May 5, 2010
What's new from the Courts

Koch Industries is involved in the road construction industry. The company created Koch Performance Roads, Inc., to market higher-cost, longer-lasting roads made of polymer-modified asphalt. To offset the higher initial construction costs, Koch offered extended warranties to customers.

Koch entered into a contract with the state of New Mexico regarding the expansion of a state highway using Koch's Performance Roads concept. The project was divided into two phases, a construction phase and a rehabilitation phase. Koch received $46.7 million for the construction phase and $62 million for the rehabilitation phase.

Koch used the percentage-of-completion method of accounting to report the $62 million. The IRS denied use of the percentage-of-completion method and a federal district court sided with Koch. Now the Court of Appeals for the 10^th Circuit has overturned the district court's decision and sided with the IRS.

The percentage-of-completion method may be used if manufacture, building, installation or construction is necessary for the taxpayer's contractual obligations to be fulfilled, and non-long-term contract activities that are incident to or necessary for the completion of a long-term contract may be taken into account using a long-term contract method.

However, the regulations specifically state that performance under a guarantee, warranty or maintenance agreement is a non-long-term contract activity that is never incident to or necessary for the manufacture or construction of property under a long-term contract. Even though it was virtually certain that Koch would have to perform some work at some point during the warranty period, Koch had no obligation to perform any work unless and until the highway and its associated structures failed to meet performance standards.

In the court's view, the warranty agreements did not require Koch to perform manufacture, building, installation or construction to fulfill its obligations.

Read more in Koch Industries, Inc. v. United States, 105 AFTR 2^nd 2010-XXXX, CA-10, April 27, 2010. 

Contact our firm if you have any questions or comments about this article.

The technical information here is necessarily brief. No final conclusion on these topics should be drawn without further review and consultation. Please be advised that, based on current IRS rules and standards, the advice contained herein is not intended to be used, nor can it be used, for the avoidance of any tax penalty assessed by the IRS.

© 2010, CPAmerica International. All Rights Reserved.