(Editor’s note: The is the second of a two-part column on deducting the costs of buying a business. See part I here.)
So-called bright line date costs are considered facilitative if they are incurred investigating or pursuing an acquisitive transaction on or after the earlier of two dates: The letter of intent or the agreement of material terms.
The letter of intent date is the “date on which a letter of intent, exclusivity agreement, or similar written communication [other than a confidentiality agreement] is executed by representatives of the acquirer and the target.”
The agreement of material terms date is the date that the target board of directors or otherwise authorized personnel approve or authorize the agreement of the parties, except that where no authorization is required, the material terms date is the date the parties execute a binding written agreement that includes all material terms.
Inherently facilitative costs are defined as costs incurred:
• Securing an appraisal, formal written evaluation or fairness opinion related to the transaction.
• Structuring the transaction, including negotiating the structure of the transaction and obtaining tax advice on the structure of the transaction [for example, obtaining tax advice on the application of Code Section 368].
• Preparing and reviewing the documents that effectuate the transaction [for example, a merger agreement or purchase agreement].
• Obtaining regulatory approval of the transaction, including preparing and reviewing regulatory filings.
• Obtaining shareholder approval of the transaction [for example, proxy costs, solicitation costs and costs to promote the transaction to shareholders].
• Conveying property between the parties to the transaction [for example, transfer taxes and title registration costs].
Although success-based fees are contingent upon a closed transaction, the services performed by the service provider generally take place both before and after the bright line date, and in the case of acquisitive transactions, are both inherently facilitative and general due diligence. Economic performance on the fee occurs as the service provider provides services; however, the liability remains contingent on a closed transaction. Therefore, the all-events test is not met until a transaction closes. The delay of establishing that all events have occurred to fix the liability should not cause capitalization of otherwise deductible costs.
The IRS has provided a simplified safe harbor election for allocating a success-based fee between activities that facilitate a covered transaction and activities that do not facilitate a covered transaction [Rev. Proc. 2011-29]. The IRS will not challenge a taxpayer’s allocation of a success-based fee between activities that facilitate a covered transaction and activities that do not facilitate the transaction if the taxpayer:
• Treats 70%of the amount of the success-based fee as an amount that does not facilitate the transaction.
• Capitalizes the remaining 30% as an amount that does facilitate the transaction.
• 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.
Kevin Eagan is a managing director in the Tax Group at CBIZ & MHM New England. He can be reached at keagan@cbiz.com. CBIZ & MHM has offices nationwide, including in Providence and Boston.
