IRS issues technical advice on success-based fees.

• Author: Hanway, Kurt

When a taxpayer incurs success-based fees--for example, payments to professional service providers that are contingent upon the successful closing of an acquisition or restructuring transaction--the determination of whether the fees are currently deductible, as opposed to capitalizable, depends on whether the taxpayer can establish contemporaneously that all or a portion of the fees are allocable to activities that do not facilitate the transaction. Taxpayers can establish that fees are not facilitative, and therefore deductible, through supporting records (for example, time records, itemized invoices, or other records). The IRS recently released Technical Advice Memorandum (TAM) 201002036, concluding that allocation spreadsheets developed by a taxpayer's accounting firm qualify as "other records" and therefore satisfy the documentation requirement, despite the lack of time records or itemized invoices.

Summary of TAM 201002036

A taxpayer hired an investment bank to evaluate the taxpayer's potential suitors. The service agreement obligated the taxpayer to pay the investment bank a contingent, or success-based, fee if the taxpayer entered into a sale agreement with a suitor. The investment bank found an acquirer who purchased the taxpayer's stock. The investment bank provided the taxpayer with invoices for its contingent fee without time reports or a detailed breakdown of its services.

The taxpayer engaged an accounting firm to evaluate the tax treatment of the investment bank fees. The accounting firm discussed the investment bank's fees and services with employees of the acquirer and the investment bank. Based upon the investment bank's best guess, the accounting firm created allocation spreadsheets of activity categories to summarize how much time the investment bank's employees spent on each activity, including, when relevant, the percentage of time spent before and after the date on which the taxpayer's board of directors approved the proposed form, terms, and provisions of the transaction. In support of the allocation spreadsheets, the taxpayer provided numerous forms of documentation supporting the investment bank's work product, including documentation of potential buyers, financial models for various scenarios, contracts, agreements, spreadsheets, presentation materials, employee notes, and invoices. The taxpayer, relying on the accounting firm's spreadsheets and the supporting documentation, deducted a portion of the contingent fees.

In the TAM, the IRS considered whether the spreadsheets developed by the accounting firm in conjunction with the assistance of employees of the taxpayer and the investment bank qualified as other records, required by the regulations to support the deduction.

Regs. Sec. 1.263(a)-5

Regs. Sec. 1.263(a)-5(a)...