Petitioner’s summary analysis of its Schedule M shows that petitioner
calculated this amount using a monthly payment rate of $110,535. Petitioner
failed to offer any explanation, and the record contains no evidence, as to why
petitioner used a monthly payment rate of $110,535 rather than the amount
specified in the 949 East 36th Avenue commercial sublease agreement.
                                       - 28 -

Services agreed to make monthly rent payments of $25,785, with the first payment

made on or before the effective date32 and the remaining payments made on the

same day each month. On January 14, 2005, VECO Alaska and IKON amended

the IKON equipment lease to provide for an increased minimum monthly payment

of $27,780. On April 13, 2005, VECO Services and IKON amended the IKON

equipment lease to provide for an increased minimum monthly payment of

$28,002. On March 28, 2007, VECO Services and IKON amended the IKON

equipment lease to provide for an increased minimum monthly payment of

$37,128.

      Petitioner treated $225,738,33 which was attributable to the period April 1

through December 15, 2005, as an FYE March 31, 2006, expense in its financial

statements for that year. However, petitioner deducted the $255,739 on its return

for TYE March 31, 2005.




      32
       The record does not show the effective date of the IKON equipment lease.
VECO Services entered into the master agreement with respect to the IKON
equipment lease on May 21, 2004, and entered into the product schedule on July
15, 2004.
      33
        Petitioner’s summary analysis of its Schedule M shows that petitioner
calculated this amount using a monthly rental rate of $30,087 rather than the rate
provided for under the IKON equipment lease as amended.
                                        - 29 -

III.   Notice of Deficiency

       Respondent issued to petitioner the notice of deficiency for TYE March 31,

2005, determining that petitioner was not permitted to change its method of

accounting for its prepaid and accrued expenditures. Accordingly, respondent

disallowed portions of petitioner’s claimed deductions as follows: (1) $200,235

under the Aspen agreement; (2) $7,950 under the Primavera agreement; (3)

$51,895 under the Surveyor’s Exchange agreement; (4) $59,420 under the

Invensys agreement; (5) $225,000 under the Marsh agreement; (6) $14,779 under

the ACS agreement; (7) $16,575 under the Otis Elevator agreement; (8) $6,250

under the Schwamm & Frampton agreement; (9) $59,940 under the Q-1

agreement; (10) $2,304,165 under the insurance premium agreement; (11) $22,501

under the Arctic Spur lease; (12) $8,468 under the Wyoming lease; (13) $34,359

under the Golden lease; (14) $4,134 under the Durango lease; (15) $294,696 under

the Bay Street lease; (16) $380,103 under the Englewood lease; (17) $107,637

under the Frontier Building lease; (18) $515,324 under the 6411 A Street lease;

(19) $220,066 under amendment XIV to the 949 East 36th Avenue lease; (20)

$221,070 under the 949 East 36th Avenue commercial sublease agreement; and

(21) $255,738 under the IKON equipment lease. Respondent determined that

petitioner was not entitled to these deductions because: (1) petitioner failed to
                                        - 30 -

establish that it incurred the related expenses during TYE March 31, 200534 and

(2) petitioner’s method of claiming the deductions did not clearly reflect income

within the meaning of section 446(b). Respondent alternatively determined that if

VECO Alaska was entitled to deductions of $220,066 and $221,070 for expenses

under amendment XIV to the 949 East 36th Avenue lease and the 949 East 36th

Avenue commercial sublease agreement, VECO Properties was required to

recognize the receipt of income to that extent under section 1.1502-13, Income

Tax Regs.

                                     Discussion

I.    Burden of Proof

      Generally, the Commissioner’s determinations in a notice of deficiency are

presumed correct, and the taxpayer bears the burden of proving that the

determinations are erroneous.35 See Rule 142(a); Welch v. Helvering, 290 U.S.


      34
         Respondent also determined that even if petitioner satisfied the all events
test of sec. 461 for the claimed deductions, petitioner was required to capitalize
those amounts under sec. 263(a).
      35
        Where a taxpayer has requested the Commissioner’s consent to change its
method of accounting, this Court generally reviews the Commissioner’s refusal to
give consent for abuse of discretion. See Capitol Fed. Sav. & Loan Ass’n v.
Commissioner, 96 T.C. 204, 209-210 (1991). The use of an abuse of discretion
standard is premised on the idea that the Commissioner’s “determination with
respect to the issue of whether income is reflected clearly is entitled to more than
                                                                         (continued...)
                                        - 31 -

111, 115 (1933). However, if a taxpayer produces credible evidence with respect

to a factual issue relevant to ascertaining the taxpayer’s Federal income tax

liability, the burden of proof as to that issue may shift to the Secretary36 under

section 7491(a)(1) if the taxpayer satisfies certain requirements under section

7491(a)(2).37



      35
        (...continued)
the usual presumption of correctness.” Id. at 209.

       In the notice of deficiency respondent rejected petitioner’s attempt to
change its former method of accounting with respect to the disputed deductions.
Respondent explained that petitioner had failed to establish that petitioner incurred
the expenses attributable to the disputed deductions in its TYE March 31, 2005,
and in addition, petitioner’s method of claiming the disputed deductions did not
clearly reflect income within the meaning of sec. 446(b). However, in
respondent’s brief respondent argues only that petitioner failed to establish that it
incurred the expenses attributable to the disputed deductions in its TYE March 31,
2005. Respondent does not contend that this Court should review respondent’s
determinations in the notice of deficiency for abuse of discretion.
      36
        The term “Secretary” means “the Secretary of the Treasury or his
delegate”, sec. 7701(a)(11)(B), and the term “or his delegate” means “any officer,
employee, or agency of the Treasury Department duly authorized by the Secretary
of the Treasury directly, or indirectly by one or more redelegations of authority, to
perform the function mentioned or described in the context”, sec.
7701(a)(12)(A)(i).
      37
        If the taxpayer is a partnership, a corporation, or a trust (other than a
qualified revocable trust as defined in sec. 645(b)(1)), sec. 7491(a)(2) requires the
taxpayer to establish, among other things, that it meets the requirements of sec.
7430(c)(4)(A)(ii) (which in turn references the net worth requirements of 28
U.S.C. sec. 2412(d)(2)(B)).
                                        - 32 -

      Petitioner does not argue that section 7491(a)(1) shifts the burden of proof

to respondent. In addition, petitioner has not established (nor do we

find) that it satisfied the requirements of section 7491(a)(2). Petitioner bears the

burden of proof. See Rule 142(a).

