Year 2000 expenditures.

As the clock ticks past midnight on December 31, 1999, many software-driven systems may respond as though the year 1900 followed 1999, potentially wreaking havoc with normal operations in virtually every sector of the economy. Computers, manufacturing systems, elevators, vending machines--almost anything that depends on time and date--will be affected. (For additional discussion on the Year 2000 issue, see the articles beginning on page 33.)

Companies will have to spend a lot of money to avoid the problems that could occur if a system interprets 00 as 1900. The IRS has been looking at how companies treat such expenditures for tax purposes and soon may issue some guidance.

Under current law, most taxpayers deduct software development costs on a current basis in a manner consistent with revenue procedure 69-21 (1969-2 C.B. 303). The IRS is not expected to change that treatment. However, Year 2000 "fixes" will not be limited to software development. There will be other costs, such as hardware, labor and consulting, that may be more difficult to classify.

Companies may be able to deduct some costs as incidental repairs and maintenance--for example, the replacement of a chip. However, other costs will have to be capitalized and amortized. For example, Year 2000 costs must be capitalized if a company elects to replace its systems on a wholesale basis or if the IRS views an expense as having been incurred as part of an overall plan of renovation. The IRS also may scrutinize consultants' fees to determine whether they should be capitalized. Further, the IRS may be concerned that taxpayers will claim some Year 2000 costs as creditable research costs.

Observation: Companies should look carefully at the full panoply of related expenditures to ensure they are properly characterized. Equally important, taxpayers will need to make certain that these characterizations are properly documented.

Tracy Hollingsworth, Esq., staff director of tax councils at Manufacturers Alliance, Arlington, Virginia.