IRS applies option rule to find covered transaction for 50% or less stock acquisition.

• Author: Geracimos, John

Taxpayers generally must capitalize costs incurred to facilitate an acquisition of a target corporation's stock. An exception to this rule exists for a portion of costs incurred in a taxable transaction in which the taxpayer acquires sufficient stock to own more than 50% of the target's stock. A 2014 private letter ruling clarifies that an acquisition after which the acquirer owns 50% or less of the stock of the target can qualify for this exception if the taxpayer has an option to acquire an amount of target stock that, if exercised, would put its ownership of the target above 50%. Taxpayers that incur significant costs for taxable stock acquisitions after which they own less than 50% of the target corporation may want to consider using an option to qualify for this exception to capitalization.

Treatment of Stock Acquisition Costs

Generally, a taxpayer must capitalize costs incurred to facilitate a stock acquisition. However, for taxable stock acquisitions, two sets of rules potentially apply to those costs--Regs. Secs. 1.263(a)-4 and 1.263(a)-5--depending on the amount of stock that the acquiring person owns in the target corporation immediately after the acquisition. The rules of Regs. Sec. 1.263(a)-5 probably give a more favorable result than those of Regs. Sec. 1.263(a)-4. As described below, the use of an option potentially can cause a transaction to be subject to the more favorable Regs. Sec. 1.263(a)-5.

Regs. Sec. 1.263(a)-4

Through a series of nested provisions, Regs. Sec. 1.263(a)-4 requires a taxpayer to capitalize amounts paid to facilitate a stock acquisition. Specifically, Regs. Sec. 1.263(a)-4(b)(1)(v), in relevant part, requires a taxpayer to capitalize an amount paid to facilitate the acquisition of an intangible described in Regs. Sec. 1.263(a)-4(b)(l)(i). Regs. Sec. 1.263(a)4(b)(1)(i) requires a person to capitalize an amount paid to acquire an intangible described in Regs. Sec. 1.263(a)-4(c). Regs. Sec. 1.263(a)-4(c)(l)(i), in relevant part, requires a person to capitalize an amount paid to acquire an ownership interest in a corporation, limited liability company, or other entity (see also Regs. Sec. 1.263(a)-4(e)(5), Example (4)).

Regs. Sec. 1.263(a)-5

Through a series of nested provisions, Regs. Sec. 1.263(a)-5(a)(2) requires a taxpayer to capitalize an amount paid to facilitate the taxpayer's acquisition of an ownership interest in a business entity if, in relevant part, immediately after the acquisition, the taxpayer and the business entity are related within the meaning of Sec. 267(b). Specifically, Sec. 267(b)(3) defines "related" persons to include two corporations that are members of the same "controlled group" as defined by Sec. 267(f). Sec. 267(f)(1) defines a "controlled group" to have the meaning given by Sec. 1563(a), except, in relevant part, that the "at least 80 percent" threshold in Sec. 1563(a)(1) is revised to be "more than 50 percent." Sec. 1563(a)(1), as...