IRS Should Allow Expensing of ERP Implementation Costs

In examinations, IRS agents are questioning the treatment of costs to implement enterprise resource planning (ERP) software. Even though the Service recognizes that these expenditures are not software costs amortizable over 36 months under Sec. 167(f), agents are treating implementation costs in the same manner.

This IRS examination position derives in part from an IRS Industry Specialization Program newsletter that identifies ERP costs as an emerging issue. In this newsletter (which has been published internally), the Service supports capitalization of implementation costs by stating:

Many of the people working on the implementation are business consulting types, who may not be software programmers....Because the companies are redesigning and mapping out how they are going to do business, they incur significant costs in discussing and planning out how their business processes are going to work in conjunction with the new software.

Is the IRS Position Correct?

The Service's examination position is open to question. A stronger position is that ERP implementation costs generally are ordinary and necessary business expenses deductible under Sec. 162. Based on its own description of a company's ERP implementation in the ISP newsletter—"redesigning and mapping out how [companies]...are going to do business"—the IRS could reach the same conclusion.

A recent revenue ruling raises the question of whether the IRS National Office would agree with the position of Service examiners on ERP implementation. Rev. Rul. 2000-4 concludes that ISO 9000 costs are currently deductible, and also states more broadly that expenditures that primarily benefit current operations generally are deductible.

Rev. Rul. 2000-4 cites a number of court cases, which the IRS summarizes in the ruling as standing for the propositions that (1) payments made to protect and supplement income from the taxpayer's existing business are deductible and (2) expenses incurred to protect, maintain or preserve a taxpayer's business generally are deductible. Applying the rationale of these cases (and the rationale of Rev. Rul. 2000-4) to ERP software implementation suggests that such costs should be treated similarly.

From Vicki Howe Zenner, J.D., LL.M., Washington, DC