Employer Contribution to Strike Fund Is Capital Expenditure

A is an organization that is a member of Association B, an unincorporated exempt business league under Sec. 501(c)(6). B acts as the collective bargaining representative of its members in their negotiations with employees. In Year 1, B members established a line of credit with banks to provide loans to members in the event of an employee strike. In fact, a long strike occurred in Year 1 and members made use of the credit line.

In Year 2, the members contemplated replacing the credit line with their own internal strike fund, to provide certain advantages (e.g., guaranteed access to market-rate loans, elimination of expensive borrowing fees and conditions imposed on the previous bank borrowings). The members authorized the establishment of the strike fund on Date 1; a mandatory annual assessment was imposed on members to finance the fund. The members later unanimously resolved to increase the annual assessment. After that, the members unanimously voted to suspend the planned assessment for Years 3 and 4, respectively.

The strike fund made no loans to its members from Year 2 (the inception of the fund) through Year 6 (the tax year at issue). In Year 5, A and the other B members entered into a court-approved agreement settling long-standing litigation brought against them by their employees, obligating the members to make settlement payments. The members voted unanimously to use the strike-fund assets to satisfy part of their individual settlement obligations. The entire strike-fund balance was used to satisfy part of such obligations. A acknowledged that this use of fund assets was not a loan.

In Year 6, B imposed a strike-fund assessment on members. A paid this assessment, and deducted it on its income tax return as an ordinary and necessary business expense.

Analysis

Sec. 162 generally allows a deduction for all ordinary and necessary expenses paid or incurred during the tax year in carrying on a trade or business. Regs. Sec. 1.162-15(c) provides that dues and other payments to a trade association that otherwise meet the requirements are deductible in full. Sec. 263(a) provides that no deduction shall be allowed for any amount paid out for permanent improvements or betterments made to increase the value of any property. Regs. Sec. 1.263(a)-2(a) clarifies that Sec. 263(a) requires capitalization of costs incurred to acquire property having a useful life substantially beyond the close of the tax year. The Codes capitalization provisions take precedence over its deduction provisions; see Secs. 161 and 261.

The Supreme Court has held that an expenditure must be capitalized if it creates or enhances a separate and distinct asset or otherwise provides significant future benefits for the taxpayer; see Lincoln Sav. & Loan Assn, 403 US 345 (1971). The IRS National Office contends that the issue here is governed by Lincoln Savings, because B members maintain a property interest in the strike fund and contributions to the fund are thus nondeductible capital expenditures. A contends that it maintains no property interest in the strike fund assets, and that the assessments constitute a temporary increase in membership dues that allow B to provide an additional service to members in the form of strike loans.

Rev. Rul. 82-15 specifically allows a deduction for contributions to a strike fund. In that ruling, members paid an increased dues charge to an exempt trade association to establish a loan fund for the sole purpose of providing loans to members experiencing a labor strike. Any amounts remaining in the loan fund on fund termination were to be used to further the trade associations exempt purposes. The ruling concludes that the additional dues charges are ordinary and necessary expenses, because they do not result in the acquisition by the members of any permanent interest in property.

The facts here are distinguishable from Rev. Rul. 82-15, because the members voted unanimously in Year 5 to use all of the accumulated fund contributions (and the earnings thereon) to satisfy their individual settlement obligations under the settlement agreement. In this case, the strike fund resembles the secondary reserve in Lincoln Savings that was determined by the Supreme Court to constitute a separate and distinct asset of the insured institutions. Accordingly, contributions to the strike fund are not deductible as ordinary and necessary expenses.

IRS Letter Ruling (TAM) 200240001 (10/4/02)