Executive Summary: The IRS has recently issued relief for companies that failed to fully and completely make affirmative elections in order to deduct very large portions of success-based fees that were incurred during acquisitive transactions. There are several requirements that must be met in order to fall into the IRS issued safe harbor rules. One of the steps is ministerial in nature. Nonetheless, missing that step invalidates a company’s attempt at automatically deducting 70% of the success-based fees incurred at time of acquisition. Review tax returns that include acquisitions within the last three years. If the required election disclosures are missing related to the safe harbor method for handling such fees, steps should be immediately taken to request administrative relief. Your Calvetti Ferguson tax partner is well versed in these rules and can quickly and efficiently mediate the request with the IRS.
Discussion: For a number of years, the IRS and taxpayers have had significant and ongoing controversy regarding how to properly account for deductible versus non-deductible portions of success-based fees. The controversy was so intense that the IRS finally issued Rev. Proc. 2011-29 in order to provide a safe harbor method for deducting and capitalizing such fees. Private Equity as well, as other types of entities, have incurred substantial amounts of success-based fees due to the volume of acquisitive transactions undertaken in recent years. Due to these fact patterns, many private equity funds could have a large underlying tax exposure in their portfolio companies and not even realize the risk.
Under the Treasury Regulations interpreting IRC sec. 263, taxpayers have been allowed to rebut the presumption that all success-based fees are facilitative / non-deductible in nature. The trouble with taking advantage of that latitude has been the intensive nature of the studies that needed to be performed; the lack of readily available evidentiary documentation; and high cost, both internal and external, associated with digging up and creating the needed evidence. Part of that effort is typically to map out work performed by third parties who’s fees were paid at the successful closing of a deal along a timeline or otherwise. The result is a split of fees into those that were not facilitative / deductible and those that were facilitative / non-deductible. Results of those studies vary. Oftentimes, though, a large portion of the success-based fees could be properly supported as being immediately deductible.
As a highly simplified alternative, Rev. Proc. 2011-29 allows taxpayers to immediately deduct 70% of the success-based fees incurred as part of a transaction. The remaining 30% must be capitalized. The catch is that taxpayers must also affirmatively attach an election statement to their originally filed tax return. The statement must include certain elements including stating that the taxpayer is electing the safe harbor, identifies the transaction, and states the amounts of success-based fees that are being deducted and being capitalized. Even if the taxpayer properly accounted for the deductible and capitalized portions appropriately, the failure to take the ministerial step of formally inserting an election statement makes the safe harbor election invalid. If the election is invalid, there is a real risk that all success-based fees could be treated as being non-deductible.
For a number of years, the IRS provided no guidance about what taxpayers could do if tax returns were filed without affirmative election statements attached. However, in recent months, the IRS has issued a series of Private Letter Rulings (PLRs) granting 9100 / administrative relief to taxpayers who have requested it. Now that the IRS National Office agrees that granting such relief can be appropriate, Private Equity and other taxpayers should proactively work with their tax advisors to verify that all requirements of intended safe harbor elections under Rev. Proc. 2011-29 were met. If not, quick action should be taken which can result in the granting of 9100 relief before time runs out on the statute of limitations for the affected tax year. Once granted, such PLRs often grant 45 to 60 days in which to file an amended return in order to perfect the originally intended election.
For further information and assistance with such issues, please contact your Calvetti Ferguson tax partner at 713-957-2300.
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