IRS Chief Counsel Advice Memo 201624021 is an internal communication between the IRS National Office and LB&I on the issue of whether an acquired S corporation that engages in a Section 338(h)(10) transaction can use Rev. Proc. 2011-29 to deduct 70% of its success-based transaction fees. The communication concludes “no” on the position that the S corporation (as seller) cannot treat a taxable asset sale as a “covered transaction” within the meaning of Reg. 1.263(a)-5(e)(3)(i). The CCA goes on to state that while the S corporation must capitalize its success-based fees, such expenses can be deducted to the extent that the S corporation establishes through documentation that a portion of the costs are allocable to activities that do not facilitate the transaction, citing Reg. 1.263(a)-5(f). This is a particularly important issue for pass-through entities (S corporations, LLCs, and partnerships) whose ownership interests are owned by individuals. An ordinary deduction to the selling target entity that flows through to the individual shareholders on an asset sale can provide a larger tax benefit than treating the success-based transaction fee as a capitalized cost and reducing the amount realized on the deemed sale.
This IRS conclusion that Rev. Proc 2011-29 is unavailable in this context has been stated informally, but there are counter points to this position. The following link is to a detailed comment letter that discusses the counter points. Please click here to access the letter.