On May 31, 2002, Verizon Communications and its affiliates ("Verizon"), represented by Alston & Bird LLP, and the IRS filed stipulated decision documents with the U.S. Tax Court for 16 docketed cases, including the test case Fresno MSA Limited Partnership v. Commissioner (Docket No. 11170-99). These decision documents finalize the IRS' concession that cellular telephone commissions are currently deductible. Not only is the IRS concession a significant victory for the wireless communications industry, the concession and the internal IRS directives that followed the case may have broad application to other taxpayers with Indopco-type issues.
From its inception, the cellular telephone industry has paid commissions to both employees and independent agents whenever new customers are enrolled in the cellular business. Cellular providers have always treated these commissions as current expenses and, as such, claimed billions of dollars of deductions on their tax returns. Several years ago, the IRS startled the industry by challenging the current deductibility of the commissions paid since 1990, stating that such commissions must be capitalized and amortized over customer life. As a result, the tax treatment of cellular commissions has been the subject of a long-running and major dispute with the IRS.
Test Case Litigated
Representing Verizon, Alston & Bird docketed multiple cases in court involving the tax treatment of cellular commissions. The case selected as the best test case involving this industry-wide issue was tried in the Tax Court in June 2001 by an Alston & Bird trial team led by
Early this year, while the industry was awaiting a decision in the test case, Treasury announced that it intended to issue Proposed Regulations that would affect the tax treatment of the cellular commissions. Following this announcement and with the possibility of a taxpayer-favorable Tax Court decision, the IRS' Chief Counsel announced a change in litigating position with respect to costs incurred to acquire customers in all industries. Specifically, the IRS indicated that, until further guidance is finalized:
(tab)(tab)the Service will not assert capitalization under section 263(a) for employee
(tab)(tab)compensation (other than bonuses and commissions that are paid with
(tab)(tab)respect to the transaction), fixed overhead, or de minimis costs related to the
(tab)(tab)acquisition, creation, or enhancement of intangible assets or benefits.
(tab)(tab)For purposes of this Notice, costs will be considered de minimis to the extent they
(tab)(tab)do not exceed $5,000 per transaction.
See CC-2002-021 (Mar. 19, 2002). After this announcement, the IRS offered to concede the test case pending before the Tax Court. Although the IRS conceded this case, the language relating to "bonuses and commissions" was ambiguous in its application to cellular telephone commissions and, as a result, it did not resolve Verizon's 100+ commission cases in IRS examination and appeals or the countless cases of other taxpayers. To achieve a concession of the commission issue at all levels, Alston & Bird worked directly with the IRS in requesting two separate "internal directives" from the Commissioners of the LMSB and SB/SE Divisions (published on April 26, 2002) and the Commissioner of the Appeals Division (issued May 2, 2002, but unpublished). These directives clarified the language contained in the Chief Counsel notice. The LMSB directive, for example, clearly indicated that even a bonus or commission would be deductible if it was less than $5,000 per transaction. The Appeals directive went even further by specifically referencing cellular telephone commissions (as well as loan origination fees and merger transaction costs). As a result of these directives, Alston & Bird was able to obtain a significant victory for the entire cellular telephone industry and for all taxpayers with Indopco-type expenses.
Although the LMSB and SE/SE directive and the Appeals directive permit deductibility on the basis of a preservation of limited IRS resources and they caution that future guidance may require capitalization, taxpayers are still provided with planning opportunities that are not limited to the cellular telephone industry. For example, taxpayers may have expenses of creating an intangible that is significant in the aggregate but perhaps nominal on a transaction by transaction basis. These taxpayers should review their capitalization practices to determine if they have capitalized any de minimis expenses that can be currently deducted under the Chief Counsel notice or either of the IRS directives described above. In addition, industry groups should be attuned to the regulatory process to make sure that the more reasonable approaches in these notices are not reversed.
For additional information, contact Michelle Henkel at 404-881-7633, Philip Cook at
404-881-7491, or Pinney Allen at 404-881-7485.