To accrue a tax is to record it as an expense of a period and as a liability at the end of that period, before the money leaves. The word describes timing rather than payment, so an accrued tax is an amount already charged against income and still owed.
The complication is that two systems decide the timing and they use different tests. The books ask when the obligation arose. The return asks a stricter question, and for taxes the answer is usually the date of payment.
On the Books
Accrual is the accounting process of recognizing assets or liabilities and the related changes in revenues, expenses, gains, losses, or equity for amounts expected to be received or paid, usually in cash, in the future (FASB Statement of Financial Accounting Concepts No. 8, Chapter 1 (As Amended)). The framework names this case directly: common examples of accruals include purchases and sales of goods or services on account and not-yet-paid interest, rent, wages and salaries, and taxes (FASB Statement of Financial Accounting Concepts No. 8, Chapter 1 (As Amended)). Accruing a tax is that process applied to a tax obligation: the charge goes to the period, and the unpaid balance sits as a liability until it settles.
The general mechanics are the same as for any incurred cost, and they are set out in accrued expenses and accruals. Income taxes are the one category with a standard of their own, because the book charge is not simply the amount owed for the year, and what that standard requires is in ASC 740.
On the Return, the Test Is Stricter
The starting rule is neutral. The amount of any deduction or credit allowed by subtitle A is taken for the taxable year which is the proper taxable year under the method of accounting used in computing taxable income (26 U.S.C. 461(a)). For an accrual method taxpayer, the proper year is decided by two tests stacked on each other.
The all events test. It 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 (26 U.S.C. 461(h)(4)). Both halves have to hold. A liability that certainly exists but cannot be quantified with reasonable accuracy has not met it, and neither has a quantifiable amount whose existence is still contingent.
Economic performance. In determining whether an amount has been incurred with respect to any item during any taxable year, the all events test shall not be treated as met any earlier than when economic performance with respect to such item occurs (26 U.S.C. 461(h)(1)). This is a floor on the first test rather than a replacement for it.
For a tax, the regulation collapses the second test into the payment date. Except as otherwise provided in the same paragraph, if the liability of a taxpayer is to pay a tax, economic performance occurs as the tax is paid to the governmental authority that imposed the tax (26 CFR 1.461-4(g)(6)(i)).
Three details in that paragraph decide real cases. Payment includes payments of estimated income tax, and payments of tax where the taxpayer subsequently files a claim for credit or refund. A tax does not include a charge collected by a governmental authority for specific extraordinary services or property provided to the taxpayer, and the regulation’s own examples are the purchase price of a parcel of land sold to a taxpayer by a governmental authority and a charge for labor engaged in by government employees to improve that parcel. And a licensing or permit fee required by a governmental authority reaches economic performance as the fee is paid to that authority, or as payment is made to any other person at the direction of that authority (26 CFR 1.461-4(g)(6)).
The Recurring Item Exception
The payment rule has a documented way out, and it is conditional on four things at once.
An item is treated as incurred during a taxable year if the all events test is met during that year determined without regard to the economic performance rule, if economic performance occurs within the shorter of a reasonable period after the close of that year or 8½ months after the close of that year, if the item is recurring in nature and the taxpayer consistently treats items of that kind as incurred in the year the first condition is met, and if either the item is not a material item or accruing it in that year results in a more proper match against income than accruing it in the year economic performance occurs (26 U.S.C. 461(h)(3)(A)). The regulation on taxes points at the same relief (26 CFR 1.461-4(g)(6)(i)).
One taxpayer is shut out of it entirely. In the case of a tax shelter, economic performance is determined without regard to the recurring item exception (26 U.S.C. 461(i)(1)).
Real Property Taxes Have Their Own Election
A separate subsection handles the tax that most obviously straddles two years. If taxable income is computed under an accrual method of accounting, then at the election of the taxpayer any real property tax which is related to a definite period of time is accrued ratably over that period (26 U.S.C. 461(c)(1)).
Two limits are inside that sentence. It is an election, so it does not happen by itself, and it reaches only a real property tax related to a definite period of time.
The Rule That Stops a Jurisdiction Moving the Date
A taxing authority can change when its tax becomes due, and the Code refuses to let that change a taxpayer’s deduction year.
For a taxpayer whose taxable income is computed under an accrual method, to the extent that the time for accruing taxes is earlier than it would be but for any action of any taxing jurisdiction taken after December 31, 1960, those taxes are treated, under regulations prescribed by the Secretary, as accruing at the time they would have accrued but for that action (26 U.S.C. 461(d)(1)). The date in that sentence is part of the rule, not decoration: only jurisdiction actions after it are disregarded.
The rule has its own release valve. Under regulations, it does not apply to any item of tax to the extent its application would otherwise prevent all persons, including successors in interest, from ever taking the item into account (26 U.S.C. 461(d)(2)).
What Accruing a Tax Is Not
Paying it. The accrual is the charge and the liability. The payment discharges the liability and, for a tax on the return, is usually the moment the deduction becomes available at all.
A deferred tax. An accrued tax is a present obligation for a tax already determined. A deferred tax balance measures the future tax effect of a difference between the books and the return, which is the subject of deferred income tax and deferred tax liability.
Cash basis accounting. A cash method taxpayer takes the deduction when the tax is paid because that is what the method does, not because of the economic performance rule. The difference between the two methods is in accrual accounting.
Common Questions
To charge a tax to the period it relates to and carry the unpaid amount as a liability, rather than waiting for the payment. On the books that follows the general recognition process. On the return it additionally requires that all events have occurred which determine the fact of liability, that the amount be determinable with reasonable accuracy, and that economic performance have occurred (26 U.S.C. 461(h)(1) and (h)(4)).
Because the return adds the economic performance floor. A tax accrued at year end and paid the following spring has met the all events test but not, on its own, economic performance, since for a tax that occurs as the tax is paid (26 CFR 1.461-4(g)(6)(i)). Unless the recurring item exception applies, the deduction waits. That gap between the book charge and the return deduction is a timing difference, and where it lands is the ground deferred income tax covers.
With the other amounts owed and payable within the entity’s operating cycle, ordinarily as a current liability on the classification test in current liabilities. It is commonly captioned taxes payable or accrued taxes.
Yes, for the economic performance rule. The regulation states that for its purposes payment includes payments of estimated income tax, and also payments of tax where the taxpayer subsequently files a claim for credit or refund (26 CFR 1.461-4(g)(6)(i)).
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