M&A termination fees under Sec. 1234A: Developments since 2016

Editor: Robert Venables, CPA, J.D., LL.M.

Termination fees (often called breakup fees) are a familiar deal–protection feature in merger–and–acquisition (M&A) agreements. They may take many forms, including payments that may function like liquidated damages for walking away from a deal, reimbursement of the other party’s transaction costs, or payments made to extinguish contractual rights and obligations created by the deal’s documents. Their tax treatment has long been contentious because the distinction between ordinary and capital treatment can materially affect whether the payer receives a current deduction or capital–loss treatment that may or may not yield a current benefit. That character question often turns on Sec. 1234A, which generally treats gain or loss from the cancellation, lapse, expiration, or other termination of a right or obligation with respect to a capital asset as capital gain or loss.

Since 2016, IRS guidance and court decisions have brought Sec. 1234A into sharper focus. This section plays a critical role in determining the tax character of termination fees. To navigate this area effectively, practitioners must understand both its historical roots and recent shifts in interpretation.

Although the tax treatment of termination fees may differ depending on whether the taxpayer is paying or receiving the fee, this item focuses primarily on the payer side of the analysis. However, it also looks at guidance addressing both the payer and recipient in order to fully examine the scope of Sec. 1234A. That said, the underlying Sec. 1234A framework generally is the same for both parties because it turns on the nature of the terminated right or obligation and the character of the underlying property in the hands of the taxpayer.

Sec. 1234A: Enactment and expansion

Congress enacted Sec. 1234A in 1981 to address inconsistent character treatment of gain or loss arising from the termination of rights or obligations with respect to capital assets. Initially, the statute applied only to rights or obligations tied to actively traded personal property. A 1997 amendment to Sec. 1234A expanded its reach to cover all capital assets and promoted more consistent character treatment (see H.R. Rep’t No. 105–148, 105th Cong. 1st Sess., at 451—54 (1997), explaining that the amendment expanded Sec. 1234A from rights or obligations with respect to actively traded personal property to rights or obligations with respect to all capital assets).

In its current version, Sec. 1234A provides that:

Gain or loss attributable to the cancellation, lapse, expiration, or other termination of a right or obligation … with respect to property which is (or on acquisition would be) a capital asset in the hands of the taxpayer … shall be treated as gain or loss from the sale of a capital asset.

The practical goal of Sec. 1234A is to align tax treatment with the economic substance of the terminated transaction. How those statutory limits apply to real–world termination fees has evolved through a series of IRS rulings, memoranda, and recent case law.

The IRS’s initial guidance

For a time in the 2000s, the IRS appeared to treat termination fees received by a would–be acquirer as ordinary income rather than capital gain. In Technical Advice Memorandum (TAM) 200438038, the IRS treated a termination fee received by a taxpayer as ordinary income. Without discussing Sec. 1234A, the TAM relied instead on a recovery–based analysis that did not tie the fee to capital treatment. In Private Letter Ruling 200823012, the IRS concluded that Sec. 1234A did not apply and treated the termination fee received by the taxpayer as ordinary income rather than capital gain, a result consistent with viewing an unallocated termination fee as more akin to a recovery of lost profits than damage to capital. These rulings illustrate the IRS’s pre–2016 approach to termination fees before its later shift in analysis.

Subsequent court cases and guidance

Non—termination-fee cases relevant to Sec. 1234A: The following two cases clarified important threshold limits on Sec. 1234A that later shaped the analysis of failed acquisition transactions, even though neither was itself a review primarily of the tax treatment of termination fees.

Pilgrim’s Pride Corp., 779 F.3d 311 (5th Cir. 2015),clarified the distinction between an interest in property itself and a right or obligation with respect to that property. In Pilgrim’s Pride, the taxpayer abandoned preferred stock after a failed acquisition and claimed an ordinary loss, but the IRS asserted that capital–loss treatment applied. After the Tax Court raised Sec. 1234A sua sponte and requested briefing on that issue, the IRS argued that Sec. 1234A applied. The Tax Court agreed (Pilgrim’s Pride Corp., 141 T.C. 533 (2013)), but the Fifth Circuit reversed, holding that Sec. 1234A applies to rights or obligations with respect to property, not to the property itself.

CRI–Leslie, LLC, 147 T.C. 217 (2016), addressed a different threshold issue under Sec. 1234A: whether the underlying property qualified as a capital asset in the taxpayer’s hands.

