IRS clarifies applicability of sec. 195 to business acquisitions.

• Author: Thornton, David A.
• Position: IRC section 195

The IRS recently issued Rev. Rul. 99-23, in response to a growing debate over the treatment of investigatory costs related to business acquisitions. This ruling offers guidance in determining whether such costs qualify as deductible start-up expenditures under Sec. 195 or are required to be capitalized under Sec. 263. Prior to its issuance, the Service's position had been presented in Letter Rulings (TAMs) 9901004 and 9825005.

Background

Prior to the enactment of Sec. 195, there was no Code provision permitting a deduction for investigatory costs incurred in connection with the creation or acquisition of a new trade or business. While Sec. 162 permits a deduction for most trade or business expenses (including certain costs of expanding an existing business), only those costs incurred in carrying on a trade or business fall within its scope. Any costs incurred to investigate the creation or acquisition of a new trade or business fail to meet the "carrying on" requirement of Sec. 162, because the taxpayer is not otherwise engaged in the business being acquired. Thus, no Sec. 162 deduction is available for these costs.

Sec. 195 was enacted in 1980 to stimulate new business investment by minimizing the disparity between the tax treatment of investigatory costs related to the expansion of an existing business and those related to the creation or acquisition of a new trade or business. This section permits taxpayers to amortize qualifying start-up expenditures over a period of not less than 60 months, beginning with the month in which the active trade or business begins.

Sec. 195(c)(1)(A) defines" start-up expenditure" as, among other things, any amount paid or incurred in connection with investigating the creation or acquisition of an active trade or business. However, under Sec. 195(c)(1)(B), start-up expenditures include only those expenses that would otherwise qualify for deduction if incurred or paid in connection with the operation of an existing trade or business in the same field as the business being acquired. In other words, the expenditure would have to qualify as a deductible business expense under Sec. 162, assuming the taxpayer was already engaged in the trade or business being acquired. Sec. 195 does not permit an amortization deduction for costs subject to capitalization under Sec. 263. The term "start-up expenditure" does not include any amount for which a deduction is allowable under Sec. 163(a) (interest), 164 (taxes) or 174...