Deductibility of legal expenses in corporate reorganizations.

• Author: Crum, Cynthia A.

Legal and professional fees, including accounting fees, are frequently incurred at various stages of corporate life--at the commencement or acquisition of the corporate entity, during the course of daily corporate business, when reorganizing or restructuring and, ultimately, at liquidation. When the amounts of these fees are significant, their deductibility (or nondeductibility) can become an important tax consideration. Familiarity with the relevant Code provisions is a necessary prerequisite to strategic tax planning in this area.

With few exceptions, the deductibility of professional fees begins and ends with Sec. 162. If a corporation makes an election under Sec. 248, organizational expenses incurred incident to the creation of a corporation may be amortized over 60 months or more. Professional fees incurred in the ordinary course of business that do not fall within the realm of Sec. 263 capital expenditures are generally deductible Sec. 162 business expenses. Reorganization expenses or expenses incurred to effectuate a corporate restructuring, even if not technically under the guise of Sec. 368, are usually nondeductible. And liquidation expenses, exclusive of costs relating to the sale of assets properly charged against sales proceeds, are deductible as ordinary and necessary business expenses.

Depending on the facts and circumstances, the application of the provisions on the tax treatment of corporate professional fees can be very complex. The deductibility of reorganization expenses, for example, has been litigated a number of times and has resulted in diverse outcomes. Reasons cited for nondeductibility are that such expenses are not ordinary or usual in the life of a corporation (Missouri-Kansas Pipe Line Company, 148 F2d 460 (3d cir. 1945)) or that such expenses are capital in nature as they provide a continuing benefit to the surviving corporation (Mid-State Products, Co., 21 TC 696 (1954)).

Additionally, reorganization expenses have been held nondeductible if they contribute to creating or enhancing a long-term asset (the corporation) or produce significant benefits lasting beyond the current tax year (Rev. Ruls. 73-580 and 77-204). In INDOPCO, Inc., 112 Sup. Ct. 1039 (1992), aff'g 918 F2d 426 (3d Cir. 1990), a deduction for expenses incurred by a target corporation acquired in a transaction (not a reorganization) was denied; the expenses could be expected to produce a benefit to the corporation that extended beyond the year in...