Many U.S. businesses have used the recent economic downturn as a stimulus to revisit and revise their short- and long-term strategic plans. As such, many businesses have streamlined their operations, invested in capital equipment, and engaged in merger and acquisition activity. Statistics show that 2010 M&A activity is up significantly over the prior year.
It is important to consider the tax implications of costs incurred during M&A transactions, as many might be nondeductible. Internal Revenue Service Treasury Regulations require the capitalization of amounts paid that provide a long-term benefit. Ordinary and necessary business expenditures are typically deductible in the year incurred.
Treasury Regulation 1.263(a) provides guidance for the treatment of transaction-related costs. Generally, amounts paid to “facilitate” a transaction are required to be capitalized. Pursuant to Treasury Regulation 1.263(a)-5, amounts paid to facilitate a transaction are “paid in the process of investigating or otherwise pursuing the transaction.” If the costs incurred meet three requirements, they are considered to be nondeductible expenses, and are required to be capitalized for income tax purposes.
The first requirement relates to the nature of the transaction. Pursuant to Treasury Regulation 1.263(a)-5, amounts paid to facilitate “covered transactions” are required to be capitalized. Covered transactions include taxable asset acquisitions, certain taxable acquisitions of an ownership interest in an entity, and certain reorganizations.
The second requirement is that the costs incurred are for “inherently facilitative” activities, which include securing an appraisal of the target business, writing evaluations or fairness opinions, negotiating the structure of the transactions (including obtaining tax consultation), and preparing and reviewing documents to effectuate the transaction.
The final requirement is that costs are incurred subsequent to a “bright-line” date, which may be the date a letter of intent or exclusivity agreement is executed, or the date on which the material terms of the transaction are authorized or approved.
Additionally, success-based fees paid to an investment banker for services provided relative to the successful closing of a covered transaction are likely nondeductible costs. If a taxpayer can establish and support that some of the investment banking fees were not incurred to facilitate a transaction, the tax payer might be entitled to a deduction for that portion.
In an asset acquisition, capitalized transaction costs are allocated among the assets purchased, thereby increasing the assets’ tax basis. The portion of the acquisition costs that are allocated to an amortizable asset would be amortized over 15 years as Internal Revenue Code Section 197 intangibles. In a stock transaction, capitalized acquisition costs increase the basis of the stock acquired and are not recovered until disposition or dissolution.
The costs of obtaining a loan to finance an acquisition are typically amortized over the term of the loan.
Currently, the treatment of acquisition costs for GAAP purposes is to deduct as expenses in the year incurred. As a result, there could be significant book-versus-tax accounting differences for acquisition costs in both the year of acquisition and subsequent years.
As you can see, there are complex rules associated with the tax deductibility of M&A transaction costs. Please consult a Schneider Downs tax advisor to assist you in analyzing the tax impact of your transaction costs.
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This advice is not intended or written to be used for, and it cannot be used for, the purpose of avoiding any federal tax penalties that may be imposed, or for promoting, marketing or recommending to another person, any tax-related matter.