Credit Card Initiation Fee

Technical topics regarding tax preparation.
#1
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We have a business client that just signed up for the AMEX Centurion card. $10k one-time initiation fee. The annual fee on the card is $5k. The annual fee is clearly deductible. The initiation fee, though, I’m not so sure about. Seems there’s a long-term benefit there. However, there really is only a long-term benefit (that extends greater than 1-year) IF the card is renewed at the beginning of Year2 and the $5k annual fee for Year2 is paid at that time.

So, what’s the deal?

If we have to capitalize it, is it an amortizable 197 intangible?
 

#2
Nilodop  
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Wouldn't it generally be true of most initiation/membership fees that the upfront fee needs annual payments to renew it and thus maintain the long-term benefit? They still have to be capitalized.

1.263(a)-4(d)
(4) Certain memberships and privileges -

(i) In general. A taxpayer must capitalize amounts paid to an organization to obtain, renew, renegotiate, or upgrade a membership or privilege from that organization. A taxpayer is not required to capitalize under this paragraph (d)(4) an amount paid to obtain, renew, renegotiate or upgrade certification of the taxpayer's products, services, or business processes.

(ii) Examples. The following examples illustrate the rules of this paragraph (d)(4):

Example 2. Initiation fee.
X corporation pays a $50,000 initiation fee to obtain membership in a trade association. X must capitalize the $50,000 payment under this paragraph (d)(4).
 

#3
Nilodop  
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As to the 197 question, I'm pretty sure this excerpt does not mean what it literally says, but rather applies only to a contract with a governmental unit to receive services from a governmental unit. Reg. 1.197-2
(c) Section 197 intangibles; exceptions. The term section 197 intangible does not include property described in section 197(e). The following rules and definitions provide guidance concerning property to which the exceptions apply:

(6) Certain rights to receive tangible property or services. Section 197 intangibles do not include any right to receive tangible property or services under a contract or from a governmental unit if the right is not acquired as part of a purchase of a trade or business.
. I think the word "with" is omitted right after the word "contract". But if it means whatit says, as it says it, then it's not a 197 intangible.
 

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Wouldn't it generally be true of most initiation/membership fees that the upfront fee needs annual payments to renew it and thus maintain the long-term benefit?


I guess it depends. If you buy a house and have to put something into the HOA up front, they don’t kick you out if you don’t pay your annual dues thereafter. Rather, they just put a lien on your property.

In your Example #2, they don’t say if there’s a recurring annual membership dues amount or not. And if there is, they don’t say what happens if you don’t pay it.

And here’s Example #1 from that same regulation:

Example (1). Hospital privilege. B, a physician, pays $10,000 to Y corporation to obtain lifetime staff privileges at a hospital operated by Y. B must capitalize the $10,000 payment under this paragraph (d)(4).

Interesting how those privileges are “lifetime.”

I know the rule seems simple enough:

A taxpayer must capitalize amounts paid to an organization to obtain, renew, renegotiate, or upgrade a membership or privilege from that organization.


But thinking this through: If my client paid a $10k initiation fee for his AMEX Centurion card, did that payment, all by itself, obtain him “a membership or privilege from that organization?”

I can’t say that it did. That payment, plus the $5k Year1 annual fee is what gave him the privileges of AMEX Centurion membership. It’s almost like – and maybe it really is – that the Year1 “annual fee” is $15k. That $10k “initiation fee” is more like a deterrent for leaving the program early.

(Also, I take a bit of issue with your phrase “and thus maintain the long-term benefit.” If I’m making sense here, then the $10k initiation fee, in isolation, does not accord a long-term benefit up front. And if there’s no long-term benefit up front, there is not a long-term benefit to be “maintained.” If the guy ends up using his Centurion card for 10-years, that would be a succession of short-term benefits, if I’m making sense).
 

#5
Nilodop  
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As a nerd, I feel compelled to point out that "if" appears 9 times (so far) in your posts here, not counting the ifs in sentences not written by you.

Putting aside the onerous rules about country club memberships, i.e., disregarding how they are hard to deduct, i.e., assuming they might be deductible, there's a real fancy club near where I live that charges a huge fee upfront plus an annual fee to keep on using the club's facilities, and you have to be invited just to have the privilege of paying them. Wouldn't that be comparable, and wouldn't that huge upfront fee be capitalized?

Rather, they just put a lien on your property.
. But what does Amex do if you don't pay the annual fees?

In your Example #2, they don’t say if there’s a recurring annual membership dues amount or not. And if there is, they don’t say what happens if you don’t pay it.. Right, so it must not matter. The reg. is the reg.

Interesting how those privileges are “lifetime.”
. And are Amex's also lifetime?

If my client paid a $10k initiation fee for his AMEX Centurion card, did that payment, all by itself, obtain him “a membership or privilege from that organization?”. Yes, including the privilege of paying the annual fee, just like the country club near me.

