USFreightways supports IRS no "one-year rule" stance.

• Author: Godshalk, Richard

In the recent decision in USFreightways Corp., 113 TC No. 23 (1999), the Tax Court, for the first time, specifically addressed whether a one-year rule exists for determining whether a payment is a capital expenditure or a deductible expense. The court concluded that there is no one-year rule, and appears to have established different capitalization criteria for cash- and accrual-method taxpayers. Tax practitioners should assess the possible effect of this holding on their clients.

A number of practitioners contend that the touchstone for determining whether a payment is a capital expenditure is whether it creates a benefit with a duration in excess of one year; a payment that creates a benefit with a duration of one year or less is a deductible expense. On the other hand, the IRS contends there is no one-year rule and has begun to challenge deductions for prepayments.

In USFreightways, an accrual-basis, calendar-year taxpayer that transports freight by truck was required under state and local laws to pay for various licenses. USFreightways paid $4.3 million for licenses in 1993; none of the licenses had a duration in excess of one year, but some had an effective period extending into 1994. USFreightways also paid $1 million for liability and property insurance coverage in 1993, covering the one-year period July 1, 1993-June 30, 1994. For book purposes, USFreightways deducted the cost of the licenses and insurance ratably over the periods to which they related. For tax purposes, it deducted the cost of the licenses and insurance in the payment year. The Tax Court held that USFreightways was not entitled to deduct the license and insurance costs in the payment year, but should have deducted them ratably over the tax years to which they related.

The Tax Court concluded that the duration of a benefit beyond the current year (and not whether the duration of the benefit exceeds one year) is critical in distinguishing between capital expenditures and deductible expenses. The court analyzed cases involving prepayments and concluded that there was no support for widespread existence of a one-year rule.

The Tax Court further concluded that, even if a one-year rule existed, it would be inapplicable to an accrual-method taxpayer. Analyzing the cases involving prepayments, the court concluded that a one-year rule for accrual-method taxpayers was precluded. The court noted that the accrual method, unlike the cash method, attempts to match expenses with...