At a Glance
Main Takeaway
As your company participates in a deal, such as a merger and acquisition (M&A), you should seek tax strategies to maximize the transaction’s profitability. One strategic approach involves the treatment of transaction costs incurred during an M&A.
Transaction costs refer to fees for services provided by investment bankers, attorneys, accountants, and consultants during the transaction. These costs can significantly impact your realized gain and often offer tax advantages you can benefit from in future years with the right accounting approach.
Next Step
Understanding the tax treatment of transaction costs and implementing strategies to maximize tax benefits associated with these expenses lets you experience increased profitability.
What are Transaction Costs?
Transaction costs are the expenses you encounter when buying or selling an asset, like an investment or a business. For businesses that participate in M&A deals, transaction costs are an expected expense for closing the deal at the time of purchase.
These costs can include fees associated with completing the transaction. For instance, brokerage fees, legal fees, accounting fees, appraisal costs, and regulatory compliance expenses are transaction costs related to the purchase of the underlying asset.
These costs directly impact the total costs and potential profitability of an M&A deal. Higher transaction costs can cut into the returns, reducing the net profit realized from the purchase. Fewer transaction costs can increase the profitability of a transaction; therefore, managing transaction costs is crucial for maximizing the potential profitability of your M&A deal by providing additional tax deductions associated with the purchase of the asset(s).
What are the Major Tax Implications of Transaction Costs?
When determining how to maximize the tax benefits of transaction costs, you must understand the IRS categorizes these expenses and the available deductions for companies that incur transaction costs.
Capitalization: Treasury Regulation §1.263(a)-5 generally requires capitalization of transaction costs for specific types of transactions. These include costs related to:
- Acquisitions of a trade or business
- Changes in the capital structure of a business entity (mergers)
- Other specified transactions, such as transfers of intangible assets or changes in the ownership of copyrights, patents, or intellectual property
- Goodwill can be associated with the “synergies” of a merger and the combined intellectual property obtained after the deal
Bright-Line Date Rule: The exception to capitalization allows the deduction of certain transaction costs incurred before a specific date. Although the date may vary, it typically refers to when the M&A target and acquirer sign a letter of intent or exclusivity agreement. It may also refer to the date when the M&A terms are authorized or approved by the stakeholders in the transaction.
Deductibility: Transaction costs incurred before the bright-line date, which do not directly facilitate a covered transaction, are generally deductible as ordinary and necessary business expenses under Section 162. Taking these allowable deductions reduces your tax liability, resulting in higher profits from the M&A. Deductible costs may include:
- Taxable acquisition of assets constituting a trade or business by the acquirer
- Taxable acquisition of ownership interests in business entities
- Reorganizations under specific sections of the Internal Revenue Code
Capitalization of Inherently Facilitative Costs: Inherently facilitative costs, or costs that directly support or facilitate the M&A transaction, must be capitalized for tax purposes, no matter when they are incurred. These include expenses such as:
- Costs of structuring the transaction
- Document preparation and review
- Appraisal or fairness opinion expenses
- Shareholder or regulatory approval costs
Safe Harbor for Success-Based Fees: Rev. Proc. 2011-29 offers a safe harbor election to treat success-based fees as partially deductible and partially capitalizable. These fees are based on the successful completion of the transaction rather than hourly or retainer fees. They are a simplified approach without extensive analysis under the bright line date rule.
- 70% non-facilitative (deductible) treatment
- 30% facilitative (capitalizable) treatment
Strategies to Maximize Tax Benefits of Transaction Costs
You can work with a tax professional to maximize the potential tax benefits of transaction costs during an M&A to implement effective accounting and tax planning strategies. These approaches may include:
- Transaction Cost Study: Working with an M&A strategy partner to conduct a thorough transaction cost study can help identify costs that qualify for immediate deductions and those that should be capitalized. This analysis involves reviewing the nature and timing of each cost incurred during the transaction process to determine the most favorable tax treatment.
- Timing of Transactions: Timing plays a crucial role in optimizing tax benefits. By strategically structuring transactions, you can align the incurrence of transaction costs with the appropriate tax year. For example, accelerating or deferring certain costs to take advantage of favorable tax rates or deductions. You can also finalize the agreement with all stakeholders to determine the bright-line date within a particular tax year advantageous to the businesses under the agreement.
- Expense Categorization and Tracking: Properly categorizing and tracking transaction expenses is essential for accurate reporting and maximizing deductions. Maintaining detailed records and using appropriate accounting methods helps you identify deductible expenses and support your tax position.
- Capitalizing vs. Expensing: Understanding the capitalization rules and exceptions under the applicable tax regulations is vital to complete tax planning. Differentiating between inherently facilitative costs that must be capitalized and non-inherently facilitative costs that can be deducted as current expenses helps you optimize your tax benefits.
Tax Reporting and Documentation
Properly documenting transactions and complying with tax regulations is crucial for taking advantage of transaction costs and tax benefits. In financial reporting, businesses should consider ASC 740, which provides guidance on U.S. GAAP accounting for income taxes. It requires recognizing, measuring, and disclosing income tax uncertainties related to your tax position. When analyzing the costs associated with an M&A deal, you must include the projections from the analysis in your company’s issued financial statements.
ASC 805 deals with business combinations. This standard helps determine how to recognize and measure assets, liabilities, and goodwill resulting from a transaction. Given the new combination, documenting the allocation of transaction costs among these categories is essential for accurate financial reporting.
For ASC 805 and ASC 740 considerations, working with a professional to ensure compliance with your issued financials is crucial to maintaining confidence in your reporting. The U.S. GAAP experts at Windes can help you with all issues related to ASC 740 and 805 guidelines to ensure a smooth M&A transaction and maximize deductions available for transaction costs.
Maximize Your Tax Benefits With Windes
Understanding and maximizing the tax benefits of transaction costs can impact your business’s bottom line. Your company can optimize its year-over-year tax position by employing transaction cost studies, strategic timing, expense categorization, and understanding applicable capitalization rules.
Navigating the complex tax rules for transactional costs can feel overwhelming. Our advisory team is prepared to assist you in effectively managing your tax planning approach to transaction costs during an M&A transaction. Our experienced professionals can provide guidance tailored to help you maximize tax incentives and see increased profitability.
Contact us today, and let us help you maximize the tax benefits of your transaction costs to ensure your company’s continued success.