IRS Examines Treatment of Restructuring Costs

Editor: Lorin D. Luchs, CPA, J.D., LL.M.

In December 2007, the IRS issued Technical Advice Memorandum (TAM) 200749013, providing guidance on the treatment of costs related to investigating various corporate restructuring transactions that ultimately were not consummated. Specifically, the TAM addresses whether these costs are deductible as ordinary and necessary business expenses under Sec. 162(a), are deductible losses under Sec. 165, or must be capitalized under Sec. 263(a).

Costs incurred while investigating and pursuing mutually exclusive proposed business restructurings (meaning that only one restructuring transaction can be completed) must be capitalized as part of the completed transaction costs. If part of the mutually exclusive proposal is abandoned, no abandonment loss under Sec. 165 is recognized unless the entire proposal is abandoned (United Dairy Farmers, Inc., 267 F3d 510 (6th Cir. 2001)). Alternatively, restructuring costs incurred in investigating and pursuing nonmutually exclusive potential business restructurings, otherwise capitalized under Sec. 263(a), are deductible under Sec. 165 when each proposed transaction is abandoned (Rev. Rul. 73-580). 

The TAM was written in response to a taxpayer engaged in one primary and two lesser businesses that restructured its business in order to refocus its efforts on its core activities. Before restructuring, the taxpayer investigated several options, including (1) maintaining the status quo, (2) a leveraged recapitalization or a full recapitalization with a spin-off of the lesser business divisions, and (3) divestiture of the lesser business divisions, including a targeted stock offering or an initial public offering (IPO) with a split-off or spin-off. The taxpayer’s board of directors quickly eliminated the first two alternatives and then shortly thereafter eliminated the consideration of a spin-off or targeted stock offering. The only restructuring option remaining was an IPO split-off, and the board soon approved this alternative. Subsequently, the taxpayer formed a subsidiary and contributed to the subsidiary its lesser business divisions. The IPO of the subsidiary was soon completed. The taxpayer abandoned the split-off of the subsidiary because it would not maximize shareholder value but later completed a spin-off of the subsidiary.

The IRS field personnel maintained that the taxpayer intended to enter into one restructuring transaction; thus, all of the transactions considered were mutually exclusive and the associated costs should be capitalized under Sec. 263(a). The taxpayer disagreed and claimed that the different restructuring transactions were not mutually exclusive. Therefore, according to the taxpayer, all of the costs associated with the abandoned transactions were deductible under Sec. 165. Furthermore, the taxpayer claimed that all of the investigatory costs incurred when deciding whether or not to enter into a restructuring transaction were amortizable under Rev. Rul. 99-23, relating to start-up expenditures under Sec. 195.

The IRS National Office concluded that the taxpayer’s first option of maintaining the status quo was mutually exclusive but that not much of the cost at issue was attributable to that option. The Service further concluded that the second and third alternatives were not mutually exclusive. Because the board eliminated the second option, the associated costs were deductible under Sec. 165. Regarding the third option, the Service concluded that a spin-off and a split-off are very similar transactions. Therefore, all costs incurred by the taxpayer from day one of the restructuring proposal related to the IPO, spin-off, or split-off must be capitalized as part of the restructuring that was completed. The Service also rejected the taxpayer’s claim that the investigatory costs were amortizable as start-up expenditures under Rev. Rul. 99-23 because the ruling pertains only to acquisitions of new businesses and not the division of existing businesses.

The TAM serves as a reminder that it is important to identify the costs associated with potential business restructuring transactions and to determine whether the transactions considered are or are not mutually exclusive in order to determine whether the costs of abandoned transactions are deductible or must be capitalized.

EditorNotes

Lorin D. Luchs, Partner, Washington National Tax Office BDO Seidman, LLP, Bethesda, MD.

Unless otherwise indicated, contributors are members of or associated with BDO Seidman, LLP.

If you would like additional information about these items, contact Mr. Luchs at (301) 634-0250 or lluchs@bdo.com.