One of the most difficult and important issues facing taxpayers and the Internal Revenue Service (IRS) is whether the often substantial costs that must be incurred to clean up environmental hazards are deductible or must be capitalized. The general rule provided in the Internal Revenue Code and accompanying regulations permits a deduction for expenditures which neither materially add to the value of property nor appreciably prolong its life. However, capitalization is required of expenditures which add to the value, substantially prolong the useful life, or create a new or different use of property. This general rule of deductibility vs. capitalization has spawned hundreds of court cases and has resulted in few definitive principles to guide taxpayers. This area became even more uncertain as a result of the Supreme Court's 1992 holding in INDOPCO, Inc. v. Commissioner, to the effect that expenditures producing significant long-term benefits must be capitalized, irrespective of whether a separate and distinct asset is created. While the IRS has stated that the INDOPCO decision does not change the fundamentalprinciples regarding expensing vs. capitalization, the decision declares that capitalization is the "norm."
The IRS over the past few years has issued several Technical Advice Memoranda and a Revenue Ruling directed at environmental remediation costs, but has failed to enunciate general guidance on which that taxpayers can rely in determining whether, in particular cases, such costs are deductible. In addition, few court decisions have yet been issued in this specific area.
Recently, in an effort to encourage the cleanup of contaminated sites, Congress enacted Code section 198. This provision allows taxpayers to elect to treat certain environmental remediation costs that otherwise would be required to be capitalized as deductible in the year paid or incurred. However, the benefits of this provision are quite limited, as it applies only to qualified environmental remediation expenses incurred with respect to geographical tracts or zones and does not apply to building-specific expenditures, such as those for asbestos abatement. Therefore, much uncertainty remains.
In an effort to provide more certainty to taxpayers, the IRS recently issued Revenue Procedure 98-17, which provides a procedure for requesting written guidance on the tax treatment of environmental cleanup costs incurred in projects that may span several years. This new procedure will be available during a two-year trial period, beginning on Feb. 2, 1998. Environmental cleanup costs are defined extremely broadly to include any costs associated with the assessment, mitigation, removal or remediation of environmental hazards, whether latent or imminent, on the taxpayer'sor on the property of another.
While the IRS generally does not issue advance rulings on matters involving factual determinations, the Revenue Procedure provides that only in rare or unusual circumstances will the IRS decline to issue a ruling in this particular area because of the factual nature of the question. Furthermore, in contrast to its normal policy of not issuing rulings on alternative plans of proposed transactions or on hypothetical situations, the IRS will issue a ruling based on a proposed environmental cleanup plan. If the plan changes, the taxpayer can request that the IRS modify or supplement its letter ruling to address the changes to the project. The taxpayer may not request guidance under this new Revenue Procedure if the identical environmental cleanup issue is in the taxpayer's return for an earlier period and that issue is pending in litigation involving the taxpayer (or a related taxpayer); the fact that the issue is under audit, but not yet in litigation will not, however, bar the issuance of a ruling. A "user fee" of $3,650 is generally charged in connection with the filing of a ruling request.
Generally, a taxpayer may rely on a ruling issued on a specific environmental cleanup project only with regard to that project. This IRS will not consider itself bound to apply the same principles to the taxpayer's other cleanup projects. The ruling will generally be applied prospectively to all future project years; if the ruling involves years for which a return has already been filed, it will also apply retroactively to all open years, unless the IRS exercises its discretionary authority to limit retroactive effect. If the IRS subsequently decides that a ruling was issued in error or does not accord with its current views, it can revoke or modify the ruling, and the revocation or modification applies to all open years under the statute of limitations, subject again to discretionary authority to limit retroactive effect.
Unfortunately, there are not many circumstances where it will be advantageous for the taxpayer to request a ruling. Unless and until the IRS establishes a "track record" of granting favorable rulings (i.e., generally those allowing immediate deductibility of costs), most taxpayers will prefer uncertainty to an adverse ruling. However, if a taxpayer is engaged in the sort of project on which the IRS mightbe expected to rule favorably (such as a soil and groundwater remediation project to correct damage that the taxpayer itself caused) a ruling can provide cheap insurance that the IRS will concur that the expenditures are deductible. Another circumstance where a taxpayer might likely receive a favorable ruling is an environmental remediation project involving primarily the encapsulation of asbestos. In contrast thehas in the past taken the view that asbestos removal costs decrease the taxpayer's risk of liability to contaminated employees and make the taxpayer's property inherently more valuable and has required capitalization of these costs. Similarly, under present IRS views, a taxpayer might not receive a favorable ruling for expenditures regarding property contaminated prior to its purchase by the taxpayer, even if the taxpayer was unaware of the contamination at the time of purchase.
Therefore, until the courts address a number of these issues, it appears unlikely that many taxpayers will seek guidance from the Service. As a policy matter, the Service should develop the law in this area through the issuance of regulations and/or published rulings which provide taxpayers general guidance and precedent on which they can rely, rather than through private rulings which have no precedential value. A taxpayer who is contemplating an environmental remediation project should consult a tax advisor to determine whether a ruling request makes sense in the particular circumstances.
Ronald A. Morris and Elliot Pisem, members of thebar, are partners in the law firm of Roberts & Holland LLP, New York City and Washington, D.C.
Code section 198: * Provision allows taxpayers to elect to treat certain environmental remediation costs that otherwise would be required to be capitalized as deductible in the year paid or incurred.
* Limited benefits because it applies only to qualified environmental remediation expenses incurred with respect to geographical tracts or zones and does not apply to building-specific expenditures.
Revenue Procedure 98-17: * This provides a procedure for requesting written guidance on the tax treatment of environmental cleanup costs incurred in projects that may span several years.
* It is currently available for a two-year trial period which began on Feb. 2.