federal tax
Accounting
Our client, Blue Corporation, distributes home improvement products to independent retailers throughout the country. Its management wanted to explore the possibility of opening its own home improvement centers. Accordingly, they commissioned a consulting firm to conduct a feasibility study, which ultimately persuaded BC to expand into retail sales. The consulting firm billed BC $135,000, which BC deducted on its current year tax return.
The IRS disputes the deduction, contending that, because the cost relates to entering a new business, it should be capitalized. BC’s management, on the other hand, firmly believes that, because the cost relates to expanding BC’s existing business, it should be deducted. As a result, BC’s management wants to pursue legal action against the IRS.
The state of judicial precedent is as follows: the federal court for BC’s district has ruled that the cost of expanding from distribution into retail sales should be capitalized. The appellate court for BC’s circuit has stated in dictum that, although in some circumstances switching from product distribution to product sales entails entering a new trade or business, improving customer access to one’s existing products generally does not. The Federal Circuit Court has ruled that wholesale distribution and retail sales, even of the same product, constitute distinct businesses. In a case involving a taxpayer from another circuit, the Tax Court has rules that such costs invariably should be capitalized.
BC’s Chief Financial Officer has asked our office to determine whether to pursue legal action against the IRS, and if so, where. Please draft a memo addressing this issue so that I may advise our client appropriately. Please include as part of your analysis the justification for pursuing, or not pursuing, a case against the IRS in the chosen forum as compared to the other alternatives.