Proposed guidance on capitalization.

• Author: Fitzpatrick, Cathy
• Position: Treasury Department advance notice of proposed rulemaking

On Jan. 17,2002, Treasury issued an advance notice of proposed rulemaking (ANPRM) (REG-125638-01). The ANPRM describes regulations it expects to provide in 2002, which will help taxpayers distinguish between Sec. 263(a) capital expenditures and currently deductible Sec. 162(a) expenditures incurred in acquiring, creating or enhancing intangible assets or benefits.

The ANPRM (and the forthcoming regulations) is the result of a long-standing controversy over whether capitalizaton is required for intangible assets or benefits. Due to the lack of clarity and detailed guidance under Sec. 263(a) and its regulations, taxpayers had to resolve many disputes on a case-by-case basis, through rulings or court cases. Two landmark Supreme Court cases in this area, decided over 20 years apart, are Lincoln Savings & Loan Ass'n, 403 US 345 (1971), and INDOPCO, Inc., 503 US 79 (1992). In Lincoln Savings, the Court provided that an expenditure is capital if it creates or enhances a "separate and distinct asset." In INDOPCO, however, the Court found that the creation of a separate and distinct asset was not a necessary condition for classifying it as a capital expenditure; rather, the taxpayer had to capitalize expenditures that produced a "significant long-term future benefit." Unfortunately, INDOPCO may have done more harm than good, as the broad nature of the long-term future-benefit test only increased uncertainty, reinforcing the need for additional detailed guidance.

Thus, almost 10 years after INDOPCO, the ANPRM was issued to clarify the long-term future-benefit test by outlining the framework for capitalization issues that the IRS and Treasury expect to provide. The ANPRM is an attempt to provide clear and administrable rules that will significantly reduce uncertainty and controversy in this area, freeing up both IRS and taxpayer resources.

ANPRM Summary

The ANPRM addresses specific types of expenditures for which capitalization is expected to be required, and specifically provides that "[t]he IRS and Treasury Department anticipate that other expenditures to acquire, create, or enhance intangible assets or benefits generally will not be subject to capitalization under section 263(a)." In addition, to reduce administrative and compliance costs, the notice provides safe harbors and simplifying assumptions, including a "12-month rule."

The ANPRM groups expenditures into three main categories, and lists the specific types of costs that fall within each.

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