In CRI–Leslie, the taxpayer retained forfeited deposits after a failed sale of hotel property used in its trade or business. That hotel property was Sec. 1231 property — i.e., depreciable property or real property used in a trade or business and held for more than one year — and thus was not a capital asset under Sec. 1221. The Tax Court held that Sec. 1234A did not apply because its terms are limited to property that is, or on acquisition would be, a capital asset in the taxpayer’s hands. The forfeited deposits therefore did not produce capital gain under Sec. 1234A and instead were treated as ordinary income, confirming that the provision does not extend to Sec. 1231 property.

The IRS’s evolving Sec. 1234A guidance on termination fees: Against that backdrop, the IRS’s 2016 guidance marked a shift toward applying Sec. 1234A more directly and systematically to termination fees. In Field Attorney Advice 20163701F, the IRS concluded that a taxpayer’s payment of a termination fee in connection with the termination of a merger agreement produced a capital loss under Sec. 1234A because the fee related to contractual rights and obligations with respect to stock that would have been a capital asset in the taxpayer’s hands. In Chief Counsel Advice (CCA) 201642035, the IRS applied the same basic reasoning on the receipt side, concluding that gain or loss from a termination fee received by a would–be acquirer was also capital gain under Sec. 1234A, net of properly capitalized deal costs.

In 2022, the IRS issued guidance that built on its 2016 shift by extending the Sec. 1234A analysis to termination fees in a more structurally nuanced setting. In CCA 202224010, the IRS concluded that a termination fee paid by the taxpayer after a failed transaction gave rise to a loss under Sec. 165 rather than a business expense under Sec. 162 and that Sec. 1234A applied to characterize that loss as capital to the extent it was attributable to capital assets. The IRS emphasized that the fee was paid in connection with the termination of contractual rights and obligations arising from a capital transaction rather than as a stand–alone ordinary business expense.

The CCA also addressed a failed two–step reorganization in which the purchaser would have first acquired the target’s stock and then completed a forward merger of the target into a wholly owned subsidiary. The IRS treated that integrated structure, under step–transaction principles, as an asset acquisition for tax purposes, even though the transaction initially took the form of an equity deal. On that view, the termination fee and related capitalized facilitative costs were subject to Sec. 1234A only to the extent they were attributable to property that would have been capital assets in the taxpayer’s hands if acquired. The memorandum therefore underscored both the importance of the nature of the underlying property and the relevance of the planned transaction’s intended federal income tax characterization.

AbbVie and the emerging limits of Sec. 1234A: The IRS’s expanding Sec. 1234A analysis was later tested in AbbVie Inc., 164 T.C. No. 10 (2025), which involved a $1.6 billion termination fee paid after a proposed inversion transaction with Shire plc, a foreign public limited company. The two companies had entered into a cooperation agreement spelling out the terms of the planned inversion. However, following the issuance of adverse Treasury guidance (Notice 2014–52), AbbVie’s board chose not to recommend the combination to its shareholders, thus abandoning the plan.

The IRS disallowed AbbVie’s deduction of the termination fee, asserting that it resulted in a capital loss under Sec. 1234A. The IRS argued that AbbVie’s rights and obligations under the cooperation agreement were sufficiently connected to Shire stock to fall within Sec. 1234A, even though the proposed combination required additional shareholder and court approval. AbbVie maintained that the fee should be deductible as an ordinary expense, arguing that the cooperation agreement was fundamentally service–related and facilitative in nature and did not create rights or obligations with respect to property within the meaning of Sec. 1234A.

On June 17, 2025, the Tax Court issued its opinion in AbbVie Inc., ruling in favor of AbbVie and holding that Sec. 1234A did not apply to require capital–loss treatment of the $1.6 billion termination fee.

The Tax Court’s analysis centered on whether the cooperation agreement gave rise to rights or obligations “with respect to property” within the meaning of Sec. 1234A. The court concluded that it did not. Neither AbbVie nor Shire held or controlled the public shareholders’ shares in a way that allowed the cooperation agreement alone to effect their exchange, and the court therefore viewed the agreement as fundamentally service–related and facilitative in nature rather than as an agreement to buy, sell, or otherwise transfer property. Consistent with that reasoning, the court held that the agreement did not create rights or obligations with respect to property for purposes of Sec. 1234A.

AbbVie thus suggests that, even in the M&A context, Sec. 1234A applies only when the terminated agreement creates rights or obligations to transfer or receive a property interest rather than merely facilitative or service–related obligations.

