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Merger and acquisition transaction costs 2015 redux: Who gets the benefit?


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Private equity funds, strategic acquirers, and targets incur various costs in M&A transactions. The determination of which party receives the benefit of the expenditures (either current or future deductions) is not always as clear cut as the parties may first believe. Broadly speaking, the two most significant costs incurred in an M&A transaction are compensation related deductions and professional fees. 

Compensation-related deductions include items such as option cancellation payments, deferred compensation arrangements, transaction bonuses, and stay bonuses. Certain special rules (e.g., sections 83 and 404, the "next day" rule of Reg. 1.1502-76(b)(1)(ii)(B), etc.) can affect the timing of these deductions, but they are beyond the scope of this article. The focus here is on the treatment of transaction costs associated with professional services, and how recent guidance has changed the way taxpayers and advisors will treat many of these costs. 

Professional service costs are primarily legal, accounting, and investment banking fees, particularly fees paid only on the successful completion of a transaction (success-based fees), paid to either traditional investment banks or private equity firms or related entities. The primary concern to taxpayers incurring transactions costs in an M&A transaction is the ability of the taxpayer to receive a deduction for the costs.  

Secondarily, although also significant, taxpayers are concerned about the timing of the deductions. 

This article focuses on four common transaction structures used in taxable (or partially taxable) M&A transactions:

    1. Stock acquisitions (either directly or through the use of a newly created holding company).

    2. Asset acquisitions using a newly created corporation or LLC taxed as a partnership.

    3. Stock acquisitions with a section 338(h)(10) election (target is either a Subchapter S corporation or subsidiary of a     consolidated group).

    4. LLC drop-down transactions (target transfers the business to an LLC and then sells LLC interests to the acquirer).

Reprinted with permission from Business Entities Journal (Thomson Reuters).