Accounting for package design costs.by Wasserman, Philip
Rev. Rul. 90-63 also specifies that, in most circumstances, the 180- day rule is waived and taxpayers are granted automatic consent to change their method o accounting for package design costs, provided they comply with the terms of the revenue procedure.
PACKAGE DESIGN COSTS
Rev. Rul. 89-23 defines "package design" as an asset that is created by a specific graphic arrangement or design of shapes, colors, words, pictures, lettering, and so forth on a given product package, or the design of a container with respect to its shape or function.
If the taxpayer develops the package design, the term includes the cost of materials, labor, and overhead associated with the design, including all design exploration and study, refinement of the basic design selected, testing, and preparation of the final master comprehensive design.
If an independent contractor performs the work, the term includes all billings related to development of the particular package, including all design exploration and study, refinement of the basic design selected, testing and preparation of the final master comprehensive design.
If the taxpayer purchases the package design, the term includes the purchase price.
TABULAR DATA OMITTED
The costs associated with coupon inserts, refund offers, and other short-lived promotion-related changes are specifically excepted from the definition of package design cost.
Alternative Methods of
Accounting for Package Design
The methods of accounting are as follows:
1. Capitalization Method--General Rule. Taxpayers are required to capitalize package design costs under Sec. 263 if incurred prior to January 1, 1987, or under Sec. 263A in incurred after December 31, 1986. Package design costs generally do not have an ascertainable useful life. Therefore, no depreciation or amortization is allowed under Sec. 167 and the regulations thereunder. Only when a package design is abandoned or sold may the capitalized costs be recovered.
As a matter of administrative convenience, to minimize disputes regarding the proper tax accounting treatment for package design costs, the IRS will allow taxpayers who comply with the revenue procedure to utilize one of the following alternative methods of accounting for these costs.
2. Design-by-Design and 60-Month Amortization Method. Under the design-by-design and 60-month amortization method ("design method"), the taxpayer must capitalize the costs of developing or modifying any package design if the asset created by those costs has no ascertainable useful life or an ascertainable useful life that extends substantially beyond the end of the taxable year in which costs are incurred.
The taxpayer must amortize the basis of any package design over a 60- month period. This treatment is subject to a half-year convention for the year placed in service. Thus, assuming a 12-month taxable year, a taxpayer will be entitled to six months of amortization for the first year of service of a package design. If the package design is disposed of, or abandoned within the 60-month period, the taxpayer is permitted to deduct the unamortized portion of the basis of the design in the tax year of disposition or abandonment.
3. Pool-of-Cost Capaitalization and 48-Month Amortization Method. Under the pool-of-cost capitalization and 48-month amortization method ("pool-of-cost method"), the taxpayer must capitalize all of its package design costs. This must be done without regard to whether the costs have created a package design having an ascertainable useful life extending beyond the taxable year in which the costs are incurred. Such costs would then be amortized over a period of 48 months subject to a half-year convention for the year placed in service.
It should be noted that under this method, the taxpayer may not deduct the unamortized portion of the cost of a package design if abandoned or disposed of within the 48-month period. Even if a package design is never placed in service, it must be capitalized and amortized over 48 months.
The design method and the pool-of-cost method are both rules of administrative convenience that may only be adopted on the taxpayer's initial return or pursuant to the provisions of the revenue procedure. Taxpayers who are not using an acceptable method and do not voluntarily change their methods of accounting for package design costs will be required to do so on audit. The Commissioner may, on adult, require a change to the capitalization method (general rule) rather than one of the two alternative amortization methods, thus having the effect of eliminating all deductions until a package design is disposed of or abandoned.
CHOOSING A METHOD
At first glance, the shorter amortization period of 48 months under the pool-of-cost method seems preferable to the amortization period of 60 months under the design method. However, there is a significant trade-off representing a potential trap for the unwary. All package design costs must be capitalized and amortized under the pool-of-cost method, including the costs of package designs never placed in service. In addition, as noted earlier, early writeoffs for package designs abandoned or disposed of are not permitted under the pool-of-cost method. Contrast this result with the design method, which allows a taxpayer to deduct the unamortized portion of package design costs in the year of disposal or abandonment.
A brief example will illustrate the differences between the two methods. Assume the cost to develop a single package design, successfully or unsuccessfully, is $1,000.
Assume a company initiated work for, and completed, 10 such projects for a total cost of $10,000. Two package designs were successfully placed in service and the remaining eight package designs were immediately abandoned.
Under the pool-of-cost method, $10,000 would be capitalized and amortized over TABULAR DATA OMITTED 48 months even though eight projects at a cost of $8,000 have been abandoned.
Under the design method, $2,000 would be capitalized and amortized over 60 months. The $8,000 incurred in developing the eight abandoned projects could be written off immediately.
Figure 1 summarizes the yearly deductions available under each method.
Under the design method, if either of the two package designs placed in service are sold or abandoned prior to the end of the amortization period, the remaining basis associated with the package design could be written off immediately.
From this example, a reader should conclude that the design method should be the optimum choice for most taxpayers. The ability to deduct, in full, the unamortized costs of a package design in the year of disposal or abandonment certainly outweighs the "benefit" of the shorter amortization period available under the pool-of-cost method.
EFFECTING THE CHANGE IN
If a taxpayer is not currently under examination, not before an appeals office, not in federal court, or not the subject of a criminal investigation, then the taxpayer may choose any of the three methods previously described. The change under the revenue procedure would be accomplished by completing Form 3115. The original of Form 3115 must be attached to a timely filed tax return, including extension of time for filing, for the year of change. A copy of Form 3115 would be filed with the Commissioner of the IRS.
Special rules are provided for taxpayers who are required, or desire, to change their method of accounting for package design costs if they are currently under examination by the IRS, are before an appeals office, are before a federal court, or are the subject of a criminal investigation or proceeding. Implementation of the revenue procedure is complicated further, depending upon whether and when the issue of design costs has been raised. The package design issue is considered raised when the taxpayer receives written notification that thhe issue is under consideration.
The accompanying Exhibits 1, 2, and 3 summarize the filing requirements for a change in different circumstances, indicating available method, year of change, filing time frames and calculation of adjustment.
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