Rules for Capitalizing Prepayments for Goods and Services

Regs. §1.263(a)-4(d)(3) provides that in general, "[a] taxpayer must capitalize prepaid expenses". Regs. §1.263(a)-4(f) provides an exception if the right or benefit doesn't extend for more than 12 months. However, the exception doesn't apply to rights of indefinite duration, including "a right attributable to an agreement to provide or receive a fixed amount of goods or services". The preamble to the proposed regulations (at 67 FR 77701) provides further detail on this provision:

C. Rights of Indefinite Duration
The 12-month rule does not apply to contracts or other rights that have an indefinite duration. Rights of indefinite duration include rights that have no period of duration fixed by agreement or law or that are not based on a period of time, but are based on a right to provide or receive a fixed amount of goods or services. The IRS and Treasury Department believe that, in many cases, application of the 12-month rule to contracts or other rights that are not based on a period of time would necessitate speculation regarding whether the contract or other right could reasonably be expected to be completed within 12 months. In addition, the IRS and Treasury Department believe that amounts paid to create or enhance such rights should be capitalized and recovered through amortization, through a loss deduction upon abandonment of the right, or through basis recovery upon sale.

Further, § 1.167(a)-14(c) of the regulations provides rules for amortizing costs to obtain a right to receive a fixed amount of property or services. Under these rules, the basis of such right is amortized for each taxable year by multiplying the basis of the right by a fraction, the numerator of which is the amount of tangible property or services received during the taxable year and the denominator of which is the total amount of tangible property or services received or to be received under the terms of the contract. The IRS and Treasury Department believe that these amortization rules provide a reasonable recovery method for many Start Printed Page 77709rights that are required to be capitalized under these regulations, and serve as a sufficient substitute for a 12-month rule.

In light of this information, I am wondering whether there is any leeway at all for prepayments for goods and services, or whether they must always be deducted in the year the benefit is received, regardless of how small the prepayment may be.

In the case of prepayments for goods, it seems that the de minimis safe harbor rule for tangible property could be applied, as the amount would be "paid to facilitate the acquisition of real or personal property".

What about prepayments for services? If a cash basis client prepays utilities or tax prep fees in December, is there any way he can deduct these amounts in the year paid, or must they be capitalized until such time as the services are actually received?