Taxpayer Can't Deduct Settlement Payments Until Made.
(Parker Tax Publishing December 2013)

A taxpayer was not entitled to deductions for unpaid Tobacco Master Settlement Agreement obligations because economic performance did not occur until the obligations were actually paid. Suriel v. Comm'r, 141 T.C. No. 16 (12/4/13).

Vibo Corporation is an S corporation wholly owned by Vidal Suriel. Vibo began selling cigarettes in the United States in 1999. During the years at issue, 2000-2006, Vibo did not own any cigarette manufacturing or packaging equipment.

For 2000 through 2006, Vibo claimed deductions for unpaid obligations, both principal and interest, owed into a Tobacco Master Settlement Agreement (MSA) fund, which was a qualified settlement fund under Code Sec. 468B. Also during these years, Protabaco, an unrelated company in the business of manufacturing tobacco products, was the fabricator of Vibo's cigarettes. As part of its entry into the MSA, Vibo entered into an exclusive manufacturing and distribution agreement with Protabaco, whereby Vibo appointed Protabaco as its exclusive manufacturer and Protabaco appointed Vibo its exclusive importer.

The IRS disallowed the deductions on the basis that economic performance did not occur until payment was actually made into the MSA fund, pursuant Reg. Sec. 1.468B-3(c)(1). Under Code Sec. 1366, the IRS made adjustments to Vidal's individual income tax returns and determined tax deficiencies.

The IRS argued that Vibo voluntarily entered into the settlement with the settling states and should be bound by the MSA documents. Consequently, the IRS said, the regulations prohibit Vibo from deducting the MSA payment obligations until it actually makes the payments.

Vibo contended that Protabaco was the manufacturer participating in the MSA because all the documents refer to Vibo as the importer and distributor (not the manufacturer) and to Protabaco as the manufacturer. Consequently, Vibo argued, it was simply assuming Protabaco's MSA payment obligations as a cost of purchasing cigarettes and the Code allowed it to deduct the MSA payment obligations as an ordinary and necessary business expense or cost of goods sold.

The Tax Court held that Vidal was not entitled to deductions for unpaid MSA obligations because economic performance did not occur until the obligations were actually paid. Further, because the special rules governing qualified settlement funds did not differentiate between interest and principal, the court afforded such payments equal treatment.

For a discussion of economic performance, see Parker Tax ¶241,520. (Staff Editor Parker Tax Publishing)

Parker Tax Pro Library - An Affordable Professional Tax Research Solution. www.parkertaxpublishing.com

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.