Editor: Mark Heroux, J.D.
In Advice Memorandum (AM) 2020-003, the IRS addressed how a taxpayer's previously capitalized initial public offering (IPO) transaction costs are treated once the taxpayer becomes a privately held company. The IRS concluded that the expenditures were not deductible as an abandonment loss in the year the take-private transaction closed because stock issuance costs reduced the IPO proceeds and, therefore, did not result in basis that was recovered under Sec. 165.
Furthermore, the IRS concluded that even if the taxpayer had basis in the IPO costs, these expenditures continued to benefit the taxpayer after it became privately held, and, consequently, no abandonment loss deduction was available. Taxpayers considering or implementing take-private transactions should review the guidance when determining the appropriate treatment of previously capitalized stock issuance costs. This discussion summarizes the key points and potential implications of AM 2020-003.
The taxpayer incurred transaction costs consisting of advisory, regulatory, and filing fees and expenses in connection with an IPO and capitalized the costs as a separate and distinct asset rather than netting the costs against the proceeds from the stock issuance. The taxpayer subsequently ceased to be a publicly traded company after completing a take-private transaction and deducted the previously capitalized IPO transaction costs as an abandonment loss under Sec. 165.
Sec. 165 allows taxpayers to deduct losses sustained during the tax year, provided they are not compensated by insurance or otherwise.
Regs. Sec. 1.165-1(b) generally requires that deductible losses under Sec. 165(a) be evidenced by closed and completed transactions, fixed by identifiable events, and actually sustained during the tax year.
Regs. Sec. 1.165-2(a) allows a deduction for a loss incurred in a business or in a transaction entered into for profit and arising from the sudden termination of the usefulness in that business or transaction of any nondepreciable property where such business or transaction is discontinued or where such property is permanently discarded from use.
Sec. 165(b) provides that, for purposes of Sec. 165(a), the basis for determining the amount of the deduction for any loss from the sale or other disposition of property shall be the adjusted basis provided in Sec. 1011.
Regs. Sec. 1.263(a)-5 requires capitalization of amounts paid to facilitate the acquisition of a trade or business and certain other transactions described in Regs. Sec. 1.263(a)-5(a), including a stock issuance. Regs. Sec. 1.263(a)-5(g) provides rules for the treatment of capitalized transaction costs but reserves rules in certain situations, including stock issuance transactions.
Sec. 265 and Regs. Sec. 1.265-1(a)(1) provide that no deduction is allowed for any otherwise deductible expense that is allocable to a class or classes of exempt income other than exempt interest income.
Sec. 1032 and Regs. Sec. 1.1032-1(a) provide that no gain or loss shall be recognized to a corporation on the receipt of money or other property in exchange for its stock, including the receipt by a corporation of the subscription price of shares of its stock upon their original issuance, regardless of whether the subscription or issue price is equal to, in excess of, or less than the par or stated value of such stock.
The taxpayer in AM 2020-003 asserted that the Supreme Court's decision in Indopco, 503 U.S. 79 (1992), and Regs. Sec. 1.263(a)-5 overturned the long-standing principle that transaction costs incurred in connection with a stock issuance are capitalized and netted against the proceeds from the stock issuance. According to the taxpayer, the IPO transaction costs created "synergistic and resource" benefits that were analogous to expenses incurred in the purchase of an asset. Therefore, pursuant to Indopco and Regs. Sec. 1.263(a)-5, the costs were properly capitalizable as a separate and distinct asset, in which the taxpayer retained basis, the taxpayer argued. Upon subsequent completion of the take-private transaction, the public company benefits no longer existed, and an abandonment loss deduction under Sec. 165 was appropriate to recover the basis, even though the taxpayer had not abandoned the plan to undertake an IPO.
