Rev. Rul. 54-608

Further consideration has been given to I.T. 3956, C.B. 1949-1, 78, and the opinions expressed in G.C.M. 25261, C.B. 1947-2, 44, relating to the accrual of vacation pay by taxpayers employing the accrual method of accounting for Federal income tax purposes. The question of whether an accrual basis taxpayer is required to enter into a written contract in order properly to accrue vacation payments which are to be made during the succeeding year has also been considered.

In I.T. 3956, supra , the written agreements (with a labor union) provided that a vacation with pay was to be granted during the current calendar year to each employee who rendered compensated service on not less than 160 days during the preceding calendar year. The taxpayer filed its return on a calendar year basis. Under the agreements, vacations were to be taken between January 1 and December 31. An employee whose employment was terminated (by reason of quitting or being justifiably discharged) prior to his scheduled vacation period did not receive a vacation with pay, nor did he receive payment in lieu of a vacation. It was held that the employer's liability for vacation pay accrued as of the end of the taxable year with respect to which the employees qualified for a vacation with pay during the succeeding year by reason of having rendered the necessary qualifying service.

In the case covered by G.C.M. 25261, supra , the Secretary of the Interior entered into an agreement on May 29, 1946, with the M Union covering, for the period of Government possession of certain coal mines, the terms and conditions of employment in such mines. The agreement provided for vacation payments of $100.00 to all employees with a record of one year's standing (June 1, 1945 to May 31, 1946). Pro rata payments for full months of employment were provided for employees beginning employment or terminating employment during the qualifying period. The taxpayer, which kept its accounts and filed its Federal income tax return on a calendar year basis, was a party to a contract dated April 11, 1945, which contained a provision for vacation pay of $75. It was held in G.C.M. 25261, supra , that no part of the vacation pay provided for by the agreement of May 29, 1946, was accruable and deductible as of December 31, 1945, and that the accrual and deduction of vacation pay could properly be made only for amounts determinable at December 31, 1945, under the contract then in effect.

Section 43 of the Internal Revenue Code of 1939 provides generally, with an exception that is immaterial here, that deductions and credits should be taken for the taxable year in which `paid or accrued' or `paid or incurred,' dependent upon the method of accounting used, unless in order to reflect the income the deductions or credits should be taken as of a different period.

In Tennessee Consolidated Coal Company v. Commissioner , 15 T.C. 424, an accrual basis, calendar year taxpayer was denied a monthly accrual of vacation pay. The taxpayer by contract was required to pay to all employees, with a record of 12 months of continuous employment immediately preceding June 1, a stipulated amount of vacation pay. A similar set of facts existed in Morrisdale Coal Mining Company v. Commissioner , 19 T.C. 208. In E. H. Sheldon & Company v. Commissioner , 19 T.C. 481, an accrual basis, calendar year taxpayer was a party to an agreement covering the period May 1, 1945, to April 30, 1946, inclusive, under the terms of which it was obligated to grant vacations with pay to certain of its employees during the period May 1, 1945, to December 1, 1945. Vacation pay was, by specific provision, to be determined and computed at the start of each contract year. Any employee separated was entitled to his vacation pay. The time of the vacation was to be mutually agreed upon between the employee and the department head. The contract, although for only one year, would continue in effect for another year unless one of the two parties served notice not less than 60 days prior to April 30, 1946, of a desire to terminate or change it. In the Tennessee Consolidated and Morrisdale Coal Mining cases, the Tax Court interpreted the provisions of a contract similar to the one involved in G.C.M. 25261, supra , and, as stated above, the accrual of vacation payments was denied on the ground that there was no fixed and definite liability at the end of the taxable years involved. In the Sheldon case, the accrual was denied, the court holding that liability for 1946 vacation pay did not accrue in 1945 where there was no contract in existence covering it and where the contract for 1945, if allowed to remain in effect, would require employment on May 1, 1946, as a condition precedent for 1946 vacation pay. The United States Court of Appeals for the Sixth Circuit, on July 27, 1954, in affirming the Tax Court on the vacation pay issue in the Sheldon case, used the following language:

`The reasonable probability during the taxable year that a liability will accrue is not sufficient if, as a matter of fact it does not actually come into existence during the taxable year. A liability does not accrue for tax purposes as long as it remains contingent, or if the events necessary to create the liability have not occurred.'

In accordance with the decision in the Tennessee Consolidated, Morrisdale Coal Mining, and Sheldon cases, it is held that no accrual of vacation pay can take place until the fact of liability to a specific person has been clearly established and the amount of the liability to each individual is capable of computation with reasonable accuracy. It is further held that no distinction should be made between vacation plans under written contracts and vacation plans under oral agreements providing the vacation plan or policy was communicated to the employee prior to the beginning of the vacation year and that under such plan the employees' rights to a vacation with pay (or payment in lieu thereof) are vested at the time that the employer seeks to accrue the deduction.

I.T. 3956, supra , is hereby revoked, and G.C.M. 25261, supra , is modified to the extent that it is inconsistent with the views expressed herein. However, under the authority of sections 3791(b) of the 1939 Code and 7805(b) of the 1954 Code, such revocation and modification will not be applicable with respect to taxable years to which the provisions of the 1939 Code are applicable. This Revenue Ruling will be applied only to taxable years ending on or after June 30, 1955. See section 462 of the 1954 Code which permits taxpayers on the accrual basis to make an election to take into account a reasonable addition to reserves for estimated expenses in computing taxable income.