Capitalizing and amortizing debt issuance costs.

• Author: Blinder, Michael

Final regulations published under Secs. 263 and 446 (TD 9107) provide new tax accounting rules for amortizing debt issuance costs. Such costs must now be amortized in the same manner as original issue discount (OID).

The regulations generally do not change which type of debt issuance costs must be capitalized, although they do allow a current deduction for certain de minimis debt issuance costs. However, they do alter the method of amortizing capitalized debt issuance costs to conform generally to the constant yield to maturity method for OID. The new method applies to issuance costs on debt instruments issued on or after Dec. 31, 2003. Because of these new rules, the issuance costs deductible each year for tax purposes will often differ from the amount expensed for financial statement purposes. Determining the correct amount may require additional calculations.

Costs Required to Be Capitalized (Regs. Sec. 1.263-5)

Regs. Sec. 1.263(a)-5(a) provides that debt issuance costs are costs incurred by an issuer of debt (i.e., a borrower) to "facilitate" a borrowing. According to Regs. Sec. 1.263(a)-5(a)(9), a borrowing is any debt issuance, including one in an acquisition of capital or a recapitalization. It also includes debt issued in a debt-for-debt exchange resulting from a significant modification under Regs. Sec. 1.1001-3.

Under Regs. Sec. 1.263(a)-5(b)(1), an amount paid to investigate or otherwise pursue a borrowing is also paid to facilitate a borrowing. Costs that facilitate a borrowing include payments to an investment bank to market a debt instrument to investors, and to attorneys to prepare offering documents. Prior to the regulations, case law had required capitalization of investment bank fees, attorneys' fees and similar costs; see, e.g., Helvering v. Union Pacific R.R. Co., 293 US 282 (1934).

Under Regs. Sec. 1.263 (a)-5 (c)(1), an amount paid to facilitate a borrowing does not facilitate another transaction. Thus, costs incurred in issuing debt to finance an asset or stock purchase are debt issuance costs and are not capitalized into the basis of the acquired assets.

Regs. Sec. 1.263(a)-5(d)(1) does not require capitalization of employee compensation and overhead. As most taxpayers probably do not capitalize these internal costs, the regulations will not change the current practice.

In addition, under a de minimis exception, Regs. Sec. 1.263(a)-5(d)(3) allows a deduction for third-party costs that do not total more than $5,000 per transaction. If this threshold is exceeded, all costs must be capitalized. Although the exception is a departure from prior law, it may have only limited usefulness for most corporate taxpayers.

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