“Casino operators are, in effect, placed on a cash method of accounting when it comes to jackpots, so a difference between financial accounting and tax accounting for these sums will inevitably arise.” — Robert Willens
The All-Events Test
The high court noted that an accrual-method taxpayer is entitled to deduct an expense in the year in which it is incurred. The standard for determining when an expense is incurred is the so-called all-events test: all the events must have occurred that establish the fact of the liability, and the amount must be capable of being determined with “reasonable accuracy.” So to satisfy the all-events test, a liability must be “final and definite” in amount, “fixed and absolute,” and “unconditional.”1
The IRS argued that the taxpayer’s liability for the progressive jackpots was not “fixed and certain” and was not “unconditional or absolute” by the end of the fiscal year, for there existed no person who could assert any claim over those funds. It took the position that the indispensable event is the winning of the jackpot by a gambler.2
The effect of the Nevada Gaming Commission’s regulations3 was to fix the taxpayer’s liability. The regulations forbade reducing the indicated payoff without paying the jackpot. The taxpayer’s liability — that is, its obligation to pay the indicated amount — was not contingent. That an extremely remote and speculative possibility existed that the jackpot might never be won does not change the fact that, as a matter of state law, the taxpayer had a fixed liability for the jackpot that it could not escape.
The IRS, the court concluded, misstates the need for identification of a winning player. That is a matter “of no relevance” for the casino operator. The obligation is there, and whether it turns out that the winner is one patron or another makes no conceivable difference as to basic liability. In fact, the court acknowledged that there is always the possibility that a casino may go out of business with the result that the amount shown on the jackpot indicators would never be won. However, this potential nonpayment of an incurred liability exists for every business that uses an accrual method, and it does not prevent accrual. “The existence of an absolute liability is necessary; absolute certainty that it will be discharged by payment is not….” 4
The Economic Performance Test
However, under the law that exists today, a liability is not incurred until the historical all-events test is satisfied and “economic performance” occurs with respect to the liability. As a result, the all-events test cannot be met with respect to an item any earlier than the time that economic performance occurs with respect to the item.5
The introduction of the economic-performance test has the effect of overturning the holding of the court in United States v. Hughes Properties, Inc. Therefore, the tax rules — specifically Regulation Section 1.461-4(g)(4) — notes that “…if the liability of a taxpayer is to provide an award, prize, jackpot, or other similar payment to another person, economic performance occurs as payment is made to the person to which the liability is owed....” That means that the law now employs as its touchstone the litigating position the government embraced in United States v. Hughes Properties, Inc. Therefore, casino operators are, in effect, placed on a cash method of accounting when it comes to jackpots, so a difference between financial accounting and tax accounting for these sums will inevitably arise. The liability will accrue for financial-accounting purposes in advance of the time such liability is incurred for tax purposes. Therefore, a casino operator will be constrained to record a deferred tax asset to reflect the tax effect of this ”deductible” temporary difference.