Partnership received extra time for success-based fee safe harbor election

Plain-English summary

A partnership paid a success-based fee in a transaction that transferred a controlling interest in the partnership. The fee was omitted from the books and records sent to the return preparer, so the partnership's short-year return did not report the fee or make the safe harbor election under Revenue Procedure 2011-29. The IRS found that the partnership acted reasonably and in good faith and that a late election would not prejudice the government. It granted 60 days to amend the return, treat 70 percent of the fee as not facilitating the transaction, capitalize the remaining 30 percent, and attach the required election statement. The ruling did not decide whether the transaction or all claimed fees otherwise qualified for the safe harbor.

Ruling snapshot

• Question: Could the partnership make a late safe harbor election for its success-based transaction fee?
• Outcome: Approved. The partnership received a 60-day extension to amend its return and make the 70/30 allocation election.
• Key authorities: IRC § 263; Treas. Reg. §§ 1.263(a)-5 and 301.9100-1 through 301.9100-3; Rev. Proc. 2011-29

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 201908013 Third Party Communication: None
Release Date: 2/22/2019 Date of Communication: Not Applicable
Index Number: 9100.00-00, 263.14-00
Person To Contact:
--------------------------------------------------------- -----------------------, ID No. -------------------
-------------------------- ---------------------------------------------------
------------------------------- Telephone Number:
----------------------
Refer Reply To:
CC:ITA:B01
PLR-116931-18
Date:
November 16, 2018

Legend

Taxpayer = ---------------------------------------------------------
A = --------------
B = -----------------------------------
C = -------------------------------------------
D = --------------------------------
E = ----------------------------------------------------------
F = -----------------------
G = -------------------------------------------------
H = --------
J = --------
K = --------------------------------
L = -----
M = ------------------------------------------------------------------------------------------------
N = ---------
O = ------------------------------------------
P = ----------------------------------------------------
Q = -------------------------
R = -------------------------------
Products = ------------------------------------------------------------------------------------------------
-----------
Date 1 = --------------------
Date 2 = --------------------------
Date 3 = ----------------------------------------
Date 4 = --------------
Date 5 = -------------------
Date 6 = --------------------------
Date 7 = --------------------------
Date 8 = --------------------------
PLR-116931-18 2

Date 9 = ----------------------

Dear ---------------:

This letter responds to your correspondence, dated ----------------------, requesting an
extension of time under §§ 301.9100-1 and 301.9100-3 of the Procedure and
Administration Regulations to make the safe harbor election for success-based fees
provided in Section 4 of Rev. Proc. 2011-29, 2011-18 I.R.B. 746. Section 4 requires a
taxpayer, on its original federal income tax return for the year of the election, to: (1)
allocate 70 percent of its success-based fees to activities that do not facilitate the
transaction at issue and 30 percent to activities that do facilitate that transaction and (2)
attach a statement setting forth, among other items, that the taxpayer is making the
election.

                                       FACTS

Taxpayer is a limited liability company formed under the laws of A on Date 1. Taxpayer
employs an accrual method of accounting and has a taxable year ending on Date 2.
Since Date 3, Taxpayer has been treated as a partnership, for federal tax purposes and
has filed its federal income tax returns on Form 1065. Throughout its short taxable year
ending on Date 5, Taxpayer owned L percent of B, C, D, and E, all single member
limited liability companies.

Also, throughout the short taxable year ending on Date 5, holding company B, C, D. and
E were in the business of designing, manufacturing, and selling Products. During this
time, B, C, D, and E were disregarded entities for federal income tax purposes, and
Taxpayer reported their activities directly on its federal income tax return.

On Date 4, C engaged F to assist in the sale of Taxpayer or its assets. In exchange for
F’s services, F was entitled to a success-based fee, calculated as a flat fee plus a
percentage of the value for which Taxpayer was sold over a threshold amount. The
success-based fee was payable only upon the successful sale of Taxpayer (whether
through a sale of Taxpayer or its assets).

