Requirements for Students to Attend First Two Weeks of Following Semester to Obtain Tuition Discount Barred Deduction Until Actual Attendance Test Met in the View of the IRS

In Field Attorney Advice FAA 20174901F, the IRS signaled that, in addition to taking the position that the Third Circuit erred in its decision in Giant Eagle, Inc. v. Commissioner, CA3, 117 AFTR 2d 2016-1476 (822 F.3d 666) (see Action on Decision 2016 for the formal nonacquiesence announcement), it would also seek to limit any potential applicability to the exact circumstances as were found in Giant Eagle if the agency could not persuade the court that the Third Circuit’s analysis was in error.

The issue involves a taxpayer’s ability to take a deduction for accrued expenses under the all events test found in IRC §461.  The all events test, found at IRC §461(h)(4) provides:

(4) All events test

For purposes of this subsection, the all events test is met with respect to any item if all events have occurred which determine the fact of liability and the amount of such liability can be determined with reasonable accuracy.

This case involves a taxpayer in the business of providing educational services who offered a discount to students that met certain criteria.  The IRS FAA outlines the nature of the program as follows:

Taxpayer is among the largest providers of Services. Headquartered in Location A Taxpayer offers academic programs through * * *1 Taxpayer targets a large and diverse market, as its educational institutions offer students the opportunity to earn undergraduate and graduate degrees, * * *.

Taxpayer implemented a Program in the fiscal year ended Date 1, whereby, subject to the following * * * requirements and * * *, students are provided with a Reduction on the successful completion of Number during a term and complete attendance for the first two weeks of the following academic term (the following tax year for the liability at issue).

For purposes of generally accepted accounting principles, a reporting entity would have accrued the expected liability under the program for the financial statement for the fiscal year ended Date 1 for any students who had completed the requirements aside from the attendance for the first two weeks of the following academic term.  But is that the proper year for reporting the expense for tax purposes, or must the taxpayer wait until the following year when it knows how many students complete those first two weeks?

The taxpayer initially took the conservative approach of not deducting the payment until the year the attendance requirement was met, but following the issuance of the Giant Eagle decision by the Third Circuit Court of Appeals the taxpayer amended the tax return to claim the deduction for the fiscal year ended Date 1.

The IRS has tended over the years to hang its hat on the question of whether a liability is fixed based on any form of uncertainty that might exist.[1]  Giant Eagle involved a program where customers of the grocery chain received points that allowed them to get a discount on gasoline purchases for a period of time.  The taxpayer, based on the historical record of use, could reasonably project the percentage of outstanding discounts that would be used.  The Third Circuit rejected the IRS’s view that the liability wasn’t fixed until specific customers later purchased fuel.  It found, like the analysis in the Washington Post Co. case, that while the taxpayer might not know exactly to whom the benefit would be granted, the entity knew with reasonable precision the amount of the ultimate cost.

Not surprisingly, the IRS in the FAA again goes after the issue that there is no liability until each student completes the two weeks, regardless of whether the number who will complete those two weeks may be subject to accurate estimation:

We believe that Taxpayer's liability was not fixed until after the student earned Number AND complete attendance for the first 2 weeks of the following academic term. Not until the student completed the attendance requirement would the liability be fixed, assuming the other * * * requirements were satisfied, e.g., * * *. Otherwise, prior to the following academic term, Taxpayer could only make its best guess as to whether any particular student would remain in school and be entitled to a Reduction. Accordingly, the all-events test has not been satisfied in this case. The * * * clearly states that Taxpayer will not disburse the Reduction if the student fails to meet any of the * * * requirements, which includes the attendance requirement.

The FAA then goes on to attempt to explain why, this time, the objection works by finding that the students in this case needed to do more than merely show up to purchase merchandise, as was the case in Giant Eagle:

Unlike in Giant Eagle, however, there is no unilateral contract formed because of the condition precedent that the student remain in school for two weeks to receive the Reduction. The * * * requirement not only required the student to complete and earn Number, but it also required the student to complete attendance for the first two weeks of the following academic term (Taxpayer's subsequent taxable year).

* * * In Giant Eagle, the discount was applied immediately on purchase, distinguishing the contract terms. Thus, the actions required by the student for the unilateral contract to be formed did not occur until the following taxable year.

The IRS looks to the Supreme Court’s ruling in General Dynamics (481 US 239) to support the view that what the students had to do in this case was “too much” and no accrual was available.  As the FAA states:

In General Dynamics, the Supreme Court held that the taxpayer was not entitled to deduct additions to reserve accounts reflecting its obligation to reimburse employee medical expenses which, as of the close of the year, had been incurred but not yet submitted for reimbursement on an official claim form. In the Court's view, the filing requirement was “not a mere technicality;” rather, it was a “true condition precedent to liability.” Id. at 244 n.5. Stated in terms of the all-events test, “[m]ere receipt of services for which, in some instances, claims will not be submitted does not, in our judgment, constitute the last link in the chain of events creating liability.” Id. at 245. In noting that the filing of a claim was not a mere technicality, the Court stated that: "[s]ome covered individuals, through oversight, procrastination, confusion over the coverage provided, or fear of disclosure to the employer of the extent or nature of the services received, might not file claims for reimbursement to which they are plainly entitled." Id. at 244. Since the last event necessary to fix that liability in General Dynamics had not occurred by the end of the tax year, the first prong of the all-events test was not met.

The FAA applies this to the educational program in question by stating:

In the subject case, Taxpayer was aware at the end of the tax year as to which students earned Number, but each student still had to complete attendance in the first two weeks of the following academic term. Like the taxpayer in General Dynamics, at year end, Taxpayer's estimated Reductions remained only a potential expense until it became fixed, if at all, on the registration for classes the following term. Obviously, various reasons could arise that a student would not register for classes the next term, including, transferring schools, * * *, needing a break, or deciding that school is not worth the expense.

As a final issue, the FAA noted that the taxpayer retained the right to discontinue the program, though the redactions make it difficult to understand under what conditions (if any) that could happen.  In Giant Eagle the Third Circuit had found that once the customers had purchased enough groceries, the taxpayer had to honor the award so long as the customer made the later purchase in time.

[1] For instance, see the position the IRS unsuccessfully took regarding an accrued bonus in The Washington Post Co., 405 F.2d 1279 (Ct. Cl. 1969).  The agency took 42 years to finally accept the liability was fixed in that case, issuing Rev. Rul. 2011-29.  Disclosure:  Graham Holdings Company, the ultimate parent of the Loscalzo Institute and Kaplan, Inc., is the same corporation that was the plaintiff in that case, being known as the Washington Post Company until selling the newspaper of the same name.