Costs to fix computer systems for the year 2000.

• Author: Conjura, Carol

As the year 2000 approaches, many companies that process (transactions based on storing two digits for the year of the activity (e.g., "96" for 1996) will have to modify their computer software to account for the year based on storing four digits. The costs can be high, as high as $40 million at large companies and estimated billions of dollars for a worldwide fix, according to some financial analysts. Systems that attempt to process year 2000 transactions with the year "00" may encounter significant processing inaccuracies (and even inoperability). For book purposes, a Financial Accounting Standards Board task force has concluded that the costs incurred to change computer software from two-digit years to four-digit years for the year 2000 are period costs that should be expensed as incurred.

The financial accounting treatment of an item does not dictate its treatment for tax purposes. The substantial costs to correct the year 2000 problem may cause the Service to scrutinize their deductibility. The Supreme Court's decision in INDOPCO, Inc., 503 US 79 (1992), has sparked increased IRS examination activity and challenges to the current deductibility of many different expenditures generally regarded as currently deductible. In INDOPCO, the Court enunciated a "future benefit" test, which states that even though a separate and distinct asset was not created, the presence of a benefit beyond the year in which the expenditure is incurred required capitalization of the costs.

The costs of modifying computer software to accommodate four digits should be deductible currently for tax purposes, for one of two reasons. First, Rev. Proc. 69-21 provided that the costs of developing software, whether or not the particular software is patented or copyrighted, were deductible or amortizable under rules similar to those for research and experimental expenditures under Sec. 174. This treatment applies regardless of whether the costs would actually meet the Sec. 174 standard. Sec. 174(a) allows a taxpayer either to currently deduct research and experimental expenditures or to capitalize them as deferred expenses and amortize them over a period of 60 months or more (beginning with the month in which the taxpayer first realizes benefits from such expenditures).

The Service issued...