A party against whom a claim is made may set aside an amount for payment of the claim, even as that party continues to dispute its liability. For example, the obligor may be required to make a payment in order to continue to dispute the claim under judicial or administrative requirements of a court or taxing jurisdiction; or a set-aside may be necessary as an inducement to prevent the counter-party from seeking to secure its claim through means such as filing a lien or seeking the forced sale of property. If, in the absence of a dispute, payment of the claim would give rise to a deduction for income tax purposes, the question arises whether payment with respect to a disputed claim, made either to the person asserting the claim or to a third party, will provide the obligor with a deduction in the year of payment.
In general, an amount may be deducted by a taxpayer using an accrual method of accounting only “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.”1 Accordingly, if liability with respect to a claim is contested in good faith, a deduction generally cannot be claimed under the basic “all events” test, since the existence of the contest indicates uncertainty as to whether the liability is in fact due.
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