Success Based Fees and Rev. Prov. 2011-29

Prior to the enactment of the Rev. Proc. 2011-29, the treatment of success-based fees was one of the most controversial items between the IRS and taxpayers. Success-based fees are contingent on the successful close of the transaction, often paid to investment bankers and those involved in brokering the transaction. Although contingent on the close of the transaction, these services often begin prior to the transactions end date and can encompass facilitative and non-facilitative components.

Amounts paid to "facilitate" the transaction are those incurred in the process of investigating or pursuing a transaction based on a facts and circumstances analysis. Inherently facilitative fees must be capitalized regardless of when they were incurred during the acquisition process. An amount that is inherently facilitative are those incurred for: securing an appraisal, structuring a transaction, preparing and reviewing documents that effectuate the transaction, obtaining regulatory approval or shareholder approval of the transaction and conveying property between the parties of the transaction.

Under Reg §1.263(a)-5 a taxpayer must capitalize amounts paid to facilitate qualifying business transactions without regard as to whether that transaction involved a single step or a series of steps under a single plan. A taxpayer must capitalize these amounts regardless of whether gain or loss is recognized on the transaction.

Generally, costs incurred that facilitate the acquisition of a trade or business, a capital structure shift or certain other qualifying transactions under §263(a) must be capitalized. §1.263(a)-5(e)(3) identifies covered transactions which include:

  1. Taxable acquisitions by the taxpayer of assets that constitute a trade or business;
  2. Taxable acquisition of an ownership interest in a business entity if immediately after the acquisition the parties are deemed related under the code;
  3. A reorganization in which assets are transferred and distributed in a qualifying transaction.

Success-based fees are those contingent upon the successful close of the qualifying transaction described in §1.263(a)-5(e)(3). Typically, these include financial advisory fees and investment banker fees payable only after the successful close of the transaction. These fees are presumed to be facilitative and thus require capitalization unless the taxpayer was to elect safe harbor treatment under Rev. Proc. 2011-29. Taxpayers who choose not to elect safe harbor treatment must maintain sufficient documentation under §1.263(a)-5(f) establishing which portion of the success based fee is allocable to activities that do not facilitate the transaction, and those portions that do. This determination creates much controversy between the taxpayer and the IRS, whereas election of safe-harbor treatment ensures that the IRS will not challenge the taxpayers allocation of success-based fees should they comply with Rev. Proc 2011-29.

Rev. Proc. 2011-29 creates a safe-harbor election for taxpayers allowing them to exclude 70 percent of success-based fees on qualifying transactions from capitalization. If the safe harbor is elected it is irrevocable, and the taxpayer must apply safe harbor treatment to all success-based fees incurred within that qualifying transaction. The remaining 30 percent of the fee must be capitalized as an amount that facilitates the transaction. Only qualified transactions under §1.263(a)-5(e)(3) qualify for this safe harbor election, and while the creation of Rev. Proc 2011-29 did eliminate the disparity between the IRS and taxpayers for success-based fees that existed prior to its enactment, some ambiguity remains.

While Rev. Proc. 2011-29 applies broadly, it does not apply universally to all transactions. The first step in applying safe harbor treatment for any taxpayer is deciding as to whether safe harbor treatment is appropriate for the transaction in question. Since safe harbor treatment is made based on each individual transaction the taxpayer will be required to treat all success based fees for a single transaction consistently. The treatment of one transaction however, will not impact the treatment of a separate transaction, thus a taxpayer will not be forced to elect safe harbor treatment for every transaction. Ambiguity remains however over what constitutes a single transaction, especially in instances where a single transaction may encompass a series of steps which individually may not all qualify for safe harbor treatment. Furthermore, since this election is irrevocable careful consideration should be used when electing safe harbor treatment under Rev. Proc. 2011-29.

If there are any questions on success-based fees, safe harbor treatment or how they may apply to you please contact a member of TAG.

This is an HBK Tax Advisory Group publication.
About the Author(s)

Cassandra Baubie is an Associate at HBK CPAs & Consultants and is a member of its Tax Advisory Group (TAG).

Ms. Baubie joined HBK in 2017. She works in the firm’s Youngstown, Ohio office after earning a dual Bachelor of Arts degree in Legal Studies and Psychology from the State University of New York The University at Buffalo and a Juris Doctorate from the University of Pittsburgh School of Law, where she also completed a Tax Law Certification. She graduated from both schools with high honors and spent a semester studying abroad in London, England, as well.

Ms. Baubie has experience in tax law research. Prior to joining HBK, she worked for, a global legal news organization, and was a member of the University of Pittsburgh Tax Law Review Journal. Ms. Baubie also worked for the University of Pittsburgh School of Law’s Low Income Tax Clinic where she performed IRS litigation and Tax Court work, and provided compliance work for low income individuals and businesses. She was an avid volunteer with the Olmsted Center for Sight in Buffalo.

Hill, Barth & King LLC has prepared this material for informational purposes only. Any tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or under any state or local tax law or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein. Please do not hesitate to contact us if you have any questions regarding the matter.