Untidy wrappings - treatment of package design costs.

• Author: Goldberg, Michael J.

Last October, the IRS issued an action on decision (AOD) nonacquiesing in a 1998 Tax Court decision, which created uncertainty as to whether package design costs are deductible advertising expenses or costs that must be capitalized under Sec. 263. In RJR Nabisco, Inc., TC Memo 1998-252, the court held that graphic design costs were advertising and, therefore, deductible when paid or incurred. The costs in Nabisco were for graphics printed on cigarette filter paper, inside packaging foils and outside packaging. The nonacquesence (AOD/CC-1999-012, IRB 1999-40) cites recent revenue rulings, holding that package design costs are distinguishable from advertising costs. The Service's position is that package design costs are nonrecurring in nature, producing a benefit that lasts beyond the tax year.

The IRS was artful in defining package design costs. It included its hoped-for conclusion in its definition. For example, Rev. Rul. 89-23 stated that package design is "an asset that is created by a specific graphic arrangement or design of shapes, colors, words, pictures, lettering, and so forth, on a given product package, or the design of a container with respect to its shape or function." (Emphasis added.) Such costs include allocable materials, labor and overhead. The ruling provided that package design costs, unlike advertising, must be capitalized under the Sec. 263A uniform capitalization rules; Rev. Proc. 98-39 modified the Service's position by providing that such costs should be capitalized under Sec. 263, not Sec. 263A. Rev. Rul. 92-80 provided that advertising expenses are not covered by INDOPCO, Inc., 503 US 79 (1992). INDOPCO requires capitalization of certain costs that create a long-term asset, which is interpreted as including a significant future benefit. Rev. Rul. 92-80 allowed a deduction for advertising "even though advertising may have some future effect on business activities." However, the ruling also stated that certain types of advertising other than those considered "institutional or goodwill" in nature could be subject to INDOPCO.

Neither the court nor the IRS's pronouncements point to compelling authority to support their positions. The court places great emphasis on Rev, Rul. 92-80. However, the Tax Court makes no mention of Rev. Rul. 89-23. Rev. Proc. 97-35 goes to great lengths to describe the Service's position on capitalizing and amortizing package design costs. Under that procedure (and its predecessor, Rev. Proc...