August 16th, 2011 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.