Welch v. Helvering – US SC PDF

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Federal Income Tax Lecture Notes from Casebook/Spring Course...

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Tax Law! Lecture Notes! Spring 2019!

Welch v. Helvering – US SC • Π paid off unsatisfied debts of a bankrupt corporation in an effort to re-establish business relationships. The SC held that these expenses were not deductible. In coming to that conclusion, the Court assumed that the expenses were necessary, but rejected the argument that they were ordinary because businesspeople do not ordinarily pay off the debts of others without the obligation to do so. • The payments were categorized as efforts to create good will with the creditors for his new business. Good will is an intangible asset and the payments were thus capital expenditures rather than business expenses. Such goodwill payments increase basis in the new busines instead of an immediate deduction. The Cost Must be an Expense ➢ As distinguished from capex ➢ Business Expenses, in general, are immediately deductible when paid or incurred by TxP ➢ Capital expenditures are not deductible under § 162 says § 263(a)(1) (“No deductions shall be allowed for any amount paid out for new buildings or for permanent improvements or betterments made to increase the value of any property or estate”). §1.263 expands upon this and says acquisition or improvement of assets, generally, are capital expenditures. As such, if TxP acquires or improves machinery or a building, that cost is not deductible. ➢ BUT, costs spent to repair a business asset so that it remains in efficient operating condition are a deductible business expense. § 1.162-4. Conversely, replacements, alterations, improvements, or additions are not deductible (they are capex). Midland Empire. Midland Empire Packing Co. v. Commissioner • For 25 years π used the basement of his plant in the operation of his business curing hams and bacon and for storage of meat and hides. In the taxable year, as the result of a new oil refinery next door, the meat inspector found oil seeping into the basement and advised π that he either must oil proof the room or shut down operations. So, π

oil proofed the basement and sought to deduct the cost of that work as a deductible repair. Oil proofing the basement was necessary because it was appropriate and helpful, and ordinary in that doing so was a normal response to nan oil leak • In determining whether an expenditure is a capital one or is chargeable against operating income, it is necessary to bear in mind the purpose for which the expenditure was made. • To repair is to restore to a sound state or to mend, while a replacement connotes a substitution. A repair is an expenditure for the purpose of keeping the property in an ordinarily efficient operating condition. It does not add to the value of the property, nor does it appreciably prolong its life. It merely keeps the property in an operating condition over its probable useful life for the uses for which it was acquired. o Returning the basement to its use • Expenditures for that purpose are distinguishable from those for replacements, alterations, improvements, or additions which prolong the life of the property, increase its value, or make it adaptable to a different use. The one is a maintenance charge, while the other are additions to capital investment which should not be applied against current earnings. o Adapting to a new use. • Here, the court held that oil proofing the basement was a repair and thus immediately deductible. o The repairs merely served to keep the property in an operating condition over its probable useful life for the purpose for which it was used. o The court also found the expenses were normal and ordinary because protecting a business from seepage is a normal thing to do. ➢ Capital Expenditures may be “deductible” over time through depreciation, so repairs are more immediate. But, the ’17 Amendments significantly limit this distinction between business expenses and capital expenditures, at least when dealing with tangible assets other than real property. ➢ For 5 years from 2018 through 2022, the New Code allows TxPs to immediately deduct the entire cost of putting property placed into service (business or trade) other than real property and intangible assets, i.e. machinery. The distinction is still significant for real property and intangible assets...