IRS releases practice unit on transaction costs

Tax Hot Topics newsletterThe IRS recently released a practice unit, “Examining a Transaction Costs Issue,” regarding the U.S. federal income tax treatment of transaction costs incurred in certain business transactions. In general, a Practice Unit is developed to provide guidance and training to IRS personnel regarding the examination of certain types of transactions or key technical tax subjects. Practice units are not considered official guidance to taxpayers, but do provide insight into how the IRS might address certain tax issues when those issues arise in an examination.

The transaction costs practice unit addresses the application of Section 263, Treas. Reg. Sec. 1.263(a)-5 and other relevant authorities to transaction costs incurred in certain business transactions.  Transactions subject to these rules generally include acquisitions of a trade or business, reorganizations or restructurings and changes to a company’s capital structure. The transaction costs practice unit sets forth a three-step process to be used by IRS agents when examining transaction costs taken into account on a taxpayer’s return: (1) determine whether the taxpayer is the proper legal entity to take the transaction costs into account for tax purposes; (2) determine whether the costs facilitate the transaction; and (3) determine how the taxpayer should treat facilitative costs it must capitalize.

Common transaction costs include legal, accounting, consulting and investment banking fees.  Taxpayers must capitalize costs that “facilitate” one of the business transactions enumerated in regulations, such as an acquisition of an interest in a corporation or other business entity engaged in a trade or business (see Treas. Reg. Sec. 1.263(a)-5(a)). The term “facilitate” generally refers to a cost incurred to investigate or otherwise pursue a transaction. However, the determination of whether a particular expenditure facilitates a transaction is not always clear. The transaction costs practice unit provides some insight into how the IRS may apply its regulations regarding this and other issues in an IRS examination of a taxpayer’s treatment of transaction costs incurred in connection with the acquisition of a trade or business or similar transaction.

David Auclair
National Managing Principal
Washington National Tax Office
T +1 202 521 1515
Joshua Brady
National Tax Standards Group
T +1 202 521 1563

Bryan Keith
Managing Director
National Tax Standards Group
Washington National Tax Office
T +1 202 861 4116

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