Auto Manufacturer May Not Deduct Estimated Future Warranty Costs

The Tax Court ruled that an automobile manufacturer did not satisfy the first prong of the all-events test for its warranty expenses on the sale of vehicles to dealers. Instead, based on the manufacturer's obligation, the liability is fixed no sooner than when a claim is filed by either a dealer or a retail customer (Chrysler Corp., TC Memo 2000-238).

Chrysler deducted its warranty expenses in 1984 and 1985, arguing that the last event necessary to establish its warranty liability was the sale of a vehicle to a dealer. The IRS disallowed the deductions. Chrysler vehicles are covered by written warranties and by implied warranty provisions mandated by Federal and state statutes. Pursuant to separate agreements, Chrysler dealers must correct conditions covered by Chrysler's warranties and submit claims to Chrysler after completing the repairs.

Chrysler relied primarily on Hughes Properties, 476 US 593 (1986), in which a Nevada casino was required by state statute to pay out as jackpots a certain percentage of the amounts gambled in progressive slot machines and to keep on hand a cash reserve sufficient to pay the guaranteed jackpots. The Supreme Court found that the all-events test was satisfied and the casino was entitled to a deduction for the expense. The Court reasoned that the state statute made the amount shown on payout indicators incapable of reduction. Thus, the event-creating liability was the last play of the machine before the end of the fiscal year, an event that occurred during the tax year.

Chrysler relied on Hughes for the proposition that its statutory liability satisfied the first prong of the all-events test; namely, all events had occurred that establish liability. The Service, however, cited General Dynamics Corp., 481 US 239 (1987). General Dynamics deducted estimated medical-care costs under its self-insured employee medical plan. Even though employees' medical needs had arisen and treatment had occurred, the Supreme Court found that the first prong of the all- events test was not met until claims were filed.

The Tax Court agreed with the IRS, ruling that in Chrysler, as in General Dynamics, "the last event fixing liability does not occur before the presenting of a claim, either a claim for warranty service by the customer through one of petitioner's dealers or a claim for reimbursement made on petitioner by the dealer." Further, the Tax Court was not persuaded by Chrysler's argument that the statutory nature of its liability fixed the liability on the sale date, finding instead that a statutory liability will satisfy the first prong of the all-events test "when a statute has the effect of irrevocably setting aside a specific amount, as if it were to be put into an escrow account, by the close of the tax year and to be paid at a future date." Finding that the relevant statutes did not have this effect, the Tax Court held for the Service.

The focus in Chrysler appears to be on the statutory liability imposed on Chrysler, not the contractual liability arising out of Chrysler's relationships with its customers and dealers. Accordingly, its application may be limited.

From Diane Herndon, Washington, DC