IRS gives an S corporation 60 days to make a late safe-harbor election for success-based transaction fees

Plain-English summary

A holding company taxed as an S corporation paid "success-based fees" (fees contingent on a deal closing) to an advisor in connection with a business acquisition and reorganization. Under the capitalization rules (section 263(a) and Treas. Reg. § 1.263(a)-5), success-based fees are presumed to facilitate the transaction and must be capitalized rather than deducted, unless the taxpayer documents otherwise. Rev. Proc. 2011-29 offers a safe harbor: a taxpayer can elect to treat 70 percent of a success-based fee as non-facilitative (and currently deductible) by attaching an election statement to a timely filed original return. The taxpayer's advisor failed to advise making that election, so the taxpayer capitalized the entire fee and attached no statement. After discovering the omission, the taxpayer asked the IRS for an extension of time under the "9100 relief" regulations. Because the taxpayer reasonably relied on a professional who failed to advise the election and relief would not prejudice the government, the IRS granted an extension of 60 days from the date of the ruling to file an amended return making the safe-harbor election.

Ruling snapshot

• Question: Should the IRS grant an extension of time to make the Rev. Proc. 2011-29 safe-harbor election for success-based fees, where the taxpayer's advisor failed to advise making it?
• Outcome: Approved (9100 relief granted; 60 days from the ruling to elect the safe harbor on an amended return)
• Key authorities: Treas. Reg. §§ 301.9100-1, 301.9100-3; Rev. Proc. 2011-29, 2011-1 C.B. 746; IRC § 263(a); Treas. Reg. § 1.263(a)-5; INDOPCO, Inc. v. Commissioner, 503 U.S. 79 (1992)

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 202148001 Third Party Communication: None
Release Date: 12/3/2021 Date of Communication: Not Applicable
Index Number: 9100.00-00
Person To Contact:
---------------------------------------- ------------------, ID No. -----------------
----------------------------------------------------- Telephone Number:
----------------------------- ---------------------
Refer Reply To:
Attn: ------------------------------------ CC:ITA:B03
PLR-105283-21
In Re: ----------------------------------------- Date:
----------------------------------- September 03, 2021

                         TY: ---------------------------------------------------

LEGEND:

Taxpayer = -----------------------------------------------------------------
Entity A = -------------------------
Entity B = ------------------------------------
Entity C = --------------------------------------
Entity D = --------------------------
Advisor = ---------------------
State = -------------
x = ---------------------------------------------------------------------------------
------------------------------------------------------------------------------------------------------------
------------------
Date 1 = --------------------------
Date 2 = -------------------------
Date 3 = --------------------------
Date 4 = --------------------------
n1 = -----
n2 = -------------

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

This responds to a letter ruling request dated March 3, 2021, submitted on behalf of
Taxpayer. Taxpayer requests an extension of time under sections 301.9100-1 and
301.9100-3 of the Procedure and Administration Regulations to make a late election
concerning the treatment of success-based fees in accordance with Rev. Proc. 2011-
29, 2011-1 C.B. 746, which requires that a statement be attached to Taxpayer's original
federal income tax return for the taxable year ending on Date 1.
PLR-105283-21 2

                                     FACTS

Taxpayer represents that the facts are as follows:

Taxpayer is a limited liability company formed under the laws of State. Taxpayer is a
holding company that, through its operating subsidiaries, is engaged in the business of
x. For U.S. federal income tax purposes, Taxpayer has elected to be treated as an S
corporation.

Entity A was an S corporation. On Date 2, Taxpayer became the owner and parent
company of Entity A pursuant to a tax-free reorganization described in section
368(a)(1)(F) of the Internal Revenue Code (Code). Entity A then changed its legal form
to limited liability company. On Date 3, Taxpayer formed Entity B and contributed all
outstanding membership interests in Entity A to Entity B in exchange for n1% of the
membership interests in Entity B. After this contribution, Entity B gained another
member owner. This addition effectuated a partnership for U.S. federal income tax
purposes. On Date 4, Taxpayer sold a portion of its membership interest in Entity B to
Entity C.

Taxpayer represents that immediately after this transaction, the parties were related
within the meaning of sections 267(b) or 707(b) of the Code. Taxpayer also represents
that the transaction is a covered transaction under section 1.263(a)-5(e)(3)(ii) of the
Income Tax Regulations.

