The IRS has directed examiners in the Large and International Business (LB&I) Division not to challenge a taxpayer's treatment of eligible milestone payments under certain conditions (LB&I 04-0413-002). The new directive applies only for the amounts deducted on original timely filed returns, and not for claims, whether formal or informal.

In Rev. Proc. 2011-29, the IRS provided 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. IRS Chief Counsel subsequently determined in CCA 201234027 that nonrefundable milestone payments that are creditable to a success-based fee are not, themselves, success-based fees and would not qualify for the Rev. Proc. 2011-29 safe harbor. According to Chief Counsel, nonrefundable milestone payments, unlike success-based fees, are not contingent on the successful closing of the transaction.

Background

In Rev. Proc. 2011-29, the IRS provided 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. Under Rev. Proc. 2011-29, a taxpayer may 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. The IRS subsequently instructed examiners (Directive LB&I 04-0511-012) not to challenge a taxpayer's treatment of success-based fees paid or incurred in a covered transaction in tax years ended before April 8, 2011, where the taxpayer's original return position is to capitalize the fees in an amount of at least 30 percent of the total success-based fees incurred by the taxpayer with respect to the covered transaction.

Eligible milestone payments

The new directive applies to eligible milestone payments. The term eligible milestone payment means a milestone payment paid for investment banking services that is creditable against a success-based fee.

New directive

IRS examiners will not challenge a taxpayer's treatment of its eligible milestone payments if the taxpayer satisfies certain conditions:

For tax years ended on or after April 8, 2011:

Treatment of eligible milestone payment incurred in a transaction for which the taxpayer elects the Rev. Proc. 2011-29 safe harbor: The taxpayer must have qualified for and timely elected the safe harbor for the covered transaction; (2) not have deducted more than 70 percent of any eligible milestone payment incurred in connection with the respective success-based fee on its original tax return for the year in which the taxpayer's liability for the eligible milestone payment accrued; and (3) not be contesting its liability for the eligible milestone payment.

Treatment of eligible milestone payment incurred in tax years before taxpayer can elect the safe harbor: In instances where a covered transaction spans multiple years, a taxpayer may make eligible milestone payments in tax years preceding the tax year in which the success-based fee would be paid (and, therefore, also preceding the tax year in which the taxpayer could qualify for and timely elect the safe harbor if the transaction successfully closes). The taxpayer must satisfy (2) and (3) above; and have documented that in the year in which the eligible milestone payments were made, the taxpayer intended to elect Rev. Proc. 2011-29 with regard to the respective success-based fee, and if the transaction successfully closed, have in fact made the Rev. Proc. 2011-29 election for the success-based fee that was paid or incurred.

For tax years ended before April 8, 2011:

The taxpayer's return position must meet the requirements of LB&I Directive 04-0511-012 with regard to success-based fees paid or incurred in tax years ended before April 8, 2011, and the taxpayer must satisfy (2) and (3) above.

If you have questions regarding eligible milestone payments, please contact your local CBIZ MHM tax professional.

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