Opinion ID: 2995339
Heading Depth: 1
Heading Rank: 3

Heading: R.C. sec. 162(a), or capital

Text: expenditures covered by sec. 263(a). Citing INDOPCO, Inc. v. Commissioner, 503 U.S. 79 (1992), the court explained, accurately, that the essential reason behind the need to distinguish between currently deductible expenses and those that are subject to capitalization is to match expenses with the revenues of the taxable period to which they are properly attributable, thereby resulting in a more accurate calculation of net income for tax purposes. 503 U.S. at 84. Some mismatching is inevitable: it is not necessary to count every pencil on hand at the end of a tax year to determine whether it will be useful in the next tax year and, if so, to treat it as a capital asset. The critical consideration in determining whether an expense should be treated as a capital expenditure is whether the expenditure produces more than an incidental future benefit or, as the Treasury Regulations put it, whether a benefit for the taxpayer extends substantially beyond the tax year. See, e.g., Treas. Regs. sec.sec. 1.263(a)-2, 1.461-1(a)(2). This means that, but for the accident that Freightways’ expense year does not correspond with its tax year, there would be no problem in treating the FLIP expenses as current. The licenses and fees Freightways purchased conferred a 12-month benefit on the company; if it had incurred those expenses on January 1 of each year and they had all expired on December 31 (the tax year for Freightways), no one would have argued that capitalization was required. But for reasons unrelated to taxation, that is not the way the FLIP expenses worked. The Tax Court’s task was thus to unravel the tax implications of this quirk, which turn on the lines that must be drawn conceptually between deductible expenses and capital expenditures. Turning to the question whether Freightways’ FLIP expenses were deductible in full in the year they were incurred, the Tax Court understood Freightways to be arguing that it should be allowed to deduct its FLIP expenses in full under a one-year rule permitting the deduction of any current expense with a benefit that extends less than 12 months into the subsequent tax year. The application of this principle would rid the Commissioner’s position of its intrinsic arbitrariness: under a one-year rule, nothing would turn on the accident of the date during a year when a one-year expenditure was made. The worst case (from the Commissioner’s standpoint) one could imagine of a mis-match between the year of payment and the year of benefit would be the one in which a taxpayer bought all its licenses on December 31 of year 1 and deducted their entire cost in that year, even though the entire benefit accrued in year 2. (The worst for the taxpayer might be a case in which the license was purchased on February 1 of the first year and expired on January 31 of the next year, if the Commissioner regarded a full month as substantial enough to require capitalization.) The Tax Court rejected Freightways’ reliance on a one-year rule for two reasons. First, it questioned whether such rule was, in fact, well established in the case law. Second, it found that Freightways had a more fundamental problem, namely the fact that even if such a 1-year rule were widely recognized, it would be inapplicable to an accrual method taxpayer. On these two grounds, and without further explanation, the court affirmed the Commissioner’s deficiency judgment.