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Success-Based Fees – IRS Allows for Safe Harbor Election

by Tim Schlotterer

For taxpayers involved in a business acquisition or reorganization in tax years ending after April 8, 2011, IRS has issued, in early April, guidance allowing for safe harbor treatment for success-based fees.  Taxpayers who make the safe harbor election should treat 70% of the success-based fee as an amount that does not facilitate the transaction, while the other 30% should be treated as though it does.  Those amounts that do not facilitate the transaction may be deducted currently, while those amounts that do must be capitalized.

Last week, on August 11, the IRS issued a directive to its agents to not challenge a taxpayer’s treatment of success-based fees paid or incurred in tax years ending before April 8, 2011, where the taxpayer capitalized at least 30% of success based fees.  In effect, the IRS has given liberalized retroactive effect to the benefits of the safe harbor rules issued in April. Given that success-based fees typically represent large expenditures that often are difficult to document in terms of the types of activities undertaken, last week’s directive is very taxpayer friendly. From the IRS’ perspective, these policies should reduce what has historically been a highly litigated area of tax law, and appears to represent an effort to balance current IRS resources and workload priorities.

Success-based fees are amounts paid contingent upon the success of closing a transaction.  Generally, a taxpayer must capitalize the amounts paid to facilitate a transaction.  Facilitation costs include amounts paid for investigating the target company, pursuing the transaction, the creation of related legal documents, etc.  However, amounts that are not considered to have facilitated the transaction may be deducted as long as they have proper supporting documentation.  The new safe-harbor election allows for the 70%/30% treatment in lieu of maintaining documentation.

Taxpayers who have already filed their tax return for a year ending on or before April 8, 2011 may not amend their return to make the election.  However, in an originally filed return, the IRS will not challenge their position as long as they capitalized at least 30% of success-based fees.  Taxpayers who have yet to file their return may make the election by attaching a statement to the federal return.  The attachment must state that the taxpayer is electing the safe harbor, identify the transaction, and show the success-based fee amounts that are deducted and capitalized.

 

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3 thoughts on “Success-Based Fees – IRS Allows for Safe Harbor Election

  1. Nick Hauptmann

    Does anyone know the details of this revenue procedure? What are the requirements? Does this only apply to major corporations since the directive was given to the LB&I not to challenge the 70/30 treatment?

    The reason I ask is because I want to know if an individual purchasing a small company is able to take advantage of the safe harbor election. What qualifies? Will the new owner be able to deduct 70% of the success-based fees he paid to structure the deal as long as 30% of the fees are capitalized?

    Reply
    1. admin

      The safe harbor election applies no matter how large the companies are that are entering into a transaction. As long as the requirements of the Rev. Proc. 2011-29 are met, the safe harbor applies. Note that the Rev. Proc. applies only to tax years ending on or after April 8, 2011.

      The subsequent guidance issued on August 11 instructed examining agents to accept returns filed that capitalize at least 30% of success based fees for years ending prior to April 8, 2011. While true that this directive was specifically communicated to LB&I division agents, there was no mention of any segregation of small and large companies. We believe it is likely the IRS was simply attempting to get agents examining larger companies up to speed more quickly, given their belief that the vast majority of total acquisition related costs are incurred by those companies.

      Reply
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