During the taxable year ending on Date 1, Taxpayer paid $n2 in success-based fees to
Entity D for services performed in the process of investigating or otherwise pursuing this
transaction. Taxpayer represents that its payment of these fees was contingent upon
the successful closing of the transaction as described in section 1.263(a)-5(f).

Taxpayer engaged Advisor to prepare its U.S. federal income tax return for the taxable
year ending on Date 1. Taxpayer represents that it relied on Advisor to advise Taxpayer
of all relevant elections that should be made on its return. Advisor, however, failed to
advise Taxpayer to elect to apply the safe harbor set forth in Rev. Proc. 2011-29 with
respect to the success-based fees described above. Consequently, Taxpayer
capitalized these fees on its return and did not include an election statement pursuant to
Rev. Proc. 2011-29. Taxpayer discovered its failure to make this election after filing its
tax return and subsequently engaged Advisor to prepare this request.

                                      LAW

Section 263(a) of the Code provides generally that no deduction is allowed for any
amount paid out for new buildings or for permanent improvements or betterments made
to increase the value of any property or estate or any amount expended in restoring
property or in making good the exhaustion thereof for which an allowance is or has
been made. Section 1.263(a)-1(d)(3) of the Income Tax Regulations provides that no
deduction is allowed for an amount paid to acquire or create an intangible, which under
PLR-105283-21 3

sections 1.263(a)-4(c)(1)(i) and 1.263(a)-4(d)(2)(i)(A) includes an ownership interest in a
corporation or other entity. See also section 1.263(a)-4(a).

In the case of an acquisition or reorganization of a business entity, costs that are
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 (1992);
Woodward v. Commissioner, 397 U.S. 572, 575-576 (1970).

Under section 1.263(a)-5, a taxpayer must capitalize an amount paid to facilitate a
business acquisition or reorganization transaction described in section 1.263(a)-5(a). In
general, an amount is paid to facilitate a transaction described in section 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. Section 1.263(a)-
5(b)(1).

Section 1.263(a)-5(f) provides that an amount that is contingent on the successful
closing of a transaction described in section 1.263(a)-5(a), or success-based fee, is
presumed to facilitate the transaction. A taxpayer may rebut the presumption by
maintaining sufficient documentation to establish that a portion of the fee is allocable to
activities that do not facilitate the transaction. This documentation must be completed
on or before the due date of the taxpayer's timely filed original federal income tax return
(including extensions) for the taxable year during which the transaction closes.

To reduce controversy between the IRS and taxpayers over the documentation required
to allocate success-based fees between the activities that facilitate the transaction and
activities that do not facilitate the transaction, the IRS issued Rev. Proc. 2011-29. The
revenue procedure states that the IRS would not challenge a taxpayer's allocation of a
success-based fee between activities that facilitate a transaction described in section
1.263(a)-5(e)(3) and activities that do not facilitate the transaction if the taxpayer --

(1) treats 70 percent of the amount of the success-based fee as an amount that does
not facilitate the transaction; and

(2) capitalizes the remaining 30 percent as an amount that does facilitate the
transaction; and

(3) attaches 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.

The revenue procedure applies to covered transactions described in section 1.263(a)-
5(e)(3), which include --
PLR-105283-21 4

(i) A taxable acquisition by the taxpayer of assets that constitute a trade or business;

(ii) A taxable acquisition of an ownership interest in a business entity (whether the
taxpayer is the acquirer in the acquisition or the target of the acquisition) if, immediately
after the acquisition, the acquirer and the target are related within the meaning of
section 267(b) or section 707(b); or

(iii) A reorganization described in section 368(a)(1)(A), (B), or (C) or a reorganization
described in section 368(a)(1)(D) in which stock or securities of the corporation to which
the assets are transferred are distributed in a transaction which qualifies under section
354 or 356 (whether the taxpayer is the acquirer or the target in the reorganization).

Sections 301.9100-1 through 301.9100-3 of the Procedure and Administration
Regulations provide the standards the Commissioner uses to determine whether to
grant an extension of time to make a regulatory 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 section
301.9100-2.

Section 301.9100-1(b) defines the term "regulatory election" as an election whose due
date is prescribed by a regulation published in the Federal Register, or a revenue ruling,
procedure, notice or announcement published in the Internal Revenue Bulletin.

Section 301.9100-1(c) provides that the Commissioner may grant a reasonable
extension of time to make a regulatory election, or a statutory election (but no more than
six months except in the case of a taxpayer who is abroad) under all subtitles of the
Internal Revenue Code except subtitles E, G, H and I.