II.   The All Events Test

      A.     Introduction

      Section 461(a) provides that a deduction must be taken for the proper

taxable year under the taxpayer’s method of accounting. Accrual method

taxpayers generally are allowed a deduction for the year in which the taxpayer

incurred the expense, regardless of the actual date of payment. Sec. 461(h)(4);

sec. 1.461-1(a)(2), Income Tax Regs.; see also Interex, Inc. v. Commissioner, 321

F.3d 55, 58 (1st Cir. 2003) (“Accrual method taxpayers may deduct expenses

when they are incurred even if they have not yet been paid[.]”), aff’g T.C. Memo.

2002-57.38


      38
        Conversely, a taxpayer may not deduct either a prepaid amount or an
amount paid without a legal obligation to do so any earlier than the taxable year in
which such amount is incurred. Sec. 1.446-1(c)(ii)(B), Income Tax Regs.
Accordingly, we need not consider the amount and timing of payments petitioner
actually made with respect to each of the liabilities because even if petitioner
made such payment during TYE March 31, 2005, petitioner is not entitled to a
deduction for the related expense unless petitioner also incurred a liability for that
expense during TYE March 31, 2005.
                                         - 33 -

      Whether an accrual method taxpayer has incurred an expense is determined

under the “all events test”. See sec. 1.461-1(a)(2)(i), Income Tax Regs. Under the

all events test, “a liability * * * is incurred, and generally is taken into account for

Federal income tax purposes, in the taxable 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

with respect to the liability.” Id.; see also United States v. Gen. Dynamics Corp.,

481 U.S. 239, 242-243 (1987); United States v. Anderson, 269 U.S. 422, 441

(1926); Caltex Oil Venture v. Commissioner, 138 T.C. 18, 23 (2012). An accrual

basis taxpayer claiming that it incurred a liability for Federal income tax purposes

must satisfy each of the three requirements under the all events test in order to

claim a deduction for the liability.

      Respondent does not dispute that the second requirement of the all events

test (i.e., that the amount of the liability was determinable with reasonable

accuracy) was satisfied with respect to the disputed deductions. Rather,

respondent disputes whether the first and third requirements were satisfied. With

respect to the disputed deductions attributable to the Marsh, ACS, Schwamm &

Frampton, Otis Elevator, and Q-1 agreements, as well as the insurance premium

expense deduction and the real property and equipment lease expense deductions,
                                          - 34 -

respondent contends that the first requirement of the all events test was not

satisfied because all the events had not occurred to establish the fact of these

liabilities as of March 31, 2005. With respect to all of the deductions except the

insurance premium expense deduction, respondent contends that the third

requirement (economic performance) of the all events test was not satisfied

because: (1) the 3-1/2-month rule of section 1.461-4(d)(6)(ii), Income Tax Regs.,

does not apply and (2) petitioner is not entitled to rely on the recurring item

exception to the economic performance requirement.

      Petitioner contends that it satisfied each requirement of the all events test.

Petitioner argues that it satisfied the first requirement because its execution of the

relevant agreements, and assumption of binding legal obligations thereunder, fixed

the fact of the liabilities underlying the disputed deductions. Petitioner also argues

that it satisfied the economic performance requirement because the recurring item

exception of section 461(h)(3) applies.

      We first address respondent’s contention that the fact of petitioner’s

liabilities under the Marsh, ACS, Schwamm & Frampton, Otis Elevator, and Q-1

agreements, the insurance premium agreement, and the real property and

equipment rental agreements was not fixed as of the close of the taxable year in

issue. We then analyze whether there was economic performance with respect to
                                         - 35 -

the disputed deductions. If petitioner was entitled to rely on the recurring item

exception with respect to the disputed deductions, then the economic performance

requirement of the all events test is satisfied.

      B.     Fact of the Liability

      The term “liability” refers to “any item allowable as a deduction, cost, or

expense for Federal income tax purposes.” Sec. 1.446-1(c)(ii)(B), Income Tax

Regs. Generally, the fact of a liability is established on the earlier of: (1) the

event fixing the liability, such as the required performance or (2) the date the

payment is unconditionally due. See Rev. Rul. 2007-3, 2007-1 C.B. 350; Rev.

Rul. 80-230, 1980-2 C.B. 169; Rev. Rul. 79-410, 1979-2 C.B. 213.

      Petitioner argues that actual payment of an expense is not required to

establish the fact of the liability.39 As discussed supra, an accrual method taxpayer

may deduct an expense for a taxable year before the year in which the taxpayer

actually remits payment provided that the taxpayer incurred the expense during the

      39
        Petitioner also argues that “courts have repeatedly rejected the
Respondent’s arguments that a liability is not fixed until the time has come for
payment of the obligation.” Petitioner, however, overstates respondent’s
argument. Respondent contends that all events have occurred to establish the fact
of a taxpayer’s liability upon the earlier of the event fixing the liability or the
payment due date. Accordingly, respondent contends that a liability may be fixed
before the payment due date provided that the event fixing the liability already
occurred. Furthermore, in respondent’s answering brief, respondent specifically
acknowledges that “actual payment is not required to fix the liability.”
                                         - 36 -

taxable year for which it claimed the deduction. Sec. 461(h)(4); sec. 1.461-

1(a)(2), Income Tax Regs.; see also United States v. Hughes Props. Inc., 476 U.S.

