In the ongoing dispute over the distinction between costs that are currently deductible and those that must be capitalized, the Tax Court dealt two blows to taxpayers who seek to deduct what they consider to be their routine costs of doing business. The court required a bank to capitalize loan origination costs ( PNC Bancorp, Inc. v. Commissioner, 110 TC no. 27 [June 8, 1998]), and it required the parent company of the Fidelity family of mutual funds to capitalize expenses incurred in launching new funds ( FMR Corp. and Subsidiaries v. Commissioner, 110 TC no. 30 [June 18, 1998]).
In the PNC case, the taxpayer and the IRS agreed that the approved loans were "separate and distinct assets." The Supreme Court's holding in Indopco v. United States (503 U.S. 79 ) suggests expenses incurred in creating these assets should be capitalized. The taxpayer had argued that loan origination costs should be deductible because they are recurring ordinary and necessary business expenses which are integral to a bank's day-to-day business. The court rejected this argument, finding no exemption for recurring ordinary expenditures from the general rule that the expenses of acquiring or creating a capital asset must be capitalized. In other words, capitalization trumps expensing.
The court also adopted the IRS's view that loan origination costs should be amortized over the expected lives of the loans, and this view was consistent with financial accounting treatment used by the taxpayer, in accordance with FASB Statement no. 91, Accounting for Nonrefundable Fees and Costs Associated with Originating or Acquiring Loans and Initial Direct Costs of Leases.
In the FMR case, the taxpayer and the IRS agreed that if the costs of launching mutual funds created separate and distinct assets those costs should be capitalized. Focusing on the extent and duration of benefits realized by FMR, the court held that future revenue from management contracts with the mutual funds, marketing rights and " synergistic benefits" to FMR's entire family of funds are significant future benefits. Therefore, the expenses of launching mutual funds should be capitalized—even if such expenses are incurred to expand FMR's business. The court did not allow an amortization period on the grounds that FMR failed to carry its burden of establishing a limited life for the future benefits to be obtained from the launching expenditures.
Observation. Business taxpayers should be concerned about these rulings because, in each case, the taxpayer incurred the expenses at issue as it went about its regular, day-to-day business. The court's conclusion that there is no exception from capitalization for routine expenses is a major win for the IRS, strengthening its hand as it chips away at expenses traditionally treated as currently deductible. Examining agents can be expected to continue to examine day-to-day costs to determine whether they produce significant long-term benefits or separate and distinct assets. Affected costs potentially include, for example, those incurred in expanding an existing business or attracting new customers.
Tracy Hollingsworth, Esq., staff director
of tax councils at Manufacturers
Alliance, Arlington, Virginia.