FedEx v. Commissioner: the continuing debate over cyclical maintenance costs

Tax Executive, The, Nov-Dec, 2003 by James L. Atkinson

   [R]esult in substantial improvements to the overall
   condition of the engine that are not merely incidental
   and which have the effect of adding materially
   to the then value of the engine while at the same
   time prolonging the engine's useful life. Furthermore,
   these expenditures generate significant
   future benefits to Taxpayer, not the least of which
   is the fact that without them, the FAA would not
   permit Taxpayer to continue to operate its aircraft.
   Finally, in the case of the engines owned by Taxpayer,
   the major inspection costs restore exhaustion
   for which an allowance has been made.

TAM 9618004 ignited a firestorm of controversy. (23) Some commentators as well as industry experts claimed the national office had not been presented with an accurate view of the facts. Others expressed concern that the national office had placed too much reliance on the "significant future benefit" standard of INDOPCO in a context in which it did not belong. (24)

3. Rev. Rul. 2001-4

The controversy continued until the IRS issued Rev. Rul. 2001-4, (25) where the IRS sought to clarify for taxpayers and the field alike the absence of any bright line rules when considering whether an expenditure is a deductible repair versus a capital improvement. Rev. Rul. 2001-4 was designed to demonstrate that the analysis instead represents a spectrum of possible outcomes, with the proper tax treatment requiring an inquiry into the precise nature and effect of the purported repair expenditures. The revenue ruling does so by setting forth three fact patterns involving procedures incurred in connection with the continued operation of an airplane's airframe.

Scenario One appears to be the most like the fact pattern in TAM 9618004. In compliance with FAA regulations, an airline performed a "heavy maintenance visit" (HMV) (26) on the airframe of a 16-year-old aircraft. The HMV consisted of completely disassembling the aircraft and performing certain tasks on the disassembled airframe in order to prevent "deterioration of the inherent safety and reliability levels of the airframe." The tasks included lubrication and service; operational and visual checks; inspection and function checks; restoration of minor parts and components; and removal, discard, and replacement of certain life-limited single cell parts, such as cartridges, canisters, cylinders, and disks. The revenue ruling states that no major components of the airframe were replaced, and that no upgrades of or additions to the airframe's structural materials occurred. Significantly, the revenue ruling notes that because the value of an aircraft declines as it ages regardless of this work, the work at best maintained the relative value of the aircraft. The aircraft was out of service for 45 days, and the taxpayer incurred $2 million in labor and material costs.

On the facts of Scenario One, the revenue ruling concludes that the costs of the HMV may be deducted under section 162 as routine maintenance costs. The ruling notes that the maintenance did not involve replacements, alterations, improvements, or additions to the airframe that appreciably prolonged its useful life, materially increased its value, or adapted it to a new or different use. Instead, the HMV "merely kept the airframe in an ordinarily efficient operating condition over its anticipated useful life for the uses for which the property was acquired." (27) The FAA's mandating the HMV and providing that that the aircraft would be grounded if it were not completed were found irrelevant. (28)