593, 599 (1986); Interex, Inc. v. Commissioner, 321 F.3d at 57-58. “[A]lthough

expenses may be deductible before they have become due and payable, liability

must first be firmly established.” Gen. Dynamics Corp., 481 U.S. at 243.

Accordingly, we agree with petitioner that actual payment is not necessarily

required to establish that petitioner’s liability for an expense is fixed under the all

events test.

      Petitioner argues that upon its entering into the various agreements, its

liabilities under those agreements became fixed by virtue of its assumption of the

contractual obligations. Although petitioner and respondent agree that a statute40

or regulation sometimes may operate to fix a taxpayer’s liability, the parties

disagree regarding whether petitioner’s execution of each agreement constituted

an event that fixed petitioner’s liability for the entire obligation under the

agreement.




      40
         Furthermore, this Court has held that the fact that a liability is fixed by
statute does not control whether the liability is fixed for purposes of the all events
test. See Chrysler Corp. v. Commissioner, T.C. Memo. 2000-283, aff’d, 436 F.3d
644 (6th Cir. 2006).
                                        - 37 -

      The execution of a contract contemplating payment, without more, is not an

event that fixes the payor’s liability. See Spencer, White & Prentis v.

Commissioner, 144 F.2d 45, 47 (2d Cir. 1944) (“It is well settled that deductions

may only be taken for the year in which the taxpayer’s liability to pay becomes

definite and certain, even though the transactions (such as the contract in the

present case) which occasioned the liability, may have taken place in an earlier

year.”). In particular, where a contract “contains mutually dependent promises,

liability under it is contingent upon performance or tendered performance”, and is

not fixed by merely entering into the contract. Levin v. Commissioner, 219 F.2d

588, 589 (3d Cir. 1955), aff’g 21 T.C. 996 (1954); see also Gulf Oil Corp. v.

Commissioner, 914 F.2d 396, 409 (3d Cir. 1990) (“Unconditional liability under

an executory contract is not created until at least one party performs.”), aff’g 86

T.C. 115 (1986). For example, this Court has held that taxpayers who entered into

a contract in year 1 for the provision of services in years 1 and 2 were not entitled

to deduct the entire amount of the contract price in year 1 because they had not

incurred the entire amount of the liability in year 1. Levin v. Commissioner, 21

T.C. 996.41 In so holding, this Court stated that “it has been well established that

      41
        In Levin v. Commissioner, 21 T.C. 996 (1954), aff’d, 219 F.2d 588 (3d
Cir. 1955), the taxpayers were partners in a business that manufactured, produced,
                                                                      (continued...)
                                        - 38 -

the accrual method of accounting does not permit the anticipation in the taxable

year of future expenses in other years prior to the rendition of the services fixing

the liability for which the payment is to be made.” Id. at 999.

      Petitioner cites numerous cases that it claims stand for the proposition that

the execution of a contract fixes a taxpayer’s liability for the entire amount of the

contract price.42 None of the cases, however, stand for the proposition that the


      41
        (...continued)
and sold food products. On December 12, 1946, the business entered into an
advertising contract with a two-year term. Id. at 996-997. Under the terms of the
contract, the taxpayers were to pay the advertising agent $733 per month in
exchange for the advertisement of their food products. Id. On December 17,
1946, the advertising agent sent to the taxpayers an invoice for services rendered
from December 5, 1946, to December 4, 1947. Id. at 997. The partnership, which
used an accrual method of accounting, accrued the entire amount of the invoice on
its books for the TYE December 31, 1946, although the partnership did not begin
making payments on the invoice until February 10, 1947. Id.

        The Court held that the partnership was not entitled to accrue the entire
amount of the invoice for Federal income tax purposes. Id. at 998-999. In so
holding, the Court stated that under the contract the taxpayers “incurred no
liability but merely agreed to become liable to pay in the event the future services
called for were performed.” Id. at 998. The Court further acknowledged that the
measure of an obligation to pay for future services was not the contract price but
rather “a contingent response in damages” for breach of the contract. Id. at 998-
999. The U.S. Court of Appeals for the Third Circuit affirmed the decision of this
Court, stating that “[r]endition of the services was a condition precedent to any
obligation of the partnership to pay.” Levin v. Commissioner, 219 F.2d at 589.
      42
       Petitioner also cites Amalgamated Hous. Corp. v. Commissioner, 37
B.T.A. 817 (1938), aff’d, 108 F.2d 1010 (2d Cir. 1940), in support of this
                                                                      (continued...)
                                        - 39 -

execution of a contract, without more, establishes the fact of the taxpayer’s

liability for the entire amount due under the contract. Rather, in each of the cited

cases, the court examined the relevant contract to decide when the liability became

fixed. See Commissioner v. H.B. Ives Co., 297 F.2d 229 (2d Cir. 1961), rev’g

T.C. Memo. 1959-187; Willoughby Camera Stores, Inc. v. Commissioner, 125

F.2d 607, 608-609 (2d Cir. 1942), rev’g 44 B.T.A. 520 (1941); Helvering v.

Russian Fin. & Constr. Corp., 77 F.2d 324, 327 (2d Cir. 1935); Wash. Post Co. v.

United States, 405 F.2d 1279, 1283 (Ct. Cl. 1969); Burnham Corp. v.

Commissioner, 90 T.C. 953, 957-958 (1988), aff’d, 878 F.2d 86 (2d Cir. 1989); Ill.

