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Deductibility of Transaction Costs and Expenses

Business Buyers

Many business people and their professional advisors get confused about what costs and expenditures associated with acquiring a business are deductible. They apply to the year of acquisition, but they also wonder which costs and expenses must be capitalized and amortized over time.

The basic concept is that fees incurred to facilitate the transaction must be capitalized. “Success” based fees are 70% deductible in the year of acquisition, and 30% capitalizable. Fees to facilitate the sale are legal fees, accounting fees, and investment banking fees that are not contingent upon the outcome of their efforts.  Success-based fees are those that are contingent upon the outcome of the efforts such as contingent commissions. While this might seem simple, there is more to it than initially meets the eye.

With full documentation, success-based fees may be fully deductible, but the hurdles for compiling such documentation are significant. Instead, a safe harbor election (Regs. Sec. 1.263(a)-5(f)) may be used that allows 70% of fees to be deducted and 30% to be capitalized. To make the safe-harbor election, taxpayers must attach a statement to their federal income tax return for the fiscal year during which the fee is paid or incurred stating that the taxpayer is electing the safe harbor, identifying the transaction and specifying the amounts capitalized and the amounts deducted. Also, the IRS requires that costs incurred after a particular “bright line” date – including success-based fees – must be capitalized. This date is the earlier of: (1) the date on which a letter of intent, exclusivity agreement or similar written communication (other than a confidentiality agreement) is executed, or (2) the date on which the material terms of the transaction are authorized or approved by the taxpayer’s board of directors (or committee of the board of directors).

What must be capitalized and what can be deducted can be highly subjective and is often a judgment call.  Be prepared to be challenged by the IRS if deducting costs and expenses in the gray and be prepared to provide adequate documentation supporting your position.  Be sure to get quality tax advice.

#TaxAdvice #SafeHarborElection #NewJerseyBusinessForSale #NewJerseyBusinessBroker

Article By Brad Palmer

Content Editing and Optimization by Geoff Caplan

 


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