The IRS and business taxpayers have been engaged in an ongoing dispute for some time over when to deduct so-called success-based fees paid as the result of acquisition and reorganization transactions. Now, the IRS has decided that compromise is better than creating uncertainty in the marketplace and is offering a “safe harbor” position that may be taken without further resistance from the IRS.
The terms for the new safe harbor have surprised many tax experts as being particularly generous. As businesses in a reawakening economy start looking around for strategic alliances through acquisitions and reorganization, the new “safe harbor” can provide more certainty for greater immediate upfront tax benefits from many of the associated costs.
IRS regulations generally require amounts paid to facilitate a business acquisition or reorganization to be capitalized. The IRS has specifically maintained that an amount contingent on the successful closing of a transaction (success-based fee) is presumed to facilitate the transaction, unless the taxpayer has strong proof to rebut that presumption.
The same IRS regulations, however, do concede that certain payments are not paid to facilitate the acquisition or reorganization. For example, the purchase price paid by an acquiring taxpayer to the target’s shareholders in exchange for their stock in a stock acquisition is not an amount paid to facilitate the acquisition of the stock.
Under the new safe harbor, the IRS will not challenge a taxpayer’s allocation of a success-based fee between activities that facilitate an acquisition or reorganization if the taxpayer:
- Treats 70 percent of the amount of the success-based fee as an amount that does not facilitate the transaction (and, therefore, can be deducted immediately);
- Capitalizes the remaining 30 percent as an amount that does facilitate the transaction; and
- Attaches a statement to its original federal income tax return for the taxable year the success-based fee is paid or incurred, stating that the taxpayer is electing the safe harbor, identifying the transaction, and stating the success-based fee amounts that are deducted and capitalized.
The new safe harbor is effective for success-based fees paid or incurred in tax years ending on or after April 8, 2011.
Rev. Proc. 2011-29