The treatment of success-based fees has been the subject of controversy between the Internal Revenue Service (“IRS”) and taxpayers. On April 8, 2011, the IRS issued Revenue Procedure (“Rev. Proc.”) 2011-29 that provides guidance on the deductibility of success-based fees. These fees, generally paid to investment bankers or private equity firms, are contingent on the successful closing of certain transactions. Often, these fees are the largest single expense of an acquisition.
Under IRS Regulations, success-based fees are presumed to be “facilitative” costs that are required to be capitalized. A taxpayer could rebut this presumption by maintaining sufficient documentation to establish the fee is allocable to activities that do not facilitate the transaction. This usually involved hiring a CPA firm to assist in a “transaction cost study” to support the deductible portion of the fee.
The Rev. Proc. provides a safe harbor that allows a taxpayer to treat 70 percent of the success-based fee as an amount that does not facilitate the transaction. The remaining 30 percent is capitalized. The 70 percent safe harbor is extremely taxpayer-friendly since a “transaction cost study” can be expensive and will generally not yield a 70 percent deduction. This guidance applies to success-based fees paid in tax years ending on or after April 8, 2011.
An election is made by attaching a statement to your timely filed original tax return stating that the taxpayer is electing the safe harbor, identifying the transaction, and state the success-based fee amounts that are deducted and capitalized. This election does not constitute a change in tax accounting method.
Do you have a question about how to handle success-based fees?
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