IRS’s Denial of a Late Safe Harbor Election Is an Odd Misstep

Timing is everything in the world of tax. Missing deadlines can trigger interest, penalties, uncaptured tax benefits, and cash flow issues—not to mention employee stress and confusion.

It’s usually possible to mitigate the effects of a missed deadline by requesting a private letter ruling to obtain Section 9100 relief for the late filing of certain regulatory elections. The tax benefits from a favorable ruling generally make up for the steep associated costs of filing a PLR request.

Take the case of a missed Rev. Proc. 2011-29 70% safe harbor election. These elections must be filed with and reflected on a timely filed original—that is, not amended—federal income tax return. When properly made, they allow taxpayers to take as a current deduction 70% of any success-based fee paid in connection with certain types of business acquisitions and dispositions.

Success-based fees are typically the most significant cost incurred in a transaction. As such, many taxpayers take the PLR route if an election is late. Historically, the outcomes of the requests have been routine, but a ruling earlier this year gave one taxpayer an unpleasant surprise.

Request Denial

In PLR 202308010, a taxpayer received an insult to injury when the IRS ruled that it wasn’t eligible to make the election in the first place.

The taxpayer’s situation was like that of many other companies up for sale: It hired and retained a financial advisory firm to assist it with strategic alternatives in a success-based fee arrangement. The taxpayer was a wholly owned subsidiary of a corporation that was majority-owned by a private equity investment fund. Upon a successful sale of the parent corporation, the fund paid the financial advisory firm the fee, with the expectation that the taxpayer would make the 70% safe harbor election.

In explaining its denial of the taxpayer’s request for late filing relief, the IRS asserted that Section 1.263(a)-1(e) of the regulations was the controlling regulation, not Section 1.263(a)-5, because the fee represented the fund’s cost of selling property—that is, parent stock—and “only indirectly or incidentally related to Taxpayer’s business activity.”

Accordingly, the fee couldn’t be analyzed under the Section 1.263(a)-5 provisions, which instruct that “an amount required to be capitalized by §1.263(a)-1, §1.263(a)–2, or §1.263(a)–4 does not facilitate a transaction described in paragraph (a) of this section.”

PLR Applicability

PLR 202308010 would be a less bitter pill to swallow if the IRS solely had relied on the fund having paid the fee to deny the taxpayer’s eligibility for the 70% safe harbor election, given the unsettled area of tax law regarding payments made for other taxpayers and the proximate beneficiary concept.

However, the IRS went further when it rejected the taxpayer’s request also on the basis that the fee was “only indirectly or incidentally related” to its business.

The type of covered transaction in the PLR was a Section 1.263(a)-5(e)(3)(ii) transaction. It’s a taxable acquisition of an ownership interest in a business entity if, immediately after the acquisition, the acquirer and the target are related within the meaning of Sections 267(b) or 707(b) of the tax code. The parameters of this covered transaction don’t mention any requirement that a target show a particular transaction cost is directly or more than incidentally related to its business activity.

Section 1.263(a)-5(e)(3)(ii) of the regulations presumably doesn’t impose such a requirement on targets, because a taxpayer incurring a transaction cost in its capacity as a target itself implies that such a cost is directly or more than incidentally related to its business. Moreover, if Treasury intended to limit targets’ qualification under Section 1.263(a)-5(e)(3)(ii) transaction treatment, its decision to include a target as eligible taxpayers—without further qualification—would be nonsensical.

This is why PLR 202308010 could be read as merely a ruling about a taxpayer claiming a right to deduct or capitalize a cost that was paid by another taxpayer. It has no bearing on other taxpayer-targets described in Section 1.263(a)-5(e)(3)(ii) covered transactions that pay or incur their own transaction costs.

Lesson Learned

The key takeaway of PLR 202308010 is the importance of timely made elections. The 9100 late filing relief regulations do provide a safety net for missed elections, but not when used by the IRS to discredit a well-established tax position on which scores of similarly situated taxpayers rely. Let’s hope this ruling is an anomaly and that future IRS guidance will confirm the validity of tax positions such as the taxpayer in the PLR.

This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.

Author Information

Carolyn Linkov is a principal and the leader of Eide Bailly’s national tax office’s mergers and acquisitions group. She advises mid-size corporations on federal income tax aspects of reorganizations, spin-offs, asset sales, equity transactions, and entity restructurings.