Deductibility of legal expenses in corporate reorganizations.

In this case, the bank also divested itself of all its nonbanking assets in order to comply with the
Bank Holding Company Act of 1956. The dominant aspect in this instance, the courts reasoned, was
the partial liquidation and not the recapitalization.
Similarly, certain involuntary divisive reorganizations have received the approval of the courts.
Generally, legal and professional fees, including accounting fees, associated with a divisive
reorganization, such as a spin-off, are nondeductible (DuPont de Nemours & Co., 694 F2d 703 (D.C.
If a corporation can establish that no future benefit was produced, such expenditures would be
currently deductible business expenses. All rights reserved. 1951-1 CB 3; Doernbecher
Manufacturing Co., 30 BTA 973 (1934), acq. For instance, in Transamerica Corp., 392 F2d 522 (9th
Cir. The dominant aspect was the partial liquidation; any technical reorganization of the corporate
structure was incidental.
Conversely, in Bilar Tool & Die Corp., 530 F2d 708 (6th Cir. The deductibility of reorganization
expenses, for example, has been litigated a number of times and has resulted in diverse outcomes.
1968), a case involving a Sec. Reorganization expenses or expenses incurred to effectuate a