G emerged as a potential purchaser of Taxpayer. At that time G held no interest in
Taxpayer. On Date 5, G acquired a controlling interest in Taxpayer through the direct
and indirect acquisition of H percent of Taxpayer’s equity interests (the “Transaction”)
pursuant to an agreement and plan of merger entered into by and among G, Taxpayer,
and certain other parties. G acquired a direct J percent membership interest in
Taxpayer by purchasing membership interests from existing members. G accomplished
this by merging its subsidiary, K, a disregarded entity, into Taxpayer with existing
members of Taxpayer receiving cash consideration in exchange for their interests. As
part of the Transaction, G acquired L percent of the stock of M. M owned N percent of
PLR-116931-18 3

Taxpayer immediately before and after the Transaction. Thus, G obtained H percent of
Taxpayer’s overall capital and profits interests pursuant to the Transaction.

The transfer of all funds was settled at closing, including the O owed to F. The funds
and expenses were paid by Taxpayer and ultimately reduced the sale proceeds paid to
P and to the selling members. Because J percent of Taxpayer’s capital and profits
interest was transferred to G in the Transaction on Date 5, Taxpayer represents its
existence terminated pursuant to § 708(b)(1)(B) of the Internal Revenue Code. As a
result, Taxpayer’s taxable year ended on Date 5.

Pursuant to the merger agreement, the sellers’ member representative (Sellers’
Representative) would file all tax returns required of Taxpayer for periods on or before
Date 5. Sellers’ Representative engaged Q to prepare Taxpayer’s tax return for the
short taxable year ending on Date 5. The Sellers’ Representative provided Taxpayer’s
books and records to Q. However, the Sellers’ Representative failed to include in the
books and records, or in any other documentation, provided to Q, the success-based
fee paid to F. On Date 6, Q timely filed Taxpayer’s federal income tax return for its
taxable year ending on Date 5 by the extended due date, but the return did not reflect
the O success-based fee.

M and the direct sellers received their final Schedules K-1 from Taxpayer on or around
Date 7. R, as M’s tax preparer, reviewed M’s final Schedule K-1 on Date 8 and noted
that the income reported was significantly higher than anticipated. M then contacted
Taxpayer’s controller who ultimately determined on Date 9 that no portion of the O
success-based fee had been taken into account on Taxpayer’s tax return.

                                       LAW

Section 263(a)(1) and § 1.263(a)-2(a) of the Income Tax Regulations provide that no
deduction shall be allowed for any amount paid out for property having a useful life
substantially beyond the taxable year. In the case of an acquisition or reorganization of
a business entity, costs incurred in the process of acquisition and that produce
significant long-term benefits must be capitalized. INDOPCO, Inc. v. Commissioner, 503
U.S. 79, 89-90, 112 S. Ct. 1039, 117 L. Ed. 2d 226 (1992); Woodward v. Commissioner,
397 U.S. 572, 575-576, 90 S. Ct. 1302, 25 L. Ed. 2d 577 (1970).

Under § 1.263(a)-5(a), a taxpayer must capitalize an amount paid to facilitate the
business acquisition or reorganization transactions described in § 1.263(a)-5(a). In
general, an amount is paid to facilitate a transaction described in § 1.263(a)-5(a) if the
amount is paid in the process of investigating or otherwise pursuing the transaction.
Whether an amount is paid in the process of investigating or otherwise pursuing the
transaction is determined based on all of the facts and circumstances. See § 1.263(a)-
5(b)(1).
PLR-116931-18 4

Section 1.263(a)-5(f) provides that an amount paid that is contingent on the successful
closing of a transaction described in § 1.263(a)-(5)(a) (i.e., a success-based fee) is
presumed to facilitate the transaction. A taxpayer may rebut this presumption by
maintaining sufficient documentation to establish that a portion of the fee is allocable to
activities that do not facilitate the transaction.

