United States

IRS exam activity reinforces need to document M&A transaction costs


In many merger and acquisition (M&A) transactions, there are significant professional fees incurred by the entities involved. In general, those costs are paid upon the closing of the transaction and include fees for legal, accounting and investment banking services. With respect to success-based fees paid in a transaction, the issuance of the 70 percent success-based fee safe harbor1  has eliminated much of the need to document the various services provided under the success-based fee arrangement. However, before getting to the safe harbor, you need to determine who incurred the fee and who should report the deduction. While nothing has been announced by the IRS and we are not aware of any change in position by the IRS National Office, we have seen an uptick in IRS challenges of deductions claimed by the target (T) or purchasing entity (P) for certain M&A transaction costs. The argument being made by the IRS is that the selling owner(s) should be reporting the costs at the shareholder level as opposed to at the entity level. The IRS is in effect arguing that the shareholder received proceeds in excess of the actual consideration received and used such funds to pay the transaction fees.

The question of who is properly entitled to claim a deduction is one of fact and generally is based upon whom the costs were incurred on behalf of and for the benefit of.2  The party that arranges for the services and even pays the expense is not determinative. In many M&A transactions, the professional fees in question are paid at closing and the actual party directly paying the expense is unclear. However, the regulations addressing these types of costs clearly state that when looking at the amount paid by a taxpayer, you would include indirect amounts paid on behalf of the taxpayer by another.3  In general, it is clear that either T or P is the appropriate party to claim the transaction costs at issue because the service providers are clearly providing diligence and other legal and advisory services to the entity (as opposed to the shareholder) despite the fact that another party may have arranged for the services. Further, the fact that a P or T owner may receive some indirect benefit resulting from the costs incurred by P or T does not change the conclusion as to the level (owner or entity) at which the deduction belongs.

In summary, while the law remains clear, and in support of the T or P entity properly claiming the deduction for M&A-related transaction fees, recent IRS exam positions provide a warning that taxpayers should continue to document the services being provided by the service provider to establish that the entity is in fact entitled to the deductions, even where the 70 percent success-based fee safe harbor is otherwise available.

More information on this issue can be found in our whitepaper, Mergers and Acquisitions Transaction Costs 2015 Redux: Who gets the benefit?  

[1] In Rev. Proc. 2011-29, the IRS allowed for an election to treat 70 percent of success-based fees paid upon certain M&A transactions as not subject to capitalization.
[2] See PLRs 200830009 and 200953014, which address rulings the IRS has issued on the claiming of M&A transaction costs in common transactions.
[3] Reg. section 1.263(a)-5(k).


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