Accounting for the costs of package designs.

• Author: Rousso, Ada S.

Accounting for the Costs of Package Designs

Background

On March 6, 1989, the Internal Revenue Service published Rev. Rul. 89-23, Rev. Proc. 89-16, and Rev. Proc. 89-17, providing guidance on the tax treatment of package design costs. These pronouncements generally required capitalization of the costs of all package designs currently in service. Such costs could not be deducted until the package design was abandoned. All previously deducted package design costs had to be added back into income over a period not to exceed six years. Package designs placed in service in taxable years ending after March 6, 1989, were eligible for 60-month amortization, but only if the costs of package designs previously placed in service (which were not eligible for amortization) were included in income.

In response to an overwhelmingly negative reaction to the March 1989 pronouncements, on July 21, 1989 the IRS published Announcement 89-98. Announcement 89-98 delayed the due dates for filing Form 3115 in order to change to a capitalization method of accounting until the transition procedures in Rev. Proc. 89-16 and Rev. Proc. 89-17, requiring capitalization of all previously deducted costs of package designs, could be modified. Accordingly, during the following months, taxpayers incurring package design costs were prohibited from capitalizing and amortizing those costs under Rev. Rul. 89-23. Instead, although knowing that deducting package design costs was an improper method, taxpayers were forced to continue deducting such costs.

On December 18, 1990, 17 months after delaying imposition of the first pronouncements, the IRS issued Rev. Proc. 90-63, revising the guidance relating to accounting for the costs of package designs. Rev. Proc. 90-63 significantly improves the treatment of accounting for the costs of package designs because it permits amortization of the costs of package designs on hand as of the beginning of the year of change. In addition, the revenue procedure provides a limited look-back period during which taxpayers must determine costs that have to be capitalized.

This article analyzes the new revenue procedure and its implication for taxpayers incurring package design costs.

Overview

Rev. Proc. 90-63 establishes procedures for the adoption of alternative methods of amortizing package design costs. The revenue procedure makes available a "pool of costs" method, allowing all package design costs to be accumulated in a single pool and amortized over 48 months. Capitalization of costs on a design-by-design basis with amortization over a period of 60 months, as provided in earlier guidance, also is available. In either case, the method adopted applies to all package design costs, whenever incurred, and not only to costs incurred in certain taxable years.

The revenue procedure provides specific rules for the adoption of the amortization methods. Different rules apply depending upon whether the taxpayer is under examination, at Appeals, or in litigation with the IRS, as well as whether and when the package design issue has been raised by the IRS. Unless the package design issue was raised by the IRS prior to March 6, 1989, taxpayers generally must adopt one of the amortization methods for their first taxable year ending after December 18, 1990.

The revenue procedure is intended by the IRS to provide the exclusive procedures for the adoption of methods to amortize package design costs. Failure to follow the procedures outlined in Rev. Proc. 90-63 could result in the taxpayer's being required to use the capitalization method (described below) and may result in the recovery of package design costs being delayed until their abandonment. In addition, in certain situations a taxpayer may not change its method of accounting for package design costs if the taxpayer has changed, or received permission to change, its method within the past six years.

Package Design Costs

The term package design refers to the specific graphic arrangement or design of shapes, words, colors, pictures, lettering, and so forth on a given product package, or the design of a container with respect to its shape or function. Package design costs generally include the direct and indirect costs associated with package designs. If the taxpayer develops the package design, package design costs include the cost of materials, labor, and overhead associated with the design, including all design exploration and study, refinement of the design, testing, and preparation of the final master comprehensive design. If an independent contractor performs the work, package design costs include all billings related to the development, testing, and preparation of the final master design. If the taxpayer purchases the design, package design costs equal the purchase price.

Identification of the costs to be capitalized is determined under the principles of section 263 for costs incurred before January 1, 1987, and under the principles of section 263A for costs incurred after December 31, 1986, regardless of when the...