3rd Circuit Court Overturns Decision in Giant Eagle Inc v Commissioner

What does overturned decision in Giant Eagle Inc v Commissioner mean for future of tax deductible liability regulations?

The 3rd Circuit recently overturned an IRS decision with the assertion that Giant Eagle, a supermarket chain, was entitled to make a $3.7 million deduction on the expenses associated with loyalty discounts from its tax returns. According to a PricewaterhouseCoopers report, in its decision, the Court ruled that the IRS was incorrect in denying the deduction because the two prongs of the “all events test” were fulfilled. The first prong of the “all events test” is whether the liability is fixed.  The second prong of the test is whether the amounts can be determined with reasonable accuracy.

The case background

In Giant Eagle Inc. v. Commissioner, the supermarket chain offered a “fuelperks!” program with loyalty discounts awarded for gas that expired after three months if unused. The discounts were earned by purchases and the first prong of  the “all events test’ was easily determined. However, the IRS took exception to when Giant Eagle deducted the estimated expenses in 2006 and 2007 from customers redeeming a portion of the loyalty gas points – many of which were either unused or not expired. It is here that IRS claimed that the determination of the amount could not be made with reasonable accuracy.

The IRS denied the deductions, which prompted the company to appeal the decision to the U.S. Tax Court. The Tax Court subsequently upheld the IRS decision, whereupon Giant Eagle filed an appeal to the 3rd Circuit Court of appeals.

The 3rd Circuit reverses the IRS decision

The Court asserted that the all events test was applicable to the case. In its ruling, the Court stated that since a liability can accrue within a tax year where all events occurred, liability had been established.

The stated liabilities became fixed only when the discounts were used. Since the total amount of Giant Eagle’s expected liability could be conclusively determined by the end of the tax year, the all events test provisions were fulfilled. According to Judge Jane R. Roth’s opinion cited by Law 360, Giant Eagle entered a unilateral contract in its loyalty program for customers, so its liabilities were sufficiently fixed to be tax deductible.

“Giant Eagle amply demonstrated the existence — as of year’s end — of both an absolute liability and a near-certainty that the liability would soon be discharged by payment,” Roth explained.

The Court also reasoned that Regulation 1.451-4(a)(1) enables taxpayers to use an accrual method of accounting to deduct costs before they occur if the all events test has occurred in the tax year and liability was established and could be reasonably identified.

Significance of the ruling

The Court’s decision to appeal the previous decisions was important because it seemed to disagree with established legal precedents and published regulations. With the significance of the decision, it will be interesting to see the impact it will have on tax deductible liabilities regulations in the future or whether the IRS will seek a legislative remedy.