More on Accounting for the Assumption of Contingent Liabilities on the Sale of a Business

Abstract

In his article "Assumption of Contingent Liabilities on Sale of A Business," which appeared in this journal last year, Professor Daniel Halperin ably describes the stakes involved in properly accounting for contingent liabilities assumed by a buyer in asset acquisitions. His primary conclusion is that a buyer of a business who assumes contingent liabilities should not be allowed, as some have urged, a deduction upon payment on these liabilities. Although I agree with much of Professor Halperin's analysis and almost all of his conclusions, I disagree with some of his underlying assumptions about the universal nature of contingent liabilities.
Professor Halperin's analysis relies heavily on the related underlying assumptions that (1) there is always a legitimate reason for deferring a deduction until the person to whom the contingent liability is owed has been identified and that person has taken the amount into income and (2) more often than not, the expected value of the payments to be made on the liability can reasonably be valued in advance. If either of these assumptions is unfounded, the problems posed by contingent liabilities are more difficult than Professor Halperin's analysis might suggest, although his ultimate resolution of the situation may nevertheless be the best one available.
This comment will explore Professor Halperin's underlying assumptions regarding contingent liabilities and examine the stakes involved in fashioning tax accounting rules that rely upon them. It will attempt to demonstrate that at least some liabilities, including some contingent liabilities, are different from the liabilities upon which Professor Halperin's analysis is based. This difference may not easily be accommodated in an income tax based on realization. Nevertheless, this difference may undermine both the assumption that there is a legitimate reason for deferring a payor's deduction until the ultimate payee is known and has been taxed, and may make it substantially more difficult to establish an appropriate value for the
liability in advance of payment.