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By Roy Whitehead, Jr., JD, LLM, University of Central Arkansas

The IRS's holding in a controversial TAM (96-18004) that "the costs incurred for major inspections of aircraft engines may not be deducted as ordinary and necessary business expenses under IRC section 162, but instead must be treated as capital expenditures under IRC section 263" has resulted in an exchange of views between 31 members of Congress and the IRS. In a September 19, 1996, letter to the commissioner, House Ways and Means Chairman Bill Archer, asked for reversal of the TAM and expressed concern that the resulting additional cost is a tax burden on airline safety programs and contrary to the administration's airline safety goals. Mr. Archer, citing Trea. Reg. section 1.162-4, backed the airline industry position that the inspections neither materially add to the value of the property nor appreciably prolong its life, but merely keep the engines in an ordinary operating condition.

In an October 1, 1996 response, the chief counsel assured Chairman Archer that the TAM was not intended to deal with important public policy issues like airline safety, but was merely an interpretation of tax law. He defended the TAM by stating that the "major" inspections involve replacement or reconditioning of the engine's competent parts resulting in a material increase in value and a prolonged service life. In the TAM, the IRS rejected the "ordinary and necessary" test advanced by the industry and used by the Tax Court in Plainfield-Union Water Company v. Commissioner, 39 T.C. 33, that "the property's value after the expenditures must be compared to its value prior to the existence of the condition necessitating the expenditure in order to determine whether the value was enhanced." In classifying the major engine inspections as capital expenditures, the TAM stated that, "[t]he expenditures result in substantial improvements to the overall condition of the engine ... which have the effect of adding materially to the value while at the same time prolonging the engine's useful life." In applying IRC section 263 (a)(1) the IRS said, "[T]hese expenditures generate significant future benefits... not the least of which is... without them the FAA would not permit the taxpayer to continue to operate its aircraft.

The IRS position is troubling because logically the major inspections merely restore the engines to their original operating condition and value that existed prior to the condition (3,000­4,000 hours of use) that required the inspection. Because the taxpayer has only regained the asset that it originally possessed, the Plainfield-Union case squarely applies. The purpose of the inspections is to restore the engines to their original condition and protect the traveling public rather than create a new asset. With due respect to the general counsel, the key question is not whether the TAM was intended to deal with public safety, but whether the holding does affect airline safety. Most important, the policy creates an economic incentive to delay the inspections that cost $25,000-$80,000. Given the administration's stated desire to enhance airline safety, IRS policy should provide an economic incentive to encourage timely inspections. *

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