Publications
04.15.11
In a revenue procedure, IRS has provided a safe harbor election allowing taxpayers to allocate 70% of the success-based fees paid in business acquisitions or reorganizations to activities that don't facilitate the transaction and thus can be deducted currently. The remaining 30% is treated as going to activities that facilitate the transaction and must be capitalized. The election can be made for success-based fees paid or incurred in tax years ending on or after April 8, 2011.
Background. Under Code Sec. 263(a)(1), no deduction is allowed for any amount paid for property that has a useful life substantially beyond the taxable year. In the case of an acquisition or reorganization of a business entity, acquisition costs that produce significant long-term benefits must be capitalized.
Under Reg. § 1.263(a)-5, amounts paid to facilitate a business acquisition or reorganization must be capitalized. Such costs include those paid in the process of investigating or otherwise pursuing the transaction.
An amount paid that is contingent on the successful closing of a transaction, known as a “success-based fee,” is presumed to be an amount paid to facilitate the transaction. However, this presumption can be rebutted if the taxpayer maintains sufficient documentation to establish that a portion of the fee is allocable to activities that do not facilitate the transaction. The taxpayer's method of determining what portion of a success-based fee facilitates a transaction, and what portion does not, is a method of accounting under Code Sec. 446.
Safe harbor. Rev Proc 2011-29, provides a safe harbor election that can be used by a taxpayer that pays or incurs a success-based fee for services performed in the process of investigating or pursuing a business acquisition.
IRS won't challenge a taxpayer's allocation of a success-based fee between activities that do and don't facilitate a business acquisition or reorganization if the taxpayer:
- treats 70% of the amount of the success-based fee as an amount that doesn't facilitate the transaction;
- capitalizes the remaining 30% as an amount that does facilitate the transaction; and
- attaches a statement to its original federal income tax return for the tax year in which the success-based fee is paid or incurred stating that taxpayer is electing the safe harbor, identifying the transaction, and stating the amounts of the success-based fee that are deducted and capitalized.
It is unclear if the states will adopt the same safe harbor rule. Therefore, it may still be worthwhile to obtain documentation to support a position that the portions of success-based fees being deducted on the return are related to non-facilitative activities.
Effective date. Rev Proc 2011-29 is effective for success-based fees paid or incurred in tax years ending on or after April 8, 2011.
If you are interested in discussing how it affects your company, we would be glad to advise you.
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