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TAX STRATEGY PROBLEM
I:15-61 Your client, Home Products Universal (HPU),
distributes home improvement products to independent retailers throughout the
country. Its management wants to explore the possibility of opening its own home
improvement centers. Accordingly, it commissions a consulting firm to conduct a
feasibility study, which ultimately persuades HPU to expand into retail sales.
The consulting firm bills HPU $150,000, which HPU deducts on its current year
tax return. The IRS disputes the deduction, contending that, because the cost
relates to entering a new business, it should be capitalized. HPU’s management,
on the other hand, firmly believes that, because the cost relates to expanding
HPU’s existing business, it should be deducted. In contemplating legal action
against the IRS, HPU’s management considers the state of judicial precedent: The
federal court for HPU’s district has ruled that the cost of expanding from
distribution into retail sales should be capitalized. The appellate court for
HPU’s circuit has stated in dictum that, although in some circumstances
switching from product distribution to product sales entails entering a new
trade or business, improving customer access to one’s existing products
generally does not. The
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Federal Circuit Court has ruled that wholesale distribution
and retail sales, even of the same product, constitute distinct businesses. In a
case involving a taxpayer from another circuit, the Tax Court has ruled that
such costs invariably should be capitalized. HPU’s Chief Financial Officer
approaches you with the question, “In which judicial forum should HPU file a
lawsuit against the IRS: (1) U.S. district court, (2) the Tax Court, or (3) the
U.S. Court of Federal Claims?” What do you tell her?