In 2011, the Internal Revenue Service issued Revenue Procedure 2011-29 (Rec. Proc.) which provides a safe harbor election for allocating success-based fees paid in a variety of business transactions, such as a sale to an Employee Stock Ownership Plan or a third-party sale. In the years that followed, the IRS issued additional directive - making the documentation standards for this election more attainable for businesses. This directive has made it clear that the IRS will not challenge a taxpayer's application of the 70% elective safe-harbor deduction to milestone or success-fee payments related acquisition transactions, providing that all of the following are true about the fee:
It relates to investment banking services
It is nonrefundable
It is creditable toward an overall success-based fee that is contingent upon the successful closing of the transaction
It is contingent upon an event occurring in the course of a covered transaction
It is not contingent upon an event that occurs before the event establishing the bright-line date in Regs. Sec. 1.263(a)-5(e)(1)
Why this matters for business owners: Through this Rev. Proc., taxpayers that make this election have the option to treat 70% of a success-based investment banking services fee as an expense and the remaining 30% of the fee as a capitalized cost. In the case of an ESOP transaction, these fees, which are incurred by the company, can reduce the firm's taxable income. The IRS will not challenge this allocation of fees if taxpayers make the election according to this Rev. Proc., providing that the taxpayer does all of the following when they file:
Treats 70% 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
What business owners can do with this information: To explore how this may apply to your specific circumstances and learn more about the best way to allocate your fees and take advantage of the safe harbor election, please reach out to your tax advisor.
As always, our team is available to help illuminate how these insights might benefit your succession planning efforts. If you or one of your clients are interested in pursuing this opportunity, please contact us to schedule a discussion as soon as possible.