Section 301.9100-3(a) provides extensions of time to make a regulatory election under
Code sections other than those for which section 301.9100-2 expressly permits
automatic extensions. Requests for extensions of time for regulatory elections will be
granted when the taxpayer provides evidence (including affidavits described in the
regulations) to establish to the satisfaction of the Commissioner that the taxpayer acted
reasonably and in good faith, and granting relief will not prejudice the interests of the
government.

Section 301.9100-3(b)(1) states that a taxpayer will be 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-105283-21 5

(iii) failed to make the election because, after exercising due diligence, 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.

Under section 301.9100-3(b)(3), a taxpayer will not be considered 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 section 6662 at the time the taxpayer requests relief (taking
into account section 1.6664-2(c)(3)) 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.

If specific facts have changed since the original deadline that make the election
advantageous to a taxpayer, the Service will not ordinarily grant relief.

Section 301.9100-3(c)(1) provides that the Commissioner will grant a reasonable
extension of time only when the interests of the Government will not be prejudiced by
the granting of relief. Section 301.9100-3(c)(1)(i) provides, in part, that the interests of
the government are prejudiced if granting relief would result in the 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)(ii) provides, in part, that 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 on
assessment under section 6501(a) before the taxpayer’s receipt of a ruling granting
relief.

                                         ANALYSIS

Taxpayer's election is a regulatory election, as defined under section 301.9100-1(b),
because the due date of the election is prescribed in the Income Tax Regulations under
section 1.263(a)-5(f). The Commissioner has the authority under sections 301.9100-1
and 301.9100-3 to grant an extension of time to file a late regulatory election.
PLR-105283-21 6

Taxpayer represents that for federal income tax purposes, the transaction was a taxable
sale of membership interest. Thus, immediately after the transaction, the parties were
related within the meaning of sections 267(b) or 707(b). The transaction thus qualifies as
a covered transaction described in section 1.263(a)-5(e)(3)(ii).

Taxpayer in this case has represented that it requested relief before the failure to make
the regulatory election was discovered by the Service and that it reasonably relied on a
qualified tax professional, and the tax professional failed to make, or advise Taxpayer to
make, the election. Thus, under sections 301.9100-3(b)(1)(i) and (v), Taxpayer will be
deemed to have acted reasonably and in good faith. Taxpayer has also represented
that none of the circumstances listed in section 301.9100-3(b)(3) apply.

Based on the facts of the case Taxpayer provided, granting an extension of time to file
the election will not prejudice the interests of the government under section 301.9100-
3(c)(1). Taxpayer has represented that granting relief would not result in a lower tax
liability in the aggregate for all taxable years affected by the election than Taxpayer
would have had if the election had been timely made (taking into account the time value
of money). Furthermore, Taxpayer has represented that the taxable year in which the
regulatory election should have been made and any taxable years that would have been
affected had it been timely made, are not closed by the period of assessment.

                                 CONCLUSION

Based solely on the facts submitted and the representations made, we conclude that
Taxpayer acted reasonably and in good faith, and that granting the request will not
prejudice the interests of the government. Accordingly, the requirements of §§
301.9100-1 and 301.9100-3 have been satisfied.

Accordingly, Taxpayer is granted an extension of time until 60 days following the date of
this ruling to file an amended return for the tax year ending Date 1 electing safe harbor
treatment of its success-based fees under section 4.01(3) of Rev. Proc. 2011-29. The
amended return must include an election statement stating that Taxpayer is electing the
safe harbor for success-based fees, identifying the transaction, and stating the success-
based fee amounts that are deducted and capitalized.

The rulings contained in this letter are based upon information and representations
submitted by the 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 rulings, it is subject to verification on examination.

Except as expressly provided herein, no opinion is expressed or implied concerning the
federal income tax consequences of any aspect of any transaction or item discussed or
referenced in this ruling including whether Taxpayer properly included the correct costs
as its success-based fees subject to the election, or whether Taxpayer’s transaction
was within the scope of Rev. Proc. 2011-29.
PLR-105283-21 7

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

A copy of this ruling must be attached to any income tax return to which it is relevant.
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 representative. We are also sending a copy of this letter
to the appropriate operating division director. Enclosed is a copy of the letter ruling
showing the deletions proposed to be made in the letter when it is disclosed under
section 6110 of the Code.

                                   Sincerely,



                                   Jamie J. Kim
                                   Senior Technician Reviewer, Branch 3
                                   Office of the Associate Chief Counsel
                                   (Income Tax & Accounting)

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