Rev. Rul. 83-70: Tax Treatment of Assumed Vacation Pay

When a business changes hands, the tax treatment of vacation time earned by employees but not yet paid out is a key detail. Revenue Ruling 83-70 provides guidance on the tax deductibility of these accrued vacation pay liabilities when a business is sold through an asset purchase. This ruling clarifies which party is entitled to the tax deduction, a determination that can influence the negotiation and final structure of the sale.

The Core Principle of Revenue Ruling 83-70

The central tenet of Revenue Ruling 83-70 establishes that in an asset sale, the buyer is entitled to the tax deduction for accrued vacation liabilities, not the seller. This outcome is contingent upon the buyer expressly assuming the responsibility for these payments as a formal part of the transaction. The IRS’s reasoning is that the actual payment of the vacation liability is a cost incurred by the buyer’s business operations after the acquisition. The act of paying the employees solidifies the expense for tax purposes, and since the buyer makes that payment, the deduction belongs to them.

This guidance applies directly to asset acquisitions and other transactions treated as such for federal tax purposes. A common example is a stock sale for which a Section 338 election is made, allowing the purchasing corporation to treat the stock purchase as a purchase of the target company’s underlying assets.

Tax Treatment for the Seller

From the seller’s perspective, the seller is not permitted to claim a tax deduction for the accrued vacation pay that the buyer has agreed to assume. The assumed liability is not ignored in the seller’s tax calculation. Instead, the amount of the vacation pay liability assumed by the buyer is treated as part of the total proceeds received from the sale of the business assets. For instance, if a seller sells business assets for $1 million in cash and the buyer also assumes $50,000 of accrued vacation pay liabilities, the seller’s total amount realized for tax purposes is $1,050,000. This larger sale price increases the seller’s capital gain or reduces their capital loss, as the seller has been relieved of a debt.

Tax Treatment for the Buyer

For the buyer, the tax consequences of assuming vacation pay liabilities are twofold. The first consequence is that the amount of the assumed vacation pay liability is added to the total purchase price, which in turn increases the buyer’s basis in the assets they acquire. This higher basis can provide a future tax benefit, as it may lead to larger depreciation or amortization deductions, or a smaller taxable gain when the assets are eventually sold. The second consequence is the timing of the tax deduction for the vacation pay itself. The buyer is permitted to claim a deduction for the vacation pay, but this deduction is only available when the vacation pay is actually paid to the employees, as the act of payment triggers the ability to deduct the expense.

Structuring the Purchase Agreement

To ensure the tax outcomes described in Revenue Ruling 83-70 are respected, the asset purchase agreement must be precise. The agreement is the controlling document and must contain specific language stating that the buyer “expressly assumes” the seller’s accrued vacation pay liabilities. This contractual clarity provides unambiguous evidence of the transfer of the obligation from the seller to the buyer. If this language is vague or omitted, the IRS could challenge the intended treatment, potentially disallowing the buyer’s future deduction. This could lead to a situation where neither party receives the deduction, or it could trigger a dispute between the buyer and seller long after the deal has closed.