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I. Statutory and Regulatory Framework
The parties agree that two Code sections are implicated by
Qwest’s incremental cost allocation method, sections 263A and
460. However, the parties differ on the interpretation of each
section and its accompanying regulations and how each is applied
to the facts of the instant case.
A. Section 460: Allocation of Costs to Long-Term
Contracts
Qwest’s cost allocation to its customer contracts is
governed by section 460. Section 460 contains special rules for
the tax reporting of long-term contracts. In general, section
460 requires that the taxable income from a long-term contract
shall be determined under the percentage of completion method.
Sec. 460(a). A long-term contract is defined as one which is not
completed within the same taxable year in which the contract was
entered into. Sec. 460(f)(1). The contract must be for the
manufacture, building, installation, or construction of property.
Id. Section 460(c)(1) provides that all costs which directly
benefit or are incurred by reason of the long-term contract shall
be allocated to such contract in the same manner as costs are
allocated to extended period long-term contracts under section
451 and the accompanying regulations. We are thus directed to
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