LB&I directive on success-based fees has tax accounting implications.

• Author: Dell, Michael
• Position: Large Business and International

The treatment of success-based fees and, in particular, the type and extent of documentation required to establish that a portion of a success-based fee is allocable to activities that do not facilitate the transaction, has been a subject of much controversy between the IRS and taxpayers.

Success-based fees are amounts that are contingent on the successful closing of a transaction (i.e., usually the investment banker or other financial adviser fee), and they are presumed to be facilitative unless the requisite documentation of their allocation to nonfacilitative activities is provided. Amounts paid to facilitate a transaction are generally required to be capitalized, while amounts paid for nonfacilitative activities are generally deductible under Sec. 162 or amortizable under Sec. 195.

Rev. Proc. 2011-29, issued on April 8, 2011, permits electing taxpayers to treat 70% of success-based fees as nonfacilitative. Taxpayers must capitalize the remaining 30% as an amount that facilitates the transaction. The revenue procedure is effective for success-based fees paid or incurred in tax years ending after April 7, 2011.

A recent directive instructs Large Business and International (LB&I) examiners not to challenge the treatment of success-based fees incurred or paid in tax years ending before April 8, 2011, if the taxpayer capitalized at least 30% of the total success-based fees incurred on the transaction on its originally filed return.

As discussed further below, for affected taxpayers, the directive may have tax accounting consequences in connection with income tax uncertainty associated with success-based fees.

Background

Regs. Sec. 1.263(a)-5 requires a taxpayer to capitalize an amount paid to facilitate a business acquisition or reorganization transaction described in Regs. Sec. 1.263(a)-5(a). In general, an amount is paid to facilitate a transaction if the taxpayer pays it in the process of investigating or otherwise pursuing the transaction.

Regs. Sec. 1.263(a)-5(e) provides a bright-line rule for determining whether certain investigatory costs are facilitative. Under the bright-line rule, a taxpayer may treat a portion of the transaction costs as not facilitating the transaction and thus deduct or amortize them, as applicable. This rule applies only to transactions identified as "covered transactions" in Regs. Sec. 1.263(a)-5(e)(3).

Under Regs. Sec. 1.263(a)-5(f), an amount that is contingent on the successful closing of a transaction...