Power Co. v. Commissioner, 87 T.C. 1417, 1443-1447 (1986); Champion Spark




      42
        (...continued)
contention. In particular, petitioner contends that in Amalgamated Hous. Corp.,
the Court held that the taxpayer’s liability for service payments was not fixed
because the taxpayer had not entered into a binding contract with a service
provider and the services were not yet required under State housing law. In
Amalgamated Hous. Corp. v. Commissioner, 37 B.T.A. at 829, the taxpayers were
required under State law to make renovations at the end of particular periods of
months and accordingly “set up a reserve from the rent received during that period
sufficient to pay for” the renovations. The Court held the taxpayers could not
accrue the renovation costs as expenses before the end of the relevant period, as
defined by State law, or the time that renovation services were rendered. Id. The
Court did not discuss the effect, if any, of the taxpayers’ lack of a service contract
under which a third party agreed to provide renovation services. Amalgamated
Hous. Corp. does not stand for the proposition for which it is cited by petitioner.
                                       - 40 -

Plug Co. v. Commissioner, 30 T.C. 295, 298 (1958), aff’d, 266 F.2d 347 (6th Cir.

1959). The cited cases are distinguishable as explained below.

      Two of the cases address the treatment of payments made under a unilateral

contract. See Burnham Corp. v. Commissioner, 90 T.C. 953;43 Champion Spark

Plug Co. v. Commissioner, 30 T.C. 295.44 The agreements at issue here are not

unilateral; each party is obligated to perform the undertakings specified therein,

and petitioner is required to make payments over the term of the contract in

exchange for goods or services to be provided.

      Three of the cases involve situations where the required performance from

one of the contracting parties occurred in one taxable year but the other

contracting party did not actually make the associated payment until the following

taxable year. Willoughby Camera Stores, Inc. v. Commissioner, 125 F.2d at 608-


      43
        Burnham Corp. v. Commissioner, 90 T.C. 953 (1988), aff’d, 878 F.2d 86
(2d Cir. 1989), involved a contract under which the taxpayer agreed to make
monthly payments for the remainder of an individual’s life. The Court held that
the taxpayer was entitled to deduct the present value of the payments for the
entirety of the contract term in the taxable year in which the taxpayer entered into
the contract. Id. at 957-958.
      44
        Champion Spark Plug Co. v. Commissioner, 30 T.C. 295, 297 (1958),
aff’d, 266 F.2d 347 (6th Cir. 1959), involved a unilateral contract under which the
taxpayer agreed to make semimonthly payments to a disabled former employee for
a multiyear period. The Court found that the taxpayer was entitled to deduct the
value of the payments to be made over the entire period in the taxable year in
which the taxpayer entered into the contract. Id. at 298.
                                       - 41 -

609; Helvering v. Russian Fin. & Constr. Corp., 77 F.2d at 327; Wash. Post Co.,

405 F.2d at 1283. In contrast, the required performance under the agreements to

which the disputed deductions relate was not supposed to occur, and in fact did

not occur, until after the close of petitioner’s TYE March 31, 2005.

      One of the cases, Commissioner v. H.B. Ives Co., 297 F.2d at 229-230, is

not relevant to the issues before the Court as it involves a deduction claimed for

year 1 under a contract that was not executed until year 2.

      The other case petitioner cites, Ill. Power Co. v. Commissioner, 87 T.C. at

1443-1447, actually supports respondent’s argument that the fact of the liability is

established upon the occurrence of either the required performance or the payment

due date. Ill. Power Co. v. Commissioner, 87 T.C. at 1445, involved a lease

agreement under which the taxpayer agreed to make lease payments either

monthly, as the taxpayer’s nuclear power plant became operational, or at the

termination of the lease agreement, which would occur in 40 years. Id. The

taxpayer elected to defer its lease payments for 1981 until the plant became

operational; however, the taxpayer accrued an amount equal to its monthly lease

obligation for 1981 and deducted the amount on its 1981 return. Id. at 1428, 1445.

This Court upheld the claimed deduction, stating:
                                         - 42 -

             Whether the lease payments are made as Monthly Lease
      Charges, as the plant becomes operational, or as of the termination of
      the Lease Agreement, it is clear that in all events, the payments must
      be made. That petitioner elected to defer payments of the charges
      until the plant becomes operational is of no significance. The
      election merely affects the timing and not the certainty of payment of
      the accrued charge. * * *

Id. at 1445. Because the lease agreement provided that the taxpayer had an

unconditional liability to pay the lease obligations as they accrued each month, the

Court held that the taxpayer was entitled to deduct those obligations as they

accrued even if the taxpayer did not pay the lease obligations until later. The

holding is consistent with the general proposition that a taxpayer may deduct a

liability as an expense before payment is made so long as the event fixing the

liability (in Ill. Power Co., performance under the lease agreement) has occurred.

See also Eastman Kodak Co. v. United States, 534 F.2d 252, 259-260 (Ct. Cl.

1976).

      Although petitioner’s execution of the agreements in issue does not

establish the fact of the liabilities, the terms of the agreements are relevant in

deciding whether and when the liabilities became fixed under the all events test.

See supra pp. 38-39; see also Decision, Inc. v. Commissioner, 47 T.C. 58 (1966).

We analyze each of the relevant agreements to identify the earlier of when the
                                        - 43 -

required performance occurred or when petitioner’s payment was unconditionally

due.

             1.     Service Contracts

       An accrual method taxpayer may not deduct an expense attributable to a

bilateral service contract before performance of the services under the contract

occurs. Nat’l Bread Wrapping Mach. Co. v. Commissioner, 30 T.C. 550, 556

(1958) (“The accrual method does not permit the anticipation of future expenses

prior to the rendition of the services for which the payment is due.”); Levin v.