The IRS rejected the taxpayer's arguments and maintained that the historical treatment of stock issuance costs remains unchanged by Indopco and Regs. Sec. 1.263(a)-5. Specifically, the IRS noted: "In Indopco, the Court addressed costs incurred in facilitating a merger; it did not consider stock issuance costs or an IPO let alone overrule the IRS's position that the costs relating to an IPO are capitalized via netting the costs against the proceeds." Similarly, Regs. Sec. 1.263(a)-5 requires capitalization of stock issuance costs and, although the treatment of these capitalized costs is reserved under Regs. Sec. 1.263(a)-5(g)(3), the IRS noted that "no regulations or separate guidance have been issued which allow for the recovery of such costs." For that reason, the treatment of stock issuance costs continues to be governed by well-established legal precedent that requires such costs be offset against the proceeds of the stock sale (see Rev. Rul. 79-2). In essence, stock issuance costs are akin to commissions paid in connection with selling securities, which reduce the amount realized on the sale of the securities (see Regs. Sec. 1.263(a)-1(e)). Accordingly, since stock issuance costs were offset against the IPO proceeds, there was no separate and distinct asset or property basis to recover under Sec. 165.
The IRS further explained that, even if the taxpayer did have basis in the intangible benefits that resulted from the IPO, these attributes were not abandoned when the company was taken private because the taxpayer continued to benefit from once being a publicly traded company (e.g., enhanced public profile, name recognition, and the ability to attract management and employees). Therefore, no abandonment loss deduction was permitted under Sec. 165 upon completion of the take-private transaction.
Finally, the IRS noted that, although the IPO costs were not deductible, the taxpayer nevertheless benefited, as the related stock issuance proceeds were not includible in income pursuant to Sec. 1032 and Regs. Sec. 1.1032-1. Consequently, no deduction was permitted for the corresponding expenses under Sec. 265, which was enacted to prevent a taxpayer from obtaining a double advantage by deducting expenses attributable to tax-free income.
The issuance of AM 2020-003, along with recently published Technical Advice Memorandum (TAM) 202004010 and IRS practice unit "Transaction Costs in a Corporate Separation" (April 30, 2019), indicates that the IRS may be prioritizing the treatment of previously capitalized transaction costs as an audit issue. AM 2020-003 and TAM 202004010 reiterate the IRS's position that transaction costs generally benefit the trade or business for the duration of its existence and may not be recovered until the operations cease, are abandoned, or become worthless. Thus, the IRS has historically rejected taxpayers' attempts to characterize such amounts as a "separate and distinct asset" that may be abandoned and recovered prior to the complete cessation of the trade or business or abandonment of the transaction that gave rise to the expenditures.
While the IRS's holding in AM 2020-003 is unsurprising, given the well-established legal doctrine that governs stock issuance costs, the outcome in TAM 202004010 highlights the ongoing disagreement between the IRS and taxpayers regarding whether and when previously capitalized transaction costs are recovered under Sec. 165. The existing regulations do not address the treatment of capitalized transaction costs in certain common situations, such as the stock acquisition described in TAM 202004010. The IRS's Priority Guidance Plan removed projects related to this area in recent years, indicating that guidance is not forthcoming in the near future.
In the absence of regulatory guidance, taxpayers must perform a detailed analysis of existing legal authorities to determine the appropriate treatment of transaction costs. As demonstrated in the recent guidance, this analysis is typically subjective and fact-specific, resulting in significant uncertainty and potential controversy. Accordingly, businesses with significant capitalized costs from multiple transactions should separately track each transaction's costs and actively monitor factual and legal developments, possibly over many years, to determine the proper time for recovering previously capitalized transaction costs. Deductions may be permanently lost if not timely claimed (i.e., Sec. 165 deductions may only be taken in the year the loss is incurred).
Mark Heroux, J.D., is a tax principal and leader of the Tax Advocacy and Controversy Services practice at Baker Tilly US, LLP in Chicago.
For additional information about these items, contact Mr. Heroux at 312-729-8005 or email@example.com.
Unless otherwise noted, contributors are members of or associated with Baker Tilly US, LLP.