Section 4.01 of Rev. Proc. 2011-29 provides a safe harbor election for taxpayers that
pay or incur success-based fees for services performed in the process of investigating
or otherwise pursuing a covered transaction described in § 1.263(a)-5(e)(3). In lieu of
maintaining the documentation required by § 1.263(a)-5(f), a taxpayer may elect to
allocate a success-based fee between activities that facilitate the transaction and
activities that do not facilitate the transaction by treating 70 percent of the amount of the
success-based fee as an amount that does not facilitate the transaction and by
capitalizing the remaining 30 percent as an amount that does facilitate the transaction.
In addition, the taxpayer must attach a statement to its original federal income tax return
for the taxable year the success-based fee is paid or incurred, stating that the taxpayer
is electing the safe harbor, identifying the transaction, and stating the success-based
fee amounts that are deducted and capitalized.

Section 301.9100-1(c) provides that the Commissioner has discretion to grant a
reasonable extension of time under the rules set forth in §§ 301.9100-2 and 301.9100-3
to make certain regulatory elections. Section 301.9100-1(b) defines a "regulatory
election" as an election whose due date is prescribed by a regulation published in the
Federal Register, or a revenue ruling, revenue procedure, notice or announcement
published in the Internal Revenue Bulletin.

Sections 301.9100-1 through 301.9100-3 provide the standards the Commissioner will
use to determine whether to grant an extension of time to make an election. Section
301.9100-2 provides automatic extensions of time for making certain elections. Section
301.9100-3 provides extensions of time for making elections that do not meet the
requirements of § 301.9100-2.

Section 301.9100-3(a) provides that requests for relief under § 301.9100-3 will be
granted when the taxpayer provides evidence to establish to the satisfaction of the
Commissioner that the taxpayer acted reasonably and in good faith and that granting
relief will not prejudice the interests of the government.

Section 301.9100-3(b)(1) provides that a taxpayer is deemed to have acted reasonably
and in good faith if the taxpayer:

          (i)    requests relief before the failure to make the regulatory election is
                 discovered by the Service;
          (ii)   failed to make the election because of intervening events beyond
                 the taxpayer’s control;

PLR-116931-18 5

         (iii)   failed to make the election because, after exercising reasonable
                 diligence (taking into account the taxpayer’s experience and the
                 complexity of the return at issue), the taxpayer was unaware of the
                 necessity for the election;
         (iv)    reasonably relied on the written advice of the Service; or
         (v)     reasonably relied on a qualified tax professional, including a tax
                 professional employed by the taxpayer, and the tax professional
                 failed to make, or advise the taxpayer to make, the election.

Section 301.9100-3(b)(3) provides that a taxpayer will not be deemed to have acted
reasonably and in good faith if the taxpayer:

         (i)     seeks to alter a return position for which an accuracy-related
                 penalty has been or could be imposed under § 6662 at the time the
                 taxpayer requests relief, and the new position requires or permits a
                 regulatory election for which relief is requested;
         (ii)    was informed in all material respects of the required election and
                 related tax consequences, but chose not to file the election; or
         (iii)   uses hindsight in requesting relief.

Section 301.9100-3(c)(1) provides that an extension of time to make a regulatory
election will be granted only when the interests of the government are not prejudiced by
the granting of relief. The interests of the government are prejudiced if granting relief
would result in a taxpayer having a lower tax liability in the aggregate for all taxable
years affected by the election than the taxpayer would have had if the election had been
timely made (taking into account the time value of money). Section 301.9100-3(c)(1)(i).

The interests of the government are ordinarily prejudiced if the taxable year in which the
regulatory election should have been made or any taxable years that would have been
affected by the election had it been timely made are closed by the period of limitations
under § 6501(a) before the taxpayer’s receipt of a ruling granting relief under §
301.9100-3.