Commissioner, 21 T.C. at 998; Amalgamated Hous. Corp. v. Commissioner, 37

B.T.A. 817, 829 (1938), aff’d, 108 F.2d 1010 (2d Cir. 1940); see also Levert v.

Commissioner, T.C. Memo. 1989-333; Rev. Rul. 80-182, 1980-2 C.B. 167.

                    a.    Marsh Agreement

       The event fixing a liability under a service contract is the performance of

the services. See, e.g., Levin v. Commissioner, 21 T.C. at 998. As relevant here,

under the agreement Marsh agreed to provide VECO Corp. with various insurance

brokerage and consulting services during the period from January 10 through

December 31, 2005, in exchange for the payment by VECO Corp. of an annual

fixed fee of $300,000. The $300,000 fee was payable in installments with $75,000
                                            - 44 -

due on February 1, 2005, and four additional payments, totaling $225,000, due on

dates either on or after April 1, 2005.45

      The portion of the fee in dispute, $225,000, was not due under the

agreement until on or after April 1, 2005. Accordingly, the $225,000 qualifies as

an established liability during petitioner’s TYE March 31, 2005, only if Marsh

performed the required services under the agreement on or before March 31, 2005.

Petitioner has failed to prove that Marsh provided all of the contracted-for services

to VECO Corp. by March 31, 2005.

      VECO Corp. was required to make a $75,000 payment for services rendered

during the period January 10 to March 31, 2005, which petitioner properly

deducted. However, VECO Corp. was not required to pay the $225,000 amount

by March 31, 2005. As there is no credible evidence that either (i) the services

required under the contract for the period after March 31, 2005, had been provided

by March 31, 2005, or (ii) petitioner had an obligation to pay the $225,000 before

March 31, 2005, the fact of the liability for the $225,000 petitioner deducted was

not established by the close of petitioner’s TYE March 31, 2005.

      45
        The Marsh agreement does not provide for VECO Corp. to make payments
in equal amounts. However, the payment schedule shows that VECO Corp. was to
make payments of $75,000, or multiple amounts equal to $75,000, for each
quarter. We infer from this payment schedule that VECO Corp. was to make
payments to Marsh as the services were provided.
                                       - 45 -

                    b.    ACS Agreement

        Petitioner failed to introduce a copy of the service agreement between ACS

and VECO Alaska or any other evidence to show the performance required of

ACS under the contract. While we infer from the record that ACS provided

services to VECO Alaska, we are unable to make a finding as to whether

performance under the ACS agreement had occurred by the close of TYE March

31, 2005.

        We also infer from the record that VECO Alaska made monthly payments to

ACS. See supra note 16. The parties agree that the disputed deduction is

attributable to monthly expenses under the agreement for the period April 1 to

December 31, 2005. At best, payment of the expense generating the disputed

deduction was not due until the beginning of each month and accordingly, was not

unconditionally due until after March 31, 2005. Petitioner has failed to show that

the fact of the liability was established by the close of petitioner’s TYE March 31,

2005.

                    c.    Schwamm & Frampton Agreement

        Under the agreement Schwamm & Frampton agreed to provide property

management services and to act as agent for VECO Properties, in exchange for

monthly payments by VECO Properties that were due when it received rent for the
                                       - 46 -

month. The disputed deduction is attributable to expenses of $6,250 for services

provided by Schwamm & Frampton in April 2005. VECO Properties’ payment of

$6,250 was not unconditionally due until on or after April 1, 2005.

      Neither the performance of the services nor the payment due date occurred

before March 31, 2005. Accordingly, the fact of the liability was not established

by the close of petitioner’s TYE March 31, 2005.

                   d.    Otis Elevator Agreement

      Under the agreement Schwamm & Frampton, as agent for VECO Properties,

agreed to pay Otis Elevator a monthly service fee of $1,950.46 The terms of the

agreement provided that payments would be made quarterly, with each quarterly

payment made “on or before the last day of the month prior to the billing period,




      46
        Respondent contends that petitioner is not entitled to a deduction for
expenses under the Otis Elevator agreement because: (1) neither VECO Corp. nor
VECO Properties made any direct payments to Otis Elevator and (2) neither
VECO Corp. nor VECO Properties was a party to the contract with Otis Elevator.
Although neither VECO Corp. nor VECO Properties made any direct payments to
Otis Elevator, petitioner is entitled to deduct expenses attributable to liabilities
incurred during TYE March 31, 2005, such as the Otis Elevator monthly service
fees. See, e.g., United States v. Gen. Dynamics Corp., 481 U.S. 239, 243 (1987);
United States v. Hughes Props., Inc., 476 U.S. 593, 599 (1986). In addition, while
neither VECO Corp. nor VECO Properties was a party to the Otis Elevator
agreement, Schwamm & Frampton, the agent of VECO Properties, entered into the
Otis Elevator agreement at the direction of VECO Properties.
                                         - 47 -

beginning on the Commencement Date.” The agreement further provided for a

commencement date of February 1, 2002.

      The disputed deduction, $16,575, was attributable to expenses under the

Otis Elevator agreement for the period April 1 to December 15, 2005. Therefore,

petitioner’s liability for the amount was fixed only if payment of that amount was

unconditionally due on or before March 31, 2005.

      Under the agreement VECO Properties was required to make quarterly

payments on or before January 31, April 30, July 31, and October 31. The

advance payment due on or before January 31, 2005, was for services to be

rendered during February, March, and April 2005. VECO Properties was not

required to make another payment until April 30, 2005, at which time VECO

Properties would pay for services to be rendered during May, June, and July 2005.

