Academic journal article Journal of Accountancy

Deducting Recurring Expenditures

Academic journal article Journal of Accountancy

Deducting Recurring Expenditures

Article excerpt

Many companies incur expenses that provide benefits in future years. A business must capitalize most of these expenditures. However, some of the expenses are annual, recurring items. The Seventh Circuit Court of Appeals recently reexamined the deductibility of these items, reversing the Tax Court.

U.S. Freightways is a trucking company that operates throughout the continental United States. Each year it incurs and pays fees for licenses, permits, insurance and other recurring items that are good only for one year. However, most of these one-year periods span two tax years. In 1993 the company paid $5,400,000 of expenses covering the 1993 to 1994 tax years. For tax purposes, it deducted the expenditures in the year paid. For financial statement purposes, it capitalized $2,985,000 of the fees--the amount that benefited 1994. The IRS denied the company's deduction for the $2,985,000 that applied to that second year. The Tax Court upheld the IRS, and the taxpayer appealed.

Result. For the taxpayer. Deciding whether an expenditure is deductible or capitalizable has always been difficult. The Indopco decision, although clarifying that a separate asset was unnecessary, did not make the decision any easier. In the U.S. Freightways case, the Seventh Circuit reviewed all the reasons the taxpayer and the IRS provided. It accepted the fact that the expenditures in question were ordinary and necessary and would be deductible if the coverage period coincided exactly with a single tax year.

The first issue the Seventh Circuit looked at was whether a one-year rule applied. Under this rule, an expenditure always is deductible if its benefits do not exceed 12 months--regardless of how many tax years these months span. The Tax Court rejected this rule on the grounds that it applied only, if at all, to cash-method taxpayers. The Seventh Circuit, in turn, rejected this conclusion on the grounds an expenditure's deductibility should not be based on the taxpayer's accounting method. Whether the company is a cash- or accrual-method taxpayer, the deductibility rules should be the same.

The Seventh Circuit decided the issue should be determined based on whether or not the expenditure provided substantial future benefits. It rejected the IRS attempt to quantify "substantial" by imposing a monthly limit. (The fact that a benefit extends six months into the second tax year does not make it any more substantial than if it extends only one month. …

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