Deductions for cellular phone commissions fall victim to INDOPCO.

• Author: Burke, Michelle
• Position: U.S. Supreme Court case

The IRS ruled in Letter Ruling (TAM) 9813001 that, when a telecommunications company pays one-time commissions to third-party distributors for acquiring new cellular service customers, the commissions must be capitalized under Sec. 263. Citing INDOPCO, Inc., 503 US 79 (1992), the Service concluded that the commissions resulted in a significant long-term benefit to the company.

Since the Supreme Court's decision in INDOPCO, some IRS examiners have challenged telecommunications companies on this issue. The new TAM clarifies and publicizes the Service's position. Because most telecommunications service providers have arrangements with third parties that include customer enrollment commissions, the TAM's implications for the industry are significant, and the IRS can expect litigation. For taxpayers in other industries, the TAM serves as another illustration of the Service's use of INDOPCO.

In the TAM, a cellular telephone service provider paid commissions to third-party distributors for securing new monthly service customers for its cellular service, and residual commissions based on customers who remained with the company for more than 180 days. The company's contract with newly enrolled customers generally provided an initial one-month service term, with automatic renewal on a month-to-month basis until the customer terminated the contract by giving the taxpayer seven days' advance notice. Once a third-party distributor enrolled a customer, the distributor did not provide any additional services to the taxpayer as to that customer.

The taxpayer deducted the commissions as ordinary and necessary business expenses under Sec. 162. In general, Sec. 162 allows a deduction for all ordinary and necessary expenses paid or incurred during the tax year in carrying on a trade or business. Sec. 263 generally provides that no deduction is allowed for the cost of permanent improvements or betterments made to increase the value of property. Regs. Sec. 1.263(a)-2(a) requires the capitalization of costs incurred to acquire property with a useful life substantially beyond the close of the tax year. The Supreme Court held in INDOPCO that the costs of acquiring an asset with a useful life extending substantially beyond the end of the tax year or conferring a long-term benefit on the taxpayer must be capitalized.

IRS Attack in New TAM

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