As a result of additional regulatory requirements, merger and acquisition discussions and activity are increasing in the banking industry. Associated transaction costs incurred related to a merger or acquisition transaction can be significant. These costs can include fees for financial advice, legal services, due diligence services, and expenses to arrange debt financing and can greatly impact a company’s financial statement.
The timing and nature of these expenses will, for the most part, determine the tax treatment. Generally, costs that facilitate a transaction must be capitalized. These costs include amounts paid in the process of investigating or otherwise pursuing the transaction. The determination of whether an amount is paid in the process of investigating or otherwise pursuing the transaction is based on all of the facts and circumstances.
Bright-line date rule
The IRS has established a “bright-line date” rule for certain acquisitive transactions called “covered transactions.” Under this rule, an amount paid by the taxpayer in the process of pursuing a covered transaction facilitates that transaction only if it relates to activities performed on or after the earlier of:
- the date a letter of intent or similar communication is executed, or
- the date on which the material terms of the transaction are authorized or approved by the taxpayer’s board of directors.
Inherently facilitative costs are subject to capitalization regardless of when incurred. Thus, the bright-line date rule does not apply to these costs. Examples of inherently facilitative costs include:
- Securing an appraisal;
- Issuing a fairness opinion related to the transaction;
- Structuring the transaction;
- Preparing and reviewing documents that effectuate the transaction;
- Obtaining regulatory approval;
- Obtaining shareholder approval; and
- Conveying property between the parties to the transaction.
In general, costs relating to investigatory, pre-decisional due diligence incurred before the bright-line date that are not inherently facilitative in nature may be currently deductible as ordinary and necessary business expenses.
Amounts paid contingent on the successful closing of a transaction are commonly referred to as success-based fees. Success-based fees are generally required to be capitalized. However, to the extent the taxpayer maintains sufficient documentation to show a portion of the fee is allocable to activities that do not facilitate the transaction; the fees may be currently deductible. In general, this documentation must consist of supporting records, such as time records, itemized invoices, or other records that identity the activities performed, the fee allocable to those activities, the date of performance, and the service provider.
For covered transactions, in lieu of maintaining the appropriate documentation to show a portion of the fee is non-facilitative, a taxpayer can elect a safe harbor for success-based fees. Under this safe harbor, 70 percent of the success-based fees are deemed to be non-facilitative costs that are deductible, and the remaining 30 percent of the fees are required to be capitalized.
Financial statement impact
The financial statement impact of these transaction costs may be higher than anticipated as the institution may not be able to record an income tax benefit for certain capitalized costs.
For more information on the tax return or financial statement impact of the tax treatment of transaction costs, or to learn how Baker Tilly tax specialists can help, contact our team.
The information provided here is of a general nature and is not intended to address the specific circumstances of any individual or entity. In specific circumstances, the services of a professional should be sought. Tax information, if any, contained in this communication was not intended or written to be used by any person for the purpose of avoiding penalties, nor should such information be construed as an opinion upon which any person may rely. The intended recipients of this communication and any attachments are not subject to any limitation on the disclosure of the tax treatment or tax structure of any transaction or matter that is the subject of this communication and any attachments.