Rev. Rul. 79-266

ISSUE

Is the taxpayer, under the circumstances described below, required to report as gross income amounts paid to a security fund by a transit authority where such fund was created for the purpose of reimbursing the taxpayer for future increases in the costs of its liability insurance?

FACTS

M, a domestic corporation using an accrual method of accounting, operates a railroad line through city X. TX, the transit authority of city X, is developing an integrated rail-bus system in and around city X. TX plans to develop and construct a rapid rail transit system in the existing transportation corridors around city X, some of which are owned by M. TX and M entered into an agreement to govern the construction and operation of the transit system upon properties owned by M. TX also agreed to reimburse M for any increase in its liability insurance premium directly attributable to TX's use of M's property. This action was taken because of M's concern with the potential liability that may arise as a result of an accident involving M's property and the transit system.

To provide security for its obligation to reimburse M for the future increases in insurance premiums TX agreed to create a security fund (the fund) with an independent custodian. TX funded the fund with an initial principal deposit of 2,000x dollars, the earnings of which are to accumulate as principal until the principal amount of the fund reaches 3,000x dollars. After the fund has reached this "final level," the net cash earnings of the fund after all expenses have been paid are to be used to secure TX's obligation to M under the agreement. TX retains the right to withdraw surplus earnings from the fund for any purpose, but may not withdraw an amount that will reduce the fund below 3,000x dollars.

M may order the independent custodian of the fund to utilize the principal to reimburse it for increased premiums as a result of TX's use of the property.

LAW AND ANALYSIS

Section 451(a) of the Internal Revenue Code provides that the amount of any item of gross income shall be included in the gross income for the taxable year in which received by the taxpayer, unless, under the method of accounting used in computing taxable income, such amount is to be properly accounted for as of a different period.

Section 1.451-1(a) of the Income Tax Regulations provides that under an accrual method of accounting, income is includible in gross income when all the events have occurred that fix the right to receive such income and the amount thereof can be determined with reasonable accuracy.

Rev. Rul. 74-607, 1974-2 C.B. 149, provides that all the events that fix the right to receive income under an accrual method of accounting occur when (1) the required performance occurs, (2) payment therefor is due, or (3) payment therefor is made, whichever happens first. Thus, if at the time amounts are paid to the fund by TX any of the above three events have occurred in regard to M, then M would be required to include all or part of the initial deposit in its gross income.

The facts in this case establish that none of the three events had occurred at the time the initial payment was made. Both the required performance and TX's obligation to make payments to M were contingent upon an increase in M's liability insurance. At the time the initial payment was made to the fund, M's liability insurance had not been increased. In addition, M did not receive any reimbursements from the fund at the time the fund was established.

HOLDING

M is not required to report in its gross income the amounts paid by TX to the fund.