      Because the obligation to pay for the services to be rendered during April

2005 was unconditionally due on January 31, 2005,47 $1,950 of the disputed

deduction, attributable to services provided in April 2005, was fixed during

petitioner’s TYE March 31, 2005. See, e.g., sec. 1.446-1(c)(ii)(B), Income Tax


      47
        Petitioner is not entitled to treat this liability as incurred any earlier than
the taxable year in which economic performance occurs. See sec. 461(h)(1); sec.
1.461-4(a)(1), Income Tax Regs. We discuss the economic performance
requirement with respect to this liability in part II.C, infra.
                                       - 48 -

Regs. The remaining disputed amount attributable to services provided from May

1 to December 15, 2005, however, was not fixed during TYE March 31, 2005,

because payment for such services was not unconditionally due until after March

31, 2005.

                   e.     Q-1 Agreement

      Under the agreement Q-1 agreed to provide maintenance services to VECO

Properties and VECO Properties agreed to pay Q-1 a monthly fee of $9,984 “in

arrears, on the tenth day of the following month.” The disputed deduction,

$59,940, relates to expenses incurred under the Q-1 agreement for services

provided during the period April 1 to October 15, 2005. Neither the performance

of the services nor the payment due date occurred before the close of petitioner’s

taxable year. Accordingly, the fact of the liability was not established by the close

of petitioner’s TYE March 31, 2005.

             2.    Insurance Premium Agreement

      For purposes of the all events test, the deductibility of expenses under an

insurance contract generally is reviewed in the same manner as the deductibility of

expenses under a service contract. See, e.g., Rev. Rul. 2007-3, supra. Under

VECO Corp.’s commercial premium finance agreement with Marsh, VECO Corp.

agreed to make monthly premium payments beginning May 1, 2005, for coverage
                                         - 49 -

during the period April 1, 2005, to March 31, 2006.48 Performance of the services

did not occur and payment for the services was not due before March 31, 2005.

Accordingly, the fact of the liability was not established by the close of

petitioner’s TYE March 31, 2005.

             3.     Equipment and Real Estate Rental Agreements

      The fact of the liability of a rental expense is established as each rent

payment becomes due. Consol. Foods Corp. v. Commissioner, 66 T.C. 436, 443

(1976); see also Rod Realty Co. v. Commissioner, T.C. Memo. 1967-49. Under

all of the real estate rental leases, with the exception of the Bay Street lease,

VECO Corp. or its subsidiaries agreed to make a rent payment for each monthly

rental period either: (1) on the first day of that month or (2) “on or before” the

first day of that month. The disputed deductions attributable to these leases relate

to the rental of property on or after April 1, 2005. Under the lease agreements the

rent payments for April 2005 were not unconditionally due until April 1, 2005,

and the rent payments for the remainder of 2005 were not due until after April 1,




      48
        As noted supra pp. 37-39, the mere execution of a contract is insufficient
to establish the fact of the taxpayer’s liability. Accordingly, petitioner may not
rely on the existence of the insurance premium contract to support its claimed
deduction. Furthermore, VECO Corp. did not enter into the insurance premium
contract until April 28, 2005, after the close of petitioner’s TYE March 31, 2005.
                                         - 50 -

2005. Accordingly, the fact of these liabilities was not established by the close of

petitioner’s TYE March 31, 2005.

      Under the Bay Street lease VECO USA agreed to make monthly rental

payments in advance of the first day of each month. The disputed deduction,

$294,696, is attributable to the rental period April 1 to December 15, 2005.

VECO USA’s rent payment for April 2005 was due on or before March 31, 2005.

Accordingly, the fact of the liability for the $33,990 rent payment for the period

April 2005 was established before the close of petitioner’s TYE March 31, 2005,

because the rent payment was unconditionally due on March 31, 2005.49 See, e.g.,

sec. 1.446-1(c)(ii)(B), Income Tax Regs. Petitioner is not entitled to deduct any

amount attributable to rent for the period May 1 to December 15, 2005, because

the rent payments were not due until after the close of petitioner’s TYE March 31,

2005. Therefore, the fact of petitioner’s liability for these payments was not

established during petitioner’s TYE March 31, 2005.

      Under the IKON equipment lease VECO Services agreed to make monthly

rent payments of $25,785, with the first payment due on or before the effective


      49
         Petitioner is not entitled to treat the amount of this liability as incurred any
earlier than the taxable year in which economic performance occurs. See sec.
461(h)(1); sec. 1.461-4(a)(1), Income Tax Regs. We discuss the economic
performance requirement with respect to this liability infra part II.C.
                                         - 51 -

date and the remaining payments due on the same day each month thereafter.

Petitioner has failed to introduce evidence to prove the effective date of the IKON

equipment lease. See supra note 32. Accordingly, we are unable to find that the

rent payments for which the disputed deduction was claimed were due on or

before March 31, 2005. Petitioner has failed to prove that the fact of its liability

under the IKON equipment lease was established by the close of petitioner’s TYE

March 31, 2005.

      C.     Economic Performance and the Recurring Item Exception

             1.     Introduction

      Section 461(h)(1) provides that “in determining whether an amount has

been incurred with respect to any item during any taxable year, the all events test

shall not be treated as met any earlier than when economic performance with

respect to such item occurs.”50 If the liability is attributable to the provision of

services or property to the taxpayer by another person, economic performance

occurs as the person provides such services or property. Sec. 461(h)(2)(A)(i) and

(ii); see also sec. 1.461-4(d)(2), Income Tax Regs. If the liability is attributable to

“the use of property by the taxpayer, economic performance occurs as the taxpayer

      50
          Sec. 1.461-1(a)(2)(iii)(B), Income Tax Regs., provides examples of
liabilities that are not subject to the economic performance requirement, none of
which is relevant here. See sec. 1.461-4(b), Income Tax Regs.
                                        - 52 -

uses such property.”51 Sec. 461(h)(2)(A)(iii); see also sec. 1.461-4(d)(3), Income

Tax Regs. However, “a taxpayer is permitted to treat services or property as

provided to the taxpayer as the taxpayer makes payment to the person providing

the services or property * * * if the taxpayer can reasonably expect the person to

provide the services or property within 3-1/2-months after the date of payment.”

