Currently, IRS Treasury Regulation Section 1.263(a)-5(e)(3) requires taxpayers maintain significant documentation to support the portion of fees that must be capitalized versus those deductible as a current cost. The new Rev. Proc. provides a safe harbor permitting electing taxpayers to treat 70 percent of a success-based fee as an amount that does not facilitate the transaction (expense) and the remaining 30 percent of the fee treated as a capitalized cost.
Treasury Regulation Section 1.263 states that no deduction is allowed for any amount paid having a useful life beyond the tax year. In the case of a business acquisition or reorganization, costs incurred that produce a long term benefit must be capitalized.
Under Regulation Section 1.263(a), taxpayers must capitalize amounts paid to facilitate an acquisition or reorganization, including costs incurred to investigate or pursue a transaction. A cost that is contingent on the closing of a transaction (success-based fee) is presumed to facilitate a transaction. Because of this presumption and the requirement that documentation establish the portion of the fee not allocable to activities facilitating the transactions, a taxpayer may decide not to make the safe harbor election- choosing instead to remain subject to the onerous documentation requirements with the hope of substantiating a current deduction in excess of 70 percent of success fees paid.
The treatment of success-based fees has long been a source of controversy, and therefore, the IRS expects much of the controversy to be eliminated by providing a simplified method to allocate these fees. If a taxpayer makes the election according to the Rev. Proc., the IRS will not challenge the taxpayer's allocation of fees if the taxpayer:
- Treats 70 percent of the amounts paid as an amount that does not facilitate the transaction;
- Capitalizes the remaining 30 percent as an amount that does facilitate the transaction;
- Attaches a statement to the federal income tax return filed for the year the fee is incurred stating the taxpayer is electing the safe harbor.
This Rev. Proc. will apply to success-based fees paid or incurred on or after April 8, 2011.
Should you have any questions about this Tax Flash, contact your Marcum Tax Professional.