LB&I Directive: No Challenge to Treatment of Milestone Payments as Success-Based Fees

Feb. 6, 2014

On Jan. 27, 2014, the IRS Large Business and International (LB&I) division issued a directive that updates previous guidance for audits of taxpayers claiming a deduction for success-based milestone fees in merger and acquisition transactions under the safe harbor of Revenue Procedure 2011-29.

The new directive modifies the definition of a milestone event provided in a previously issued LB&I directive, under which the IRS would not challenge a taxpayer’s use of the safe harbor if, among other items, the milestone event occurred after the bright-line date established with the execution of a letter of intent. The new directive liberalizes the audit guidelines and indicates that the IRS will not challenge use of the safe harbor for success-based milestone events that occur at any time in the course of a transaction.

Revenue Procedure 2011-29 provides a safe harbor for allocating success-based fees paid or incurred as part of an acquisition, reorganization, or similar transaction. The safe harbor permits a taxpayer to deduct 70 percent of a success-based fee as an amount that does not facilitate the transaction and to capitalize the remaining 30 percent. For example, consider a transaction in which an investment banker is paid $15 million in success-based fees for services related to an acquisition as follows: $1 million upon identifying suitable targets for the acquirer, $2 million when a letter of intent is signed, and $12 million at closing. Under the prior guidance, only the $2 million payable upon signing the letter of intent and $12 million payable upon closing would be eligible for the safe harbor. The new guidance also allows the $1 million paid upon identification of suitable targets to qualify for the safe harbor.

This directive might further assist taxpayers whose milestone payments are an issue under consideration in an ongoing exam and eliminate controversies associated with deducting success-based fees. Taxpayers should consider applying the safe harbor to milestone payments in light of this latest directive.

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