Deduct or capitalize aircraft engine maintenance costs?

• Author: Shin, Won

In FedEx Corp., WD TN, 8/27/03, a district court held that FedEx's off-wing engine maintenance program (OWEMP) expenses were ordinary and necessary business expenses, not nondeductible capital expenditures. Relying on case law, the court created a four-factor test to determine whether the component part or the larger item of property is the appropriate "unit of property" in determining whether repair costs are deductible under Sec. 162. The court concluded that the unit of property being repaired was the aircraft, not the engine, and that engine maintenance expenses did not materially add to the aircraft's value, appreciably prolong its useful life or adapt it for a new or different use.

Facts

The taxpayer filed for a refund arising from a dispute on the tax treatment of its OWEMP for its 1993 and 1994 tax years. For those years, FedEx timely filed Form 1120, claiming and deducting OWEMP costs under Sec. 162, which the IRS denied. FedEx then paid the tax and interest due and sued in district court for a refund.

During the tax years in question, FedEx operated a fleet of over 200 aircraft. Each was propelled by three installed jet engines, plus an auxiliary power unit (APU). These engines and APUs underwent regular maintenance in accordance with the OWEMP. Under this program, when an engine or APU was due for scheduled maintenance, it was removed from the aircraft and sent for an engine shop visit (ESV). FedEx would replace that engine with an engine that had completed all ESV.

ESVs included some or all of the following integrated activities: disassembly, cleaning, inspection, repair, replacement, reassembly and testing. The ESV repairs were performed by an outside vendor or a vendor's subcontractors. If a part could be repaired, but not in time to be returned to the engine or APU with which it had arrived, the vendor would first attempt to replace the part with a similar part from customer stock. (Typically, these were used parts that had been replaced or exchanged and repaired at FedEx's cost during an earlier ESV, stored and returned to FedEx engines at no additional cost.) If a part could not be repaired, it was replaced and FedEx was charged the market price.

At issue was the invoice costs for the ESVs, which varied based on the scope of the maintenance performed and the engine or APU model. The costs ranged from 0.2% to 8.1% of the aircraft's value.

The ESVs at issue did not restore any engine or APU to "like new" condition. The value...