Deductibility of exit and entrance fees paid to the FDIC.

In a divisive decision, the Tax Court concluded in Metrocorp, Inc., 116 TC 211 (2001), that exit and entrance fees paid to the Federal Deposit Insurance Corporation (FDIC) were currently deductible under Sec. 162. The FDIC administers and maintains the Savings Association Insurance Fund (SAIF) and the Bank Insurance Fund (BIF), to which a taxpayer paid exit and entrance fees, respectively, as part of its acquisition of a failed savings and loan, which the taxpayer then converted from a savings association into a bank.

Future-Benefit Test

This decision reflects a narrowing of the significant-future-benefit test of INDOPCO, Inc., 503 US 79 (1992). In Metrocorp, the court clearly differentiated between significant benefits and incidental (and thus insignificant) benefits. The IRS argued that the taxpayer reaped incidental benefits, demonstrated by the ability to subject itself to one regulatory scheme and continue its association with the BIF (which was more stable than the SAIF). According to the Tax Court, any alleged advantages flowing from the benefits of these associations were incidental, allowing the fees to be deductible currently.

Despite its conclusion that the exit and entrance fees did not produce a significant future benefit, the court nonetheless left the door open for a misconstruction of its position when it commented on the IRS's failure to argue that the fees at issue required capitalization because the taxpayer incurred them in a capital transaction. According to the court, if "[the IRS] had made such a determination or argument, [the taxpayer] may well have wanted to offer evidence relating to it." This statement suggests that the court might have required capitalization if that argument had been raised; the taxpayer would have been forced to show that the fees were not incurred in a capital transaction.

The IRS did not appeal Metrocorp. It was appealable to the Seventh Circuit, which decided A.E. Staley Mfg. Co., 119 F3d 482 (1997), rev'g and remd'g 105 TC 166 (1995). In that case, the court concluded that certain legal and investment banking fees incurred to defend a taxpayer against a hostile takeover were currently deductible. In Metrocorp, a concurring opinion noted that "in analyzing costs allegedly incurred in connection with the acquisition or creation of a capital asset, three Courts of Appeals have reversed all or part of recent Tax Court opinions," referring to A.E. Staley, as well as Wells Fargo & Co., 224 F3d 874 (8th Cir. 2000), aff'g in part and rev'g in part sub nom Nonvest Corp., 112 TC 89 (1999); and PNC Bancorp, Inc., 212 F3d 822 (3rd Cir. 2000), rev'g 110 TC 349 (1998).

Perhaps in response to these appellate court decisions overturning Tax Court decisions, the Tax Court, in reaching its conclusion, stated, "[w]e find as a fact that Metrocorp's payment of the fees produced for it no significant long-term benefit." By finding as a fact (as opposed to a matter of law) that the taxpayer received no significant long-term benefit, the court appears to be attempting to bar any reversal. As a rule, higher courts defer to lower courts' findings of fact, on the basis that the lower court evaluates the facts first-hand, and, as such, is in a better position to determine their validity and verity. Thus, generally, higher courts review lower court decisions only for errors in the application of the law. Because the Tax Court based its decision on its findings of fact, the likelihood that it would have been overturned might have been reduced.

The Tax Court's Prescient Decision

In an advance notice of proposed rulemaking (REG-125638-01), the IRS announced its intention to issue regulations that will address capitalization issues involving the significant-future-benefit test (see "Proposed Guidance on Capitalization" below). According to the notice, the regulations will probably include a 12-month rule, under which a taxpayer does not have to capitalize certain expenditures that create or enhance intangible rights or benefits (including amounts paid to obtain certain rights from a governmental agency), provided the expenditures do not create rights or benefits that extend beyond the earlier of (1) 12 months after the first date on which the taxpayer realizes the rights or benefits attributable to the expenditure or (2) the end of the tax year following the tax year in which the taxpayer incurs them. While the benefit from the exit and entrance fees in Metrocorp is arguably indefinite, it is unclear how the 12-month rule would apply because, as the court stated in Metrocorp, the expenditure did not result in a significant benefit.

Thus, the IRS is unlikely to challenge the costs at issue in Metrocorp in the future, as INDOPCO's reach begins to erode, starting with the notice and the regulations that follow. As the IRS now recognizes, INDOPCO has no place in expenditures that create insignificant benefits, and the court in Metrocorp rightly recognized that.

FROM CAROLYN OSSEN, J.D., AND PAUL K. GIBBS, CPA, WASHINGTON, DC