IRS Provides Safe Harbor for Allocating Success-Based Fees
The release by the Internal Revenue Service (IRS) on April 8, 2011 of Revenue Procedure 2011-29 provides a welcome new safe harbor for taxpayers with respect to the deductibility of “success-based fees” paid in connection with business acquisitions and reorganizations. “Success-based fees” are generally fees paid to investment bankers and other consultants that are contingent upon the closing of a transaction. The new safe harbor allows a taxpayer to claim a current deduction for 70 percent of the success-based fees incurred in connection with a covered transaction, while requiring the taxpayer to capitalize the remaining 30 percent.
Under existing Treasury regulations, the portion of a success-based fee that is compensation for “facilitating” a transaction must be capitalized. For example, amounts paid in the process of investigating or otherwise pursuing a transaction generally are deemed to “facilitate” a transaction. Only the portion of a success-based fee that is attributable to activities that did not facilitate the transaction can be deducted currently as an expense. Moreover, the regulations presume that, success-based fees are presumed to facilitate the transaction. The burden is on the taxpayer to rebut this presumption by providing sufficient documentation to the contrary.
With the release of Revenue Procedure 2011-29, the IRS hopes to reduce the large number of disagreements between the IRS and taxpayers about the type and extent of the documentation needed to prove that success-based fees are deductible. For taxpayers opting for the safe harbor, the need to make a factual showing (and hence to establish and maintain documentation) is eliminated.
Revenue Procedure 2011-29 states that the IRS will not challenge a taxpayer’s allocation of a success-based fee between activities that facilitate a transaction (which must be capitalized) and activities that do not facilitate a transaction (which may be deducted) if the taxpayer:
treats 70 percent of the amount of the success-based fee as an amount that does notfacilitate the transaction;
capitalizes the remaining 30 percent as an amount that does facilitate the transaction; and
attaches a statement to its original federal income tax return for the taxable year the success-based fee is paid or incurred, stating that the taxpayer is electing the safe harbor, indentifying the transaction, and stating the portions of the success-based fees that are deducted and capitalized.
The new Revenue Procedure is effective for success-based fees paid or incurred in taxable years ending on or after April 8, 2011. The election under Revenue Procedure 2011-29 is made on a transaction-by-transaction basis and is irrevocable once made. Use of the election in connection with a transaction does not constitute a change in method of accounting for success-based fees generally, and therefore an Internal Revenue Code §481(a) adjustment is neither permitted nor required.