Deducting Warranty Reserves
Author: Chris Kramer
Many product manufacturers deduct warranty repair costs in the tax year the warranty reimbursement claims are submitted by authorized repair agents and approved for payment by the manufacturer. This practice generates an unfavorable book versus tax timing difference; the warranty reserves are recorded as accrued expense on financial statements in the year the repair agent performed the services, but they’re not deducted on the tax return until paid. However, product manufacturers should be able to deduct warranty expenditures in the year repair services are rendered.
In technical advice from the IRS, a manufacturer’s tax deduction for repair work performed under a warranty generally accrues when the repair services are provided, not when paid. The IRS further concluded the filing and approval of a warranty claim by a third-party authorized repair agent is not required to fix the fact of the tax liability, where the historic number of rejected claims received by the repair agents is de minimis. The repair agent’s submission of a claim is a ministerial act and not a condition precedent necessary to establish liability for the manufacturer.
Moreover, claim approval is not a condition precedent to taxpayer’s liability. This is true even if the taxpayer reserves the right to deny all or part of a claim on the basis of inaccurate or misrepresented authorized dealer information, improper repair procedures or failure to comply with warranty preparation, submission or taxpayer documentation requirements.
If the manufacturer has represented and can demonstrate that, in general, it makes every effort to satisfy all valid warranty claims, and that the number of claims received from authorized repair agents that are ultimately rejected by the taxpayer (and consequently not paid by the taxpayer) is de minimis, the taxpayer’s approval of the warranty claim submission also is ministerial and does not prevent the taxpayer’s liability from being fixed when the authorized repair agent provides repair services covered by the warranty agreement.
Manufacturers may file for advance approval from the IRS to deduct warranty reserves in the manner described above, taking the cumulative deduction on its tax return in the year of the change. For more information on pursuing this potential tax deduction, contact your BKD advisor.