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be “accrued”, until the year in which the contest is terminated.
If the contested liability is paid before the contest is
terminated, the liability is deductible in the year of payment
pursuant to section 461(f). If the same tax accrual principles
apply for purposes of section 535(b)(1), there is no basis in law
for the holding of the Court of Appeals for the Fifth Circuit in
J.H. Rutter Rex Manufacturing Co. v. Commissioner, 853 F.2d 1275
(5th Cir. 1988), revg. T.C. Memo. 1987-296, that a taxpayer’s
payment of a contested tax liability entitles the payor to treat
the contested liability as “accrued” during the prior taxable
year to which the accumulated earnings tax relates.
II. Relevance of Sec. 1.535-2(a)(1), Income Tax Regs.
The Court of Appeals for the Fifth Circuit, in J.H. Rutter
Rex Manufacturing Co. v. Commissioner, supra at 1297, noted that
the last sentence of section 1.535-2(a)(1), Income Tax Regs.,
does not prohibit an accrual deduction for paid contested taxes
prior to termination of the contest because the sentence provides
only that “an unpaid tax which is being contested is not
considered accrued until the contest is resolved.” (Emphasis
added.) In reaching that conclusion, the Court of Appeals
overlooked the fact that, at the time the cited regulation was
promulgated, pursuant to T.D. 6377, 1959-1 C.B. 125, the Internal
Revenue Service’s published position with respect to paid
contested taxes was that such taxes are deductible in the year of
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