Nonrefundable Milestone Fees Do Not Qualify as Success-Based

By Michael D. Koppel, CPA, Gray, Gray & Gray LLP, Westwood, Mass.

Editor: Michael D. Koppel, CPA/CITP/PFS, MSA, MBA

Expenses & Deductions

In the landmark case INDOPCO, Inc., 503 U.S. 79 (1992), the Supreme Court ruled that expenses incurred by a target company in a friendly acquisition should be capitalized. Ever since that ruling, the IRS and taxpayers have argued over what fees should be included. Largely as a result of INDOPCO, the IRS issued Regs. Sec. 1.263(a)-4(b), which indicates the following should be capitalized:

  1. Amounts paid to acquire or create intangible assets.
  2. Amounts paid to create or enhance separate and distinct intangible assets, i.e., property interests with ascertainable value protected under state, federal, or foreign law that are capable of being sold, transferred, or pledged, and are separate from a trade or business. (Amounts to create computer software or package design are not included.)
  3. Amounts paid to create or enhance future benefits identified as intangibles requiring capitalization, based on published guidance in the Federal Register or an Internal Revenue Bulletin.
  4. Amounts facilitating the acquisition or creation of intangible assets.

However, there was still much confusion as to what should be capitalized and what could be deducted as a business expense. The IRS issued Rev. Proc. 2011-29, which allows a business to expense 70% of “success-based fees,” meaning amounts that are contingent on the successful closing of a covered transaction. It is important to remember this safe-harbor election can apply to both sides of the transaction.

The importance of an expenditure’s being success-based is demonstrated in Chief Council Advice (CCA) 201234027, which determined that $2 million in fees was not eligible for treatment as success-based because they were nonrefundable milestone fees that were not contingent on the success of the acquisition. The CCA said that $8 million in fees that were contingent on the merger’s success did qualify for the 70% safe-harbor treatment.

As Andrew Keyso, IRS associate chief counsel (income tax and accounting), pointed out at a recent American Bar Association meeting, the 70/30 allocation is a safe harbor, not a ceiling. Taxpayers can still take a higher-percentage deduction at their own risk.


Michael Koppel is with Gray, Gray & Gray LLP in Westwood, Mass.

For additional information about these items, contact Mr. Koppel at 781-407-0300 or .

Unless otherwise noted, contributors are members of or associated with CPAmerica International.

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