Tax Treatment of Merger & Acquisition Costs

Jim Moran, Senior Manager, and Tabitha Lamontagne, Principal, Tax Practice
September 2017

Over the last several years, there has been an uptick in mergers and acquisitions among banks. As part of these deals, substantive costs are incurred to complete the transactions. Usually under US Generally Accepted Accounting Principles, these costs are expensed as incurred. However, for tax purposes, the IRS has written elaborate rules to help determine whether an expenditure can be expensed vs. capitalized, and has separate rules for the following categories of expenditures:

  • Facilitative,
  • Integration,
  • Success-based,
  • Debt finance, and
  • Non-compete based.

Facilitative Costs

The IRS requires taxpayers to capitalize amounts paid to facilitate a business acquisition or reorganization transaction. An amount is a facilitative cost if the amount is paid in the process of investigating or otherwise pursuing the transaction. Typical facilitative costs would include

  • appraisals and valuations,
  • negotiating the terms or structure of the acquisition,
  • tax advice on the acquisition,
  • application fees, bidding costs, or similar expenses,
  • preparing the bid, offer, or purchase agreement,
  • obtaining regulatory approval of the acquisition, and
  • finders’ fees or brokers’ commissions, including contingency fees

However, an exception to the general rule for capitalization is made if the activities are performed before what is known as the “bright-line” date. The bright-line date is defined as the earlier of (1) the date on which a letter of intent, exclusivity agreement, or similar written communication (other than a confidentiality agreement) is executed; or (2) the date on which the material terms of the transaction (as tentatively agreed to by representatives of the acquirer and the target) are authorized or approved by the taxpayer’s board of directors.

It is important to note that in an asset acquisition (as opposed to a stock transaction) these costs are allocated to the assets purchased, and can be depreciated or amortized over the life of the assets acquired.

Integration Costs

An amount paid to integrate the business operations of the taxpayer with the business operations of another is not considered a facilitative cost, regardless of when the integration activities occur. Examples of deductible integration costs include costs to:

  • relocate personnel and equipment,
  • provide severance benefits to terminated employees,
  • integrate records and information systems,
  • prepare new financial statements for the combined entity, and
  • reduce redundancies in the combined business operations.

Success-based Fees

An amount that is contingent on the successful closing of a transaction (“success-based fee”) is presumed to facilitate the transaction (and therefore must be capitalized). The IRS has provided a safe harbor election, however, that allows taxpayers making the election to deduct 70% of the success-based fee and capitalize the remaining 30%.

Debt Finance Costs

Under the regulations, costs incurred to facilitate a borrowing are treated as amounts that do not facilitate any other transaction. Thus, these costs can be amortized over the life of the loan.

Covenants Not to Compete

Covenants not to compete that are entered into in connection with the acquisition of a trade or business must be amortized over 15 years, even though the life of the contract may be significantly shorter.

Significant tax savings could potentially be permanently lost if deductible transaction costs are not separated from the costs that must be capitalized. Therefore it is important to identify and account for acquisition/reorganization costs carefully, and obtain sufficient documentation in advance to classify these costs. By doing so, you can maximize your tax deductions.

If you have any questions, please contact Jim Moran, Tabitha Lamontagne, or your BNN tax professional at 1.800.244.7444.

Disclaimer of Liability: This publication is intended to provide general information to our clients and friends. It does not constitute accounting, tax, or legal advice; nor is it intended to convey a thorough treatment of the subject matter.