Deal termination fees

Termination (or breakup) fees in merger and acquisition agreements are essentially intended to deter parties to a proposed acquisition from backing out of the deal. An acquisition agreement may impose a potential termination fee on the target company or on the acquirer. In many situations, however, the agreement has no provision for any termination fee. Where breakup fees apply, the fee amounts often represent a fixed percentage of the transaction value, generally between 0.5% and 5%.

Capital loss versus ordinary deduction

Capital losses generally be used only to offset capital gains. Ordinary tax deductions are preferable since they can offset nearly any sort of income. The tax benefit resulting from payment of a sizable termination fee as a result typically is less if the fee produces a capital loss rather than an ordinary deduction.

The current IRS view is that the deal termination fee produces a capital loss to the extent it relates to the purchase or sale of a capital asset. For example, corporate stock would be a capital asset to most taxpayers, and the IRS would view a stock purchase agreement breakup fee as a capital loss.

Over time, it seems the IRS changed its approach on this issue. Some years ago, taxpayers typically would claim ordinary deductions for deal breakup fees. That approach was consistent with older IRS rulings concluding that the fees represented ordinary income to the recipient. See LTR 200823012; TAM 200438038.

In 2016, the IRS concluded in ILM 201642035 and in FAA 20163701F that the party paying a breakup fee should treat the fee as a capital loss because section 1234A applied. In 2022, the IRS is adhering to that view in ILM 202224010.

The taxpayer in ILM 202224010 paid termination fees under one agreement under which it would have made an acquisition, and another agreement under which it was on the sell-side. The IRS held that section 1234A applied to both fees and denied the taxpayer’s claimed ordinary deductions.

Section 1234A says that gain or loss is capital in character if it is attributable to termination of a right or obligation with respect to property which is (or would be) a capital asset in the hands of the taxpayer. An ordinary deduction position with respect to termination fee is stronger to the extent that the terminated deal involved an acquisition (or sale) of trade or business assets that would not be capital assets. For example, a terminated acquisition to acquire depreciable (or amortizable) property categorized under the Tax Code as section 1231 assets could result in an ordinary tax deduction for a breakup fee. See, e.g., CRI-Leslie, LLC v. Comm’r, 882 F.3d 1026 (11th Cir. 2018) (forfeited deposit on uncompleted sale of property did not give rise to capital gain under section 1234A).

Conclusion

The IRS is sticking to its view that ordinary tax deductions are not available for termination fees relating to the breakup of an agreement to acquire or sell capital assets. Any acquirer or seller required to pay a termination fee should not assume that it is entitled to the tax benefit or an ordinary deduction. Instead, the character of any fee deduction should be closely considered in consultation with tax advisors.

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This article was written by Nick Gruidl and originally appeared on Aug 31, 2022.
2022 RSM US LLP. All rights reserved.
https://rsmus.com/insights/services/business-tax/deal-breakup-fees-result-in-capital-losses-irs-concludes.html

The information contained herein is general in nature and based on authorities that are subject to change. RSM US LLP guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. RSM US LLP assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein. This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer.

RSM US Alliance provides its members with access to resources of RSM US LLP. RSM US Alliance member firms are separate and independent businesses and legal entities that are responsible for their own acts and omissions, and each are separate and independent from RSM US LLP. RSM US LLP is the U.S. member firm of RSM International, a global network of independent audit, tax, and consulting firms. Members of RSM US Alliance have access to RSM International resources through RSM US LLP but are not member firms of RSM International. Visit rsmus.com/aboutus for more information regarding RSM US LLP and RSM International. The RSM(tm) brandmark is used under license by RSM US LLP. RSM US Alliance products and services are proprietary to RSM US LLP.

Estate planning should be done when you have acquired assets that you don’t want to default to state law distribution rules and the public probate process. More specifically, multigenerational wealth planning should be implemented to carry out your goals for multiple future generations in a manner that protects your assets, provides for your family, and reduces estate and income taxes.

Given that assets, tax policy, and family dynamics commonly change over time, adhering to the following do’s and don’ts can help you account for such changes and provide flexibility within the plan. 

