IRS Reverses Itself and Allows Deduction of Environmental Clean-Up Related Costs

On January 17, 1996, the Internal Revenue Service revoked a controversial technical advice memorandum ("TAM") in which it had denied current deductions for certain environmental clean-up related costs. The Service's action ended a long and contentious process in which the taxpayer, represented by Mark J. Silverman and Susan H. Serling of Steptoe & Johnson LLP, disputed the Service's conclusion that such costs were subject to capitalization. The outcome in this case was a victory for the particular taxpayer involved -- the company will be able to deduct millions of dollars in clean-up costs -- and may also be part of  a trend to liberalize the deductibility of environmental clean-up related costs.

The TAM involved a company that acquired land and conducted activities on it that caused the land to become contaminated with industrial wastes. Later, the
company contributed the land to a local municipality, which first discovered
the contamination.  The gift was rescinded. The company regained ownership of  the land and is responsible for all clean-up related costs. In the years under
review the company deducted the costs of an environmental study mandated by a consent order with the EPA and associated consulting and legal fees
(collectively, the "Costs").

Revenue Ruling 94-38, 1994-1 C.B. 35, allows a current deduction under Code section 162 for soil remediation and groundwater treatment costs (while
requiring capitalization of costs attributable to the construction of groundwater treatment facilities, which were determined to be capital expenditures under Code section 263). However, the Service refused to apply Revenue Ruling 94-38 to the company's situation on the basis that, in the ruling, the taxpayer owned the  contaminated property continuously ( i.e., when the property was contaminated through the time when clean-up costs were incurred). The Service concluded, in  TAM 9541005, dated September 27, 1995, that Revenue Ruling 94-38 was inapplicable solely because of the later-rescinded gift and held that the company's Costs must be capitalized.

On January 17, 1996, the Service released to the taxpayer a new TAM that revokes and supersedes TAM 9541005. The new TAM manifests a significant change in the Service's view of the applicability of Revenue Ruling 94-38. The Serviceholds that an interim break in ownership does not disallow a deduction when the same taxpayer contaminated the property and incurred the Costs. The Service proceeds to determine that the specific Costs at issue are deductible under Code section 162.