Tax Update Blog: Permalink

« Previous · Tax Update Blog Home · Next »

WHAT'S THE EXPECTED VALUE OF A SNOWBALL'S CHANCE X $865,235,387?

February 09, 2006

An answer that seems obvious when you are dealing with a family-owned manufacturer with $20 million in sales apparently gets cloudy when you you add a zero or three to the number. The Sixth Circuit court of Appeals yesterday said the answer is the same for a big company like Chrysler as for the little guy: you can't deduct warranty costs until the warranty claim is filed.

Chrysler deducted $865 million over 1984 and 1985 to cover the estimated costs of warranty work on cars sold in those years (remembering the K-cars, that actually sounds low). Those are the years I started doing tax work, and even then it was widely accepted that warranty costs were only deductible when the warranty work was done. But Chrysler had a consultant, and maybe that would change everything. The consultant did lots of elaborate actuarial work and concluded that $865 million was the right number.

Relying on the Supreme Court's General Dynamics decision, the Tax Court said consultant or no, the deduction isn't available until the actual warranty claim is filed. The Sixth Circuit upheld the Tax Court yesterday. It seems like Chrysler had only a snowball's chance of winning, but they apparently thought it was chance worth paying the attorneys for with that much money involved.

NO DEDUCTION FOR STOCK REDEMPTION

Chrysler took another seemingly hopeless position on its 1985 return when it claimed a $327 million deduction for amounts paid to buy back stock from its employee stock ownership plan (ESOP). To me, it seems like hardly a question worth asking - of course you can't deduct costs of redeeming your own stock. But the tax law can look funny viewed through a $327 million lens.

Chrysler's argument was that it wasn't really a stock buyback - it was extortion a payment to compensate its union members as part of a larger collective bargaining agreement. The court, predictably, said the ESOP would have received the same amount selling the stock on the market, so the redemption wasn't some sort of backdoor wage payment.

FINANCING COSTS?

It appears that the IRS assessed no penalties to Chrysler for the extra 1984 and 1985 taxes. It's likely that Chrysler knew it would lose, but if it could avoid penalties, the deductions would function as a loan from the government at rates competitive with those private creditors would have charged. In that case, even if they lose, they win, because they badly needed the financing back then. A good corporate finance decision, maybe, but not a great way to run a tax system.

Links:

Sixth Circuit decision

Tax Court Decision

      Bookmark: del.icio.us • Digg • reddit