The Test
To determine if the prepayments were deductible, the Tax Court applied a three-prong test. The test applies whenever the issue is the deductibility of prepaid items under §§ 162 and 446(b). Each prong is independent and must be satisfied for a prepayment to be deductible:
First, there must be an “actual payment of the item in question.” A mere refundable deposit will not support a deduction.
Second, there must be a “substantial business reason” for making the prepayment early. If prepayment occurred simply to accelerate a tax deduction, no deduction will be allowed in the year of prepayment. Tax reduction is not considered a “valid business purpose,” and thus is not an ordinary and necessary expense under § 162. Grynberg at
Third, prepayment of the item must not cause a “material distortion” in the taxpayer’s taxable income in the year of prepayment. IRC § 446(b). The taxpayer carries a heavy burden to overcome the IRS’s determination that the taxpayer’s method of accounting does not clearly reflect income.
Read more about this topic: Grynberg V. Commissioner
Famous quotes containing the word test:
“Preoccupation with money is the great test of small natures, but only a small test of great ones.”
—Sébastien-Roch Nicolas De Chamfort (1741–1794)
“Our decision about energy will test the character of the American people and the ability of the President and the Congress to govern this nation. This difficult effort will be the “moral equivalent of war,” except that we will be uniting our efforts to build and not to destroy.”
—Jimmy Carter (James Earl Carter, Jr.)