Indopco

The INDOPCO case in 1992 provided some guidelines concerning capitalization for the taxpayer. In the case, the Supreme Court ruled that expenses directly incurred in reorganizing or restructuring a corporate entity for the benefit of future operations are not deductible. The court also held that investment banker fees, legal fees, proxy costs, and SEC fees incurred by a target corporation in a friendly takeover must be capitalized if the takeover produces significant future benefits. The taxpayer would rather expense the costs as this would give them a deduction on their taxes. Capitalizing these costs also increases their income, increasing the amount of taxes they have to pay. Thus, the IRS encourages capitalizing costs whenever there is a question as to what method to use.

Originally the taxpayer had more of an advantage because the ruling was left open to much interpretation and the IRS was rather lenient concerning the future benefits. The Supreme Court just said that determining future benefits is undeniably important in determining whether a future expense should be capitalized. There have now been rulings where the IRS has become more aggressive in dealing with future benefits. The IRS realizes that companies will expense anything they can to reduce their tax burden. Even costs that would be incurred while investigating the expansion of a company's existing business should be expensed if they are connected to an event that produced a significant long-term benefit. The only way they can be expensed is if the acquisition proves to be an unsuccessful one.

The INDOPCO ruling also leaves open the question as to what directly incurred means. Companies were left to decide whether to capitalize a cost that was incurred to secure a benefit that extended beyond the current year, even though the transaction was not one in which a specific, identifiable asset was acquired. If it was determined the cost provided a significant long term benefit, the cost was a capital cost, and if not the cost was a period expense. Now, with the additional rulings, the IRS is the ones "dancing in the street", because companies are forced to capitalize more costs, bringing in more revenues for the government.

I think the decision was a good one in the sense that there needed to be some clarification as to what costs should be capitalized and which ones need to be expensed. However, the rule is not clear