Do

1.     Plan for yourself before you plan for others. Take inventory of your assets and income, and plan for your needs first. You and your spouse should enjoy the ability to live comfortably. Then, thoughtfully process whom you believe would be the best beneficiary of each of the assets that may be in excess of or remain from you and your spouse’s lifetime needs. Make sure to remember digital and intangible assets and any debt associated with an asset or your estate.

2.     Focus on goals first. There are several different planning strategies available. Focus first on your goals that prioritize your family and charitable intentions. Then, your advisors may better tailor a plan to achieve your goals with the added benefit of tax savings.

3.     Start early. The estate and gift tax exemption is scheduled to be reduced in 2026. The exemption allows for each individual to gift during their lifetime or hold in their estate an inflation-adjusted amount tax-free. For 2022, that amount is $12,060,000; but it will be cut in about half on January 1, 2026.

In addition, each year an individual may gift to another individual up to $16,000 without it going against the exemption amount. Taking advantage of higher exemption levels and additional years of annual exclusion gifting now creates large tax savings and increased wealth preservation for your family.

Because of this, top tax, legal and valuation firms are already seeing professional capacity constraints to complete implementation of complex planning designs. Waiting may prevent sufficient professional resources to carry out the most effective estate planning options to achieve your family goals.

4.     Plan for estate tax liquidity. Think through which assets may be needed to pay any estate tax liability and if the remaining distribution is still balanced among beneficiaries in a manner that demonstrates your overall intent. Keep in mind your family structure and dynamics and any charitable intent.

5.     Communicate. Work to instill in your family a continuation of your lifetime beliefs that you incorporate into your plan, and try to set them up for success. This communication gives your heirs an understanding of your intent behind your estate plan, an increased ability to strive to have them grow your initiatives in their unique way, and may reduce any potential family discord.

6.     Carefully consider trustees. Trustee duties usually include substantial tax and legal implications and require distribution decisions. Some individuals may not hold the skill set or the desire to be in charge of these responsibilities.

Individual trustees should be selectively appointed to ensure they are able and willing to carry out your intentions in a manner that is consistent with trust tax and legal requirements. If a corporate trustee is appointed, the firm should be reviewed based on their asset holdings, industry knowledge, and fee competitiveness. 

Don’t

1.     Be pressured. While communication is an important step of the process and you may consider the viewpoints of other family members, make sure that the ultimate distribution decisions reflect your beliefs for what is in the best interests of your family. Don’t be pressured to change distribution provisions for your assets based on what others want.

2.     Copy friends and family. Your plan should be specific to you. Don’t assume that your estate plan should look like your friends’ and family’s plans. Everyone’s circumstances are different, and your advisors will help guide you based on your particular goals, assets and family.

3.     Procrastinate. Don’t let the required thoughtfulness of planning prevent you from implementing your estate plan, or it may cost your family significantly, either through taxes or discord during estate administration due to the uncertainty of your wishes.

Once you start the process, the relief of knowing that your family will know your wishes and that your plan will be upheld will significantly outweigh the initial work to establish your estate plan. When a plan is in place, maintenance is usually limited to compliance and periodic updates due to tax or family changes.

RSM is here to advise you and your family through the process by answering any questions, offering solutions, and helping implement a plan design that is tailored to meet your goals, provide for your family and reduce the tax burden for you and future generations.

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This article was written by Andy Swanson, Rebecca Warren , Abbie Everist and originally appeared on 2022-08-05.
2022 RSM US LLP. All rights reserved.
https://rsmus.com/insights/services/private-client/multigenerational-wealth-planning-a-guide-to-dos-and-donts.html

The information contained herein is general in nature and based on authorities that are subject to change. RSM US LLP guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. RSM US LLP assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein. This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer.

RSM US Alliance provides its members with access to resources of RSM US LLP. RSM US Alliance member firms are separate and independent businesses and legal entities that are responsible for their own acts and omissions, and each are separate and independent from RSM US LLP. RSM US LLP is the U.S. member firm of RSM International, a global network of independent audit, tax, and consulting firms. Members of RSM US Alliance have access to RSM International resources through RSM US LLP but are not member firms of RSM International. Visit rsmus.com/aboutus for more information regarding RSM US LLP and RSM International. The RSM(tm) brandmark is used under license by RSM US LLP. RSM US Alliance products and services are proprietary to RSM US LLP.