Contingent Liability. Y is a C cor- poration using the cash method that elects to become an S corporation effective Janu- ary 1, 1996. In 1995, a lawsuit was filed against Y claiming $1,000,000 in damages. In 1996, Y loses the lawsuit, pays a $500,000 judg- ment, and properly claims a deduction for that amount. Under paragraph (b)(2) of this section, the $500,000 deduction allowed in 1996 is not recognized built-in loss because it would not have been allowed as a deduction against gross income before the beginning of the recognition period if Y had been an ac- crual method taxpayer (even disregarding section 461(h)(2)(C) and § 1.461–4(g)).
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