Sec. 1.461-4(d)(6)(ii), Income Tax Regs. Petitioner has conceded that it did not

satisfy the 3-1/2-month rule of section 1.461-4(d)(6)(ii), Income Tax Regs., for

any of the deductions in issue.52




      51
         The economic performance principles relating to the provision of services
or property to the taxpayer, or the use of property by the taxpayer, do not apply to
certain liabilities, including, among other things, interest expenses and liabilities
arising under a worker’s compensation act or out of any tort or breach of contract
claim. See sec. 1.461-4(d)(1), Income Tax Regs.
      52
        Sec. 461(h) also provides a general rule for economic performance,
described supra p. 33. Under the general rule, petitioner is entitled to deduct for
TYE March 31, 2005, the payments it made during that year for services actually
performed and property actually received during that year. See, e.g., Caltex Oil
Venture v. Commissioner, 138 T.C. 18, 38 (2012). The only amounts in dispute
are those attributable to deductions petitioner claimed on its TYE March 31, 2005,
return for services performed and property received after March 31, 2005.
Accordingly, economic performance with respect to the portions of the deductions
in dispute did not occur until after the close of petitioner’s TYE March 31, 2005.
See sec. 461(h)(2)(A).
                                       - 53 -

      Section 461(h)(3) provides an exception (the recurring item exception) to

the general rule requiring economic performance. Under the recurring item

exception, a taxpayer may treat an item as incurred during any taxable year if:

            (i)    the all events test with respect to such item is met during
      such taxable year (determined without regard to * * * [section
      461(h)(1)]),

            (ii) economic performance with respect to such item occurs
      within the shorter of--

                   (I)    a reasonable period after the close of such taxable
            year, or

                   (II)   8 1/2 months after the close of such taxable year,

            (iii) such item is recurring in nature and the taxpayer
      consistently treats items of such kind as incurred in the taxable year in
      which the requirements of clause (i) are met, and

            (iv)   either--

                   (I)    such item is not a material item, or

                  (II) the accrual of such item in the taxable year in
            which the requirements of clause (i) are met results in a more
            proper match against income than accruing such item in the
            taxable year in which economic performance occurs.

Sec. 461(h)(3)(A); see also sec. 1.461-5, Income Tax Regs.

      Respondent contends that petitioner failed to satisfy the economic

performance requirement and the materiality or matching requirement of the
                                       - 54 -

recurring item exception for all of the disputed deductions. Petitioner disagrees.

In particular, petitioner contends that economic performance with respect to each

expense item occurred within 8-1/2 months after the close of its TYE March 31,

2005, as specified in section 461(h)(3)(A)(ii)(II), and that each expense item is not

material within the meaning of section 461(h)(3)(A)(iv)(I). Petitioner concedes

that it did not satisfy the matching requirement for any of the disputed deductions,

with the exception of its insurance premium expense deduction.

      The deductions remaining at issue are the deductions claimed with respect

to the Aspen, Primavera, Surveyor’s Exchange, and Invensys agreements, and the

deductions claimed with respect to services and property provided to petitioner

during April 2005 under the Otis Elevator agreement and the Bay Street lease. We

examine the record to see whether petitioner has proven that: (1) each item in

dispute is not material, see sec. 461(h)(3)(A)(iv)(I), and/or (2) economic

performance with respect to each item in dispute occurred within the shorter of a

reasonable period after the close of petitioner’s TYE March 31, 2005, or within 8-

1/2 months after the close of petitioner’s TYE March 31, 2005, see sec.

461(h)(3)(A)(ii).
                                         - 55 -

              2.    Materiality Requirement

      In making a determination regarding the materiality of an item under section

461(h)(3)(A)(iv), the treatment of an item on financial statements shall be taken

into account. Sec. 461(h)(3)(B). Section 1.461-5(b)(4), Income Tax Regs., also

addresses the materiality requirement53 and provides the following general

principles:

             (i) In determining whether a liability is material, consideration
      shall be given to the amount of the liability in absolute terms and in
      relation to the amount of other items of income and expense
      attributable to the same activity.

            (ii) A liability is material if it is material for financial statement
      purposes under generally accepted accounting principles.

            (iii) A liability that is immaterial for financial statement
      purposes under generally accepted accounting principles may be
      material for purposes of this paragraph * * *

We glean from these principles that although a liability is material for purposes of

the recurring item exception if it is material for financial statement purposes, a

liability that is not material for financial statement purposes may still be material

      53
        The Financial Standards Accounting Board (FASB) defines materiality as
“[t]he magnitude of an omission or misstatement of accounting information that, in
the light of surrounding circumstances, makes it probable that the judgment of a
reasonable person relying on the information would have been changed or
influenced by the omission or misstatement.” Statement of Financial Accounting
Concepts No. 2, “Qualitative Characteristics of Accounting Information” (1980)
(SFAC No. 2).
                                       - 56 -

for purposes of the recurring item exception. See, e.g., United States v. Stover,

731 F. Supp. 2d 887, 892 (W.D. Mo. 2010), aff’d, 650 F.3d 1099 (8th Cir. 2011).54

      Section 461 does not define when an item is material under the recurring

item exception; it simply provides that in determining materiality, an item’s

treatment on financial statements must be taken into account. Sec. 461(h)(3)(B).

