IRS joins FASB on severance pay.

The IRS ruled severance payments remain deductible business expenses, notwithstanding the U.S. Supreme Court ruling in U.S. v. Indopco (112 S.Ct. 1039, 1992) that said expenses were capital if they produced a long-term benefit for the payer. The tax code generally strives to implement the "matching principle" of tax accounting--expenses should be matched with the revenue of the period to which they relate. Therefore, an expenditure may produce some future benefits and, as it was in Indopco, may be required to be capitalized, but if it is primarily a period expense it is eligible for current deduction.

This was the case with severance payments. Although severance payments may produce some future benefits, such as operating costs reduction and increasing operating efficiencies, the payments are primarily a period expense because they principally relate to previously rendered services. Thus, severance payments are deductible business expenses.

Interestingly, this decision aligns the tax and accounting treatment of these termination payments. Emerging issues task force issue no. 94-3, Accounting for Restructuring Charges, also concluded that severance costs should be accrued at the time the corporation adopts a bona fide termination plan (see Financial Accounting: EITF Update, page 89).

Observation: Severance payments are deductible business expenses even though severance costs embody an element of future benefit--the matching principle overrode the future benefit principle with the result that current deduction is appropriate. --Robert Willens, CPA, managing director at Lehman Brothers, New York City.