Deducting the Cost of Business Expansion

BY EDWARD J. SCHNEE

Tax Case

In today's rapidly changing global economy, most companies find it necessary to expand to stay competitive. This expansion can be accomplished either by acquiring another business or expanding internally. Are the costs of internal expansion deductible for tax purposes?

FMR Corp. provides investment management services to mutual funds. During the year in question, FMR incurred expenses associated with starting 82 new mutual funds. The company deducted these expenditures as ordinary business expenses. The IRS reclassified them as capitalizable expenses, which must be deducted over a period of years. FMR appealed.

Result: For the IRS. The Tax Court concluded that FMR's expenditures provided significant future benefits and therefore should have been capitalized. The court rejected the cases the taxpayer cited as precedent on the grounds they were all decided before the U. S. Supreme Court's Indopco decision. The Indopco case made clear that an expenditure must be capitalized if it provides significant future benefits even though it does not create a separate, distinct asset.

The Tax Court also rejected FMR's reliance on IRC section 195, which deals with start-up expenditures. Although the legislative history mentions that costs to expand an existing business are deductible, it does not remove the requirements for deductibility. Specifically, section 195 requires the expenditures to be deductible by an existing business. Expenditures that provide future benefits are not deductible. Therefore, FMR must capitalize its expansion expenditures.

This decision appears to contradict both precedent and current practice. If other courts follow it, companies are likely to find that all expansion costs must be capitalized unless plans to expand are abandoned.

  • FMR Corp. and Subsidiaries v. Commissioner . 110 TC no. 30.

Prepared by Edward J. Schnee, CPA,
PhD, Joe Lane Professor of Accounting and
director, MTA program, Culverhouse
School of Accountancy, University of
Alabama, Tuscaloosa.

SPONSORED QUIZ

How well do you know small business?

There are over 30 million small businesses in the U.S., and many of them are optimistic in their outlook. Are you familiar with the obstacles and opportunities they are facing? Test your small business acumen with this quiz sponsored by Chase Ink®.

SPONSORED REPORT

In focus: Payroll

Providing payroll services that comply with ever-changing regulations and meet evolving employee and employer demands is no easy task. Paychex's Tom Hammond discusses common payroll considerations for CPA firms.