The legislative history accompanying the enactment of the recurring item

exception, however, provides an example of how the materiality of an item should

be analyzed:

      For example, assume that a calendar-year taxpayer enters into a one-
      year maintenance contract on July 1, 1985. If the amount of the
      expense is prorated between 1985 and 1986 for financial statement
      purposes, it also should be prorated for tax purposes. If, however, the
      full amount is deducted in 1985 for financial statement purposes
      because it is not material under generally accepted accounting
      principles, it may (or may not) be considered an immaterial item for
      purposes of this exception.




      54
        A liability also is material if it is significant in amount. See sec. 1.461-
5(b)(4)(i), Income Tax Regs.; see also United States v. Stover, 731 F. Supp. 2d
887, 892 (W.D. Mo. 2010) (analyzing the amount of the expense, the relationship
between the expense and the taxpayer’s revenue, and the materiality of the amount
and nature of the expense for financial statement purposes in deciding whether an
expense was material under sec. 461(h)(3)(A)(iv)(I)), aff’d, 650 F.3d 1099 (8th
Cir. 2011); Rev. Rul. 2012-1, 2012-2 I.R.B. 255. However, the FASB has stated
that “[m]agnitude by itself, without regard to the nature of the item and the
circumstances in which the judgment has to be made, will not generally be a
sufficient basis for a materiality judgment.” SFAC No. 2.
                                        - 57 -

H.R. Conf. Rept. No. 98-861, at 874 (1984), 1984-3 C.B. (Vol. 2) 1, 128; see also

Staff of J. Comm. on Taxation, General Explanation of the Revenue Provisions of

the Deficit Reduction Act of 1984, at 263 (J. Comm. Print 1984). We draw from

section 461(h)(3)(B) and from the example a conclusion: If a taxpayer prorates a

liability arising under a contract over two or more taxable years for financial

statement purposes but takes an inconsistent position on its tax returns, the

liability is material.

       Petitioner prepared its financial statements in accordance with GAAP. On

its financial statements petitioner accrued its liabilities under the Aspen,

Primavera, Surveyor’s Exchange, Invensys, and Otis Elevator agreements and the

Bay Street lease over more than one year for financial statement purposes. On its

FYE March 31, 2006, financial statement, petitioner treated the disputed

deductions as expenses for that year but deducted the expenses on its tax return for

TYE March 31, 2005. Guided by section 461(h)(3)(B) and the example in the

conference report, we conclude that the liabilities giving rise to the disputed

deductions are material because petitioner prorated the liabilities between two

years on its financial statements and took an inconsistent position with respect to

the liabilities for financial statement and tax reporting purposes.
                                         - 58 -

      Petitioner bears the burden of showing that the liabilities attributable to the

disputed deductions are not material under section 1.461-5(b)(4), Income Tax

Regs. Although petitioner contends that the liabilities were not material in amount

for financial statement purposes, petitioner only introduced calculations that

compare the disputed deductions to gross receipts. Petitioner neither offered any

analysis regarding how the liabilities at issue compared in amount or relative

importance to similar types of expenses nor addressed the fact that the disputed

deductions resulted from a requested change in accounting method.55

      Even if we were to find that the amount of the liabilities was immaterial for

financial statement purposes, “[a] liability that is immaterial for financial

statement purposes under generally accepted accounting principles may be

material” for purposes of the recurring item exception. See sec. 1.461-5(b)(4)(iii),

Income Tax Regs. The disputed items resulted from a change of accounting

      55
        Additionally, the FASB has noted that an item that is too small in amount
to be considered material may be material if it arises in abnormal circumstances.
SFAC No. 2. The liabilities in dispute arose in abnormal circumstances, i.e.,
during the year in which petitioner proposed a change in its accounting method.
Petitioner’s treatment of the liabilities for tax purposes also shows abnormal
circumstances given that: (1) petitioner did not treat the liabilities the same way
for financial statement purposes and (2) petitioner’s treatment of the liabilities as
expenses for its TYE March 31, 2005, does not result in a matching of income and
expenses since petitioner did not accelerate the income attributable to the
accelerated expenses.
                                          - 59 -

method, which was disclosed on petitioner’s financial statement, and the disputed

items were treated inconsistently for financial accounting and tax reporting

purposes. In addition, the liabilities giving rise to the deductions were accrued

over more than one taxable year. Under these circumstances, the liabilities

generating the accelerated deductions were material for tax purposes.

       Petitioner had the burden of proving that the disputed items were not

material within the meaning of section 461(h)(3)(A)(iv)(I) and section 1.461-

5(b)(4), Income Tax Regs., and it did not do so. Accordingly, we hold that

petitioner may not use the recurring item exception to accrue and deduct its

liabilities under the Aspen, Primavera, Surveyor’s, Invensys, and Otis Elevator

agreements, or its liability under the Bay Street lease, for periods after March 31,

2005, on petitioner’s income tax return for TYE March 31, 2005. In the light of

our holding, we need not consider whether the other requirements of the recurring

item exception described in section 461(h)(3)(A) have been met.

III.   Conclusion

       Because neither the required performances nor the payment due dates with

respect to the majority of the accelerated deductions occurred before the close of

petitioner’s TYE March 31, 2005, petitioner failed to satisfy the first requirement

of the all events test of section 461; i.e., petitioner failed to prove that all of the
                                        - 60 -

events had occurred to establish the fact of the liabilities under section 1.461-

1(a)(2)(i), Income Tax Regs. With respect to the remaining accelerated

deductions, petitioner did not satisfy all of the requirements for the recurring item

exception under section 461(h)(3) and, consequently, is not excepted from the

general rule of section 461(h)(1) requiring economic performance, because the

liabilities underlying the deductions were prorated over more than one taxable

year, were treated inconsistently for financial statement and tax purposes, and

were material items for tax purposes within the meaning of section

461(h)(3)(A)(iv)(I). See sec. 1.461-5(b)(4), Income Tax Regs.

      To reflect the foregoing,


                                                       Decision will be entered for

                                                 respondent.