Section 301.9100-3(c)(2) provides special rules for accounting method regulatory
elections. The interests of the government are deemed to be prejudiced except in
unusual and compelling circumstances if the accounting method regulatory election for
which relief is requested:

         (i)     is subject to the procedure set forth in § 1.446-1(e)(3)(i) of this
                 chapter (requiring advance written consent of the Commissioner);
         (ii)    requires an adjustment under § 481(a) (or would require an
                 adjustment under § 481(a) if the taxpayer changed to the method of
                 accounting for which relief is requested in a taxable year

PLR-116931-18 6

                 subsequent to the taxable year in which the election should have
                 been made);
         (iii)   would permit a change from an impermissible method of accounting
                 that is an issue under consideration by examination, an appeals
                 office, or a federal court and the change would provide a more
                 favorable method or more favorable terms and conditions than if
                 the change were made as part of an examination; or
         (iv)    provides a more favorable method of accounting or more favorable
                 terms and conditions if the election is made by a certain date or
                 taxable year.

                                   ANALYSIS

Taxpayer’s election is a regulatory election, as defined in § 301.9100-1(b), because the
due date of the election is prescribed in § 1.263(a)-5(f). The Commissioner has the
authority under §§ 301.9100-1 and 301.9100-3 to grant an extension of time to file a late
regulatory election.

The information provided and representations made by Taxpayer establish that
Taxpayer acted reasonably and in good faith. Taxpayer requests relief before the
failure to make the regulatory election is discovered by the Service, and taxpayer
reasonably relied on Q to prepare its short year return. Moreover, Taxpayer is not
seeking to alter a return position for which an accuracy related penalty has been or
could be imposed under § 6662 at the time relief is requested. Taxpayer did not
affirmatively choose not to make the election after having been informed in all material
respects of the required election and related tax consequences. Taxpayer is not using
hindsight in requesting relief.

Further, based on the information provided and representations made by Taxpayer,
granting an extension will not prejudice the interests of the government. The Taxpayer
will not have a lower tax liability in the aggregate for all taxable years to which the
election applies than Taxpayer would have had if the election had been timely made. In
addition, the taxable year in which the regulatory election should have been made and
any taxable years that would have been affected by the election had it been timely
made will not be closed by the period of limitations on assessment under § 6501(a)
before Taxpayer’s receipt of the ruling granting an extension of time to make a late
election.

                                 CONCLUSION

Based solely on the information provided and representations made, we conclude that
Taxpayer acted reasonably and in good faith, and granting relief will not prejudice the
interests of the government. Accordingly, the requirements of §§ 301.9100-1 and
301.9100-3 have been met.
PLR-116931-18 7

Taxpayer is granted an extension of 60 days from the date of this ruling to file an
amended return for its taxable year ending on Date 5, reflecting 70 percent of the O
success-based fee as an amount that does not facilitate the transaction and capitalizing
the remaining 30 percent of the success-based fee as an amount that does facilitate the
transaction. Taxpayer must also attach the mandatory statement to its return, as
required by section 4.01 of Revenue Procedure 2011-29. The mandatory statement
must state that Taxpayer is electing the safe harbor for success-based fees, identify the
transaction, and state the success-based fee amounts that are deducted and
capitalized.

The ruling contained in this letter is based upon information and representations
submitted by Taxpayer and accompanied by a penalty of perjury statement executed by
an appropriate party. While this office has not verified any of the material submitted in
support of the request for this ruling, it is subject to verification on examination.
Except as expressly provided herein, no opinion is expressed or implied concerning the
tax consequences of any aspect of any transaction or item discussed or referenced in
this letter. In particular, no opinion is expressed as to whether Taxpayer properly
included the correct costs as its success-based fees subject to the retroactive election,
or whether Taxpayer's transaction was within the scope of Rev. Proc. 2011-29.

This ruling is directed only to the taxpayer requesting it. Section 6110(k)(3) provides
that it may not be used or cited as precedent.

A copy of this letter must be attached to Taxpayer’s federal tax returns for the tax years
affected. Alternatively, taxpayers filing their returns electronically may satisfy this
requirement by attaching a statement to their return that provides the date and control
number of the letter ruling.

In accordance with the Power of Attorney on file with this office, a copy of this letter is
being sent to your authorized representatives.

                                   Sincerely,


                                   Sean M. Dwyer
                                   Senior Technician Reviewer, Branch 1
                                   (Income Tax & Accounting)

Enclosure:
Copy of letter