Current framework for termination fees, including mutually exclusive transactions

Taken together, these authorities show that the tax treatment of termination fees turns less on the label attached to the payment and more on the nature of the terminated rights; the character of the underlying property; and the posture of the taxpayer as an acquirer, a target, or a shareholder.

Even in an abandoned acquisition, where a termination fee or related deal costs would otherwise be recovered under Sec. 165, practitioners must also consider whether the capitalization rules under Regs. Sec. 1.263(a)-5 require those amounts to be capitalized into a completed transaction mutually exclusive with a terminated one. Regs. Sec. 1.263(a)-5(a) generally requires capitalization of amounts paid or incurred to facilitate an acquisition of a trade or business, a change in the capital structure of a business entity, and certain other transactions. As it relates to a terminated deal, under Regs. Sec. 1.263(a)-5(c)(8), the costs are capitalized when a transaction that is a mutually exclusive alternative to the terminated transaction is undertaken. These costs may include termination fees paid as part of a contractual obligation.

A transaction is considered mutually exclusive when it cannot occur alongside the original transaction, meaning the consummation of one would necessarily preclude the other. This circumstance typically arises when a taxpayer evaluates alternative transactions and abandons one proposed deal to enable the pursuit of another. Alternatives alone, however, are not enough; if the taxpayer could have completed both transactions, the costs of the abandoned transaction generally are not capitalized into the later one. Where the first transaction is abandoned to enable a mutually exclusive second transaction, however, the costs associated with the abandoned transaction may be treated as facilitating the second transaction and therefore may need to be capitalized rather than deducted.

Termination fees in failed asset or deemed asset acquisitions: In a terminated asset or deemed asset deal, costs incurred by the purchaser, including any termination fee paid, are subject to Sec. 1234A only to the extent the underlying assets would have been capital assets in the purchaser’s hands. If the assets intended for sale include both capital and ordinary assets, Sec. 1234A applies only to the portion of the termination payment allocable to capital assets in the hands of the purchaser. For example, because not all business assets qualify as capital assets under Sec. 1221 (e.g., inventory and accounts receivable are excluded), only the portion of the termination fee attributable to capital assets would be characterized as giving rise to a capital loss. The remaining portion may be deductible as an ordinary loss under Sec. 165.

Termination fees in failed equity acquisitions: When the purchaser enters into a contract to acquire the stock of a target (which would be a capital asset if acquired), a termination fee paid upon the failure of that contract may be treated as a capital loss under Sec. 1234A.

Conversely, in the specific case of a target–paid termination fee in a failed stock acquisition involving the target’s own stock, Sec. 1234A generally should not apply at the target level because a corporation’s own stock is not a capital asset in its hands. The payment therefore generally must be analyzed outside Sec. 1234A, most often under Sec. 165 or Sec. 162, depending on the facts.

Where termination fees are paid by shareholders, such as when they are parties to a stock purchase agreement, Sec. 1234A may apply to treat the cost as capital in nature because the stock typically is a capital asset in the shareholders’ hands. However, such scenarios are less common in corporate M&A transactions, where the entity, rather than the individual shareholder, more often incurs the cost.

Careful drafting and analysis needed

The current authorities suggest that the proper treatment of a termination fee turns on three core questions: (1) what contractual right or obligation was terminated; (2) whether the underlying property would have been a capital asset in the taxpayer’s hands; and (3) whether the payment is better understood as part of an abandoned capital transaction or as linked to a separate completed transaction that must be capitalized. Over time, the IRS’s position has moved from treating many termination–fee receipts as ordinary to applying Sec. 1234A more broadly in the M&A context. Meanwhile, the courts have made clear that the statute remains limited by two core requirements: (1) The terminated agreement must involve rights or obligations with respect to property, and (2) the underlying property must be a capital asset rather than, as in CRI–Leslie, Sec. 1231 property. Parties should therefore draft termination–fee provisions with these issues in mind and carefully analyze whether the payment falls outside Sec. 1234A; is more properly deductible under Sec. 162 or Sec. 165; or instead must be capitalized under Sec. 263, including under the rules for mutually exclusive transactions.

Editor

Robert Venables, CPA, J.D., LL.M., is a tax partner with Cohen & Co. Ltd. in Fairlawn, Ohio.

For additional information about these items, contact Venables at rvenables@cohencpa.com.

Unless otherwise noted, contributors are members of or associated with Cohen & Co. Ltd.