If the guy ends up using his Centurion card for 10-years, that would be a succession of short-term benefits, if I’m making sense. Yes, you are making sense, and I (and dare I say almost all of the readers of your post) understood your point and its logic even w/o that emphasis.

When I buy real estate and pay for it in part with a mortgage loan that requires at least annual payments, the cost of geting that loan is capitalized, even though the lender will take away my property if I don't pay him or her or them or it. Yet I must capitalize that cost.

And if you capitalize the Amex fee (I say you because I have little doubt that this is really about you, not your firm's client), where do you come down on the amortizable 197 intangible question?

Kindly resolve all of this before 1pm Eastern time.
 

#6
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But what does Amex do if you don't pay the annual fees?

They charge it to your card on each anniversary. If, within the 30-day grace period, you don’t want to pay it and you cancel card, then you have no use of your card. Thus, if you don’t pay the annual fee, you have no use of your card. (And it doesn’t matter that card cancellation is, we might say, voluntary). In effect, you have to pay the annual fee to continue the membership (or start the membership in the case of Year1). This necessarily means the initiation fee isn’t - all by itself - what grants you membership privileges. You can find the agreement here:

https://www.consumerfinance.gov/credit- ... onal-bank/

Note that it refers to the initiation fee as a finance charge.

Right, so it must not matter. The reg. is the reg.

I’m not so sure about that (the first part, about it not mattering). The Reg assumes that an amount is paid to obtain membership. The examples in the Reg, therefore, are predicated on that assumption/understanding. Thus, the Reg examples would not conte
mplate a situation wherein an amount is paid, which, all by itself, doesn’t grant membership privileges.

Yes, including the privilege of paying the annual fee, just like the country club near me.

It’s not a privilege to pay an obligation. It’s the payment of the obligation that grants the privilege. Thus, Year1 initiation fee of $10k PLUS Year1 annual fee gives you the benefits and privileges that the card offers.

When I buy real estate and pay for it in part with a mortgage loan that requires at least annual payments, the cost of geting that loan is capitalized, even though the lender will take away my property if I don't pay him or her or them or it. Yet I must capitalize that cost.


That’s because you have agreed to a 30-year term up front. Had there been thirty, 1-year agreements (like the AMEX card), that would be different.

And if you capitalize the Amex fee (I say you because I have little doubt that this is really about you, not your firm's client), where do you come down on the amortizable 197 intangible question?

15-year safe harbor amortization for my client.

Wouldn't that be comparable, and wouldn't that huge upfront fee be capitalized?

Could be. If it’s an equity membership, no. If it’s not an equity membership, yes.

I’ll admit when you have a sizeable up-front fee on something, the inclination is to think “long-term benefit.” But upon digging into it, as we are doing here, it seems that line of thinking might be inappropriate, if that big up-front fee is required to be coupled with something else to kick-in the privileges sought. In effect, the big up front fee makes the Year1 cost very high (compared to the other, future years), thereby acting as a deterrent to leave the program (and acting as a mechanism to lock in future revenue for the organization). And if you leave early, you have effectively paid a penalty.
 

#7
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It’s not a privilege to pay an obligation. It’s the payment of the obligation that grants the privilege.. To some, it's a privilege to be among the select elite invitees and boast about it.
 

#8
Nilodop  
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Your logic is good. Might even win. Has it ever been tried and challenged on the public record?
 

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Let me know what you think about this case. I realize it’s before the adoption of the 263(a) Regs, but those regs attempted to assemble a whole host of prior case law (including Indopco).

https://www.courtlistener.com/opinion/4 ... missioner/?

And then this case (Howard), which is referenced in the above case:

https://casetext.com/case/howard-v-comm ... -revenue-3
 

#10
Nilodop  
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What I think about the two cases is that they are old but still authority, and I'm pretty sure they are part of the basis for the way the reg. and example are written. And, together with the reg. itself, they make it hard to win despite the fine logic of your well-reasoned argument. And note the anticipation of renewal as being treated as tantamount to a long-term membership in the one case.
 

#11
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Remember that rule about section 162 payments by credit card being deductible by a cash-method taxpayer when charged, i.e., without actual cash being paid? Not here, even for the annual $5k fee.
 

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I don't have any clients with an annual fee of $5,000 but my business clients generally have a card with a smallish fee. I have always deducted when charged. Why am I doing it wrong?
 

#13
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Are they on the cash method?
 

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All but one.
 

#15
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Well, the fees are "smallish" and I don't recall the exact rule about recurring charges, but I think the general rule that allows a credit card charge to be treated as payment by a cash-method taxpayer assumes the credit card is issued by an entity other than the vendor. To quote from RR 78-39,
The general rule is that when a deductible payment is made with borrowed money, the deduction is not postponed until the year in which the borrowed money is repaid. Such expenses must be deducted in the year they are paid and not when the loans are repaid. William J. Granan, 55 T.C. 753 (1971).
.

