Tax Research Memorandum 2
May 25, 2014
May 25, 2014
TAX FILE MEMORANDUM
SUBJECT Megacorp, Inc. Business Expense deduction
The company wants to know if the IRS is correct under the law when they wouldn’t approve a payment made to Ideas, Inc. in the amount of $5 million as a business expense. Instead, the payment should be characterized as a capital expenditure so that they won’t be able to deduct the payment.
FACTS Megacorp acquired Little, Inc. including all assets and liabilities. Prior to the acquisition, Little had a pending lawsuit from Ideas, Inc. asserting that Little had failed to comply with its patents. Megacorp agreed to pay $5 million in damages and later subtract it from business expense. The IRS states that this expense should be characterized as a capital expenditure.
ISSUE Is the IRS correct when claiming that the $5 million payment should be classified as a capital expenditure or is Megacorp allowed to deduct the amount incurred?
CONCLUSION The IRS is correct in issuing the audit notice. Megacorp is not allowed to deduct the $5 million as a business expense. The company must capitalize the payment as a capital expenditure.
ANALYSIS Section 162 indicates that a deduction is permitted on all standard and essential costs paid or acquired throughout the accessible year in convey on any exchange or business. Unluckily, for Megacorp, the installment of a risk possessed by the organization that they obtained does not qualify as essential business cost. Section 263 asserts that any sum paid out for new structures or for perpetual enhancements or improvements made to expand the quality of any property or estate, is not permitted any deduction. Because Megacorp obtained Little, Inc. and all of the assets, the installment for the infringement liability must be capitalized in the year that it is caused.