Salary expenses associated with bank acquisition are deductible.

• Author: Weinberger, Mark

Reversing in part a Tax Court decision, the Eighth Circuit ruled that salary expenses incurred in connection with a business acquisition are deductible, and that investigatory costs incurred after a final decision to acquire a business has been made should be capitalized (Wells Fargo & Co., 224 F3d 874 (2000), rev'g in part Norwest Corp., 112 TC 89 (1999)).

In Norwest, the Tax Court ruled that certain investigatory, due diligence and officer salary expenses associated with a bank acquisition could not be deducted as ordinary and necessary business expenses. The target bank had incurred the costs in evaluating a possible acquisition by Norwest. Although the costs did not directly facilitate the acquisition and were incurred before a formal decision was made about the transaction, the Tax Court ruled the costs must be capitalized because they were "sufficiently related to an event that produced a long-term benefit" to the bank.

On appeal, the Eighth Circuit analyzed the Supreme Court's opinions in Lincoln Savings & Loan Ass'n, 403 US 345 (1971), and INDOPCO, Inc., 503 US 79 (1992). The court interpreted Lincoln Savings as providing that capitalization is required if a cost creates or enhances a separate and distinct asset. The Eight Circuit noted that numerous courts had erroneously interpreted the Supreme Court's opinion as requiring capitalization only if a cost creates or enhances a separate and distinct asset.

According to the court, these erroneous interpretations were rejected by INDOPCO; INDOPCO held that a cost that creates or enhances a separate and distinct asset represents a capital item, which itself has a long-term benefit (i.e., capital items by their nature have long-term benefits). Further, if a cost were not associated with a long-term benefit, it should be deducted. However, the court noted that INDOPCO could not be read to conclude that the presence of a long-term benefit, without the creation or enhancement of a separate and distract asset, necessarily requires capitalization. Instead, the presence of a long-term benefit was an important consideration, but not a decisive factor in resolving whether to deduct or capitalize the cost.

Under this interpretation, the court found the Tax Court in Norwest erred in requiring capitalization "simply because the expenses were incidentally connected with a future benefit." To properly characterize the costs, the Tax Court should have performed "an independent and appropriate legal...