On April 8, 2011, the IRS released Revenue Procedure 2011-29, which creates a safe harbor for the deduction of success-based fees paid or incurred in connection with certain business acquisitions or reorganizations. The safe harbor allows taxpayers who make the election to expense 70 percent of success-based fees, but requires that electing taxpayers capitalize the remainder of the fees.
In general, taxpayers are required to capitalize amounts paid to facilitate business acquisitions or reorganizations of the character identified in Section 1.263(a)-5 of the Treasury Regulations. Amounts paid to facilitate acquisitions or reorganizations include amounts paid in the process of investigating or otherwise pursuing the transaction. Moreover, an amount contingent on the successful closing of a transaction (a success-based fee), such as an investment banker's fee, is presumed to facilitate the transaction. This presumption, however, may be rebutted if the taxpayer furnishes adequate documentation to the IRS to support its position that a portion of this fee relates to activities that do not facilitate the transaction.
In the past, the allocation of success-based fees has been a point of contention between the IRS and taxpayers, in particular with respect to the nature and sufficiency of the documentation required to support a taxpayer's claimed deduction. In an effort to alleviate this debate, the safe harbor gives the taxpayer a straightforward procedure to apportion success fees between activities that do and do not facilitate the subject transaction.
Under the new safe harbor, the IRS will not challenge a taxpayer's allocation of success-based fees between activities that facilitate "covered" transactions (for example, taxable acquisitions of business assets or an ownership interest in a business entity, or certain reorganizations) and those that do not, if the taxpayer:
- treats 70 percent of the fee as an amount that does not facilitate the transaction and deducts such portion of the fee, and;
- treats the remainder of the fee as an amount that does facilitate the transaction and capitalizes such portion of the fee.
In order to take advantage of the safe harbor provisions, a taxpayer is required to attach a statement to its federal income tax return to notify the IRS of its election to have the safe harbor apply, which notice must also identify the transaction and specify the success-based fee amounts that are deducted and that are capitalized. If made, the safe harbor election is irrevocable for that particular transaction and will apply to all success-based fees paid or incurred by the taxpayer with respect to that transaction.
If a taxpayer does not take advantage of the certainty afforded by making the safe harbor election, the taxpayer may attempt to deduct greater than 70 percent of these success-based fees by following the established IRS method for claiming such deductions.
The safe harbor is available for any success-based fees paid or incurred in taxable years ending on or after April 8, 2011.