Open question: If I charge a business expense to, say, an auto supply store's open account or even its own charge card, it's not treated as a third party loan. But if I use, say, my MasterCard, it is so treated. Where does the Centurion card fit in that analysis? I say it's not a loan so not deductibleby a cash-method taxpayer until paid to Amex.
 

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and I'm pretty surethey are part od the basis for the way the reg. and example are written


Oh, I think so. Example #1 in the Regs comes from the Howard case.

From the Heigerick case:

There are some differences in the facts of this case and the Howard case but we think they are insignificant on the issue to be decided.

Petitioner points out that in the Howard case the osteopaths secured lifetime staff privileges subject to revocation only by a two-thirds majority vote of the professional staff of the hospital. Here, although all appointments to the medical staff were made on an annual basis, they were renewable by the board1966 U.S. Tax Ct. LEXIS 139">*148 of trustees except where cause existed for suspension or expulsion. The record shows that staff members knew that if the hospital was financially able to continue as an open-staff hospital they would be eligible for yearly reappointment and they reasonably anticipated that they would be reappointed each year as long as they abided by the rules and regulations of the hospital. It was in effect petitioner's testimony that he expected to be reappointed each year and, in fact, reappointment did occur and he was still a member of the staff at the time of trial. The staff membership here is just about the same as the life membership in Howard. The distinguishing fact is of no real significance.

Petitioner argues that the staff fees are recurring and he points to the adoption of a rule by the new board of trustees on February 10, 1960, to the effect that "members of the staff shall be required to pay to the corporation from time to time, according to the needs of the hospital, such sum or sums as the board of trustees, in their discretion, may require." There is no evidence that assessments levied under this authority have any relationship to the staff fees in question. We are here1966 U.S. Tax Ct. LEXIS 139">*149 concerned with the rights and interests acquired by petitioner when he made the payment in order to become a member of the medical staff. These payments purchased staff rights that had no fixed relation to any period of time. The fact that staff members might be required to pay future assessments and charges based on annual dues or their use of the hospital or even to meet the needs of the hospital, is immaterial.


It is this last paragraph that interests me, especially the last sentence.

If I buy a business automobile, that I intend to drive a lot for business purposes, I can see how, at the time of purchase, I have a made a payment that has the potential to provide a long-term benefit, given the useful life of the automobile. What impacts that useful life is how well I maintain the vehicle. There is no requirement, as imposed by the seller on me the buyer, to maintain the vehicle after purchase. Thus, I cannot say, “The vehicle doesn’t necessarily provide a long-term business benefit because I might not maintain it (for whatever reason).” The seller is out of the picture once I acquire the asset. There is no further financial commitment I have to the seller after purchase. It is a condition-less purchase. There is no condition that, if not made good, would cause the seller to take the vehicle back from me. Thus, we have a clear-cut long-term asset in this case.

But I know what you will say. “Jeff, if we follow your logic, then let’s consider an installment purchase of a vehicle via seller financing. Now we do have a “post-purchase” obligation running from the buyer to the seller. If we don’t make installment payments, we lose the car. Under your logic, Jeff, this necessarily means we don’t have a long-term asset when we bought the car. That can’t be. We know we do have a long-term asset (the car) from Day1.”

The only way to reconcile this hypothetical pushback is to understand that if there is a future payment condition/obligation running to the seller, and those future payments are in payment for the asset itself, they do not impact the long-term nature of the asset.

But what if the auto dealership said, “Give us $25k now for the new car. In addition, you are required to have your car serviced with us every 6-months at a cost that will be no less than $1,500. If you fail to service your car with us, we have the right to take the car back without paying you anything.”
 

#17
Nilodop  
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But I know what you will say.
The only way to reconcile this hypothetical pushback ...
I'm struggling with whether it's hypothetical if you know ...
 

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I know a counter argument could be made. And until it is stated and made, it’s just hypothetical.
 

#19
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If you fail to service your car with us, we have the right to take the car back without paying you anything.. I wonder whether such an agreement ould be legal, let alone whether any buyer would sign it. And whether the buyer who would sign it can sell the vehicle and not have that obligation go with it, i.e., does the second buyer also have to pay the $1500= every 6 months.

Let's talk about a purchase of real estate instead of a car. Agreement requires that you hire seller to paint it evry 3 years, service all the HVAC and other systems, etc., or else he can take back the proerty "without payin you anything". I'm not sure if that's a condition precedent or a condition subsequent, but I'm sure the builder would record a lien to protect himself, and the property's value would be adversely affected.

It's like having contingent ownership. Can it even be depreciated?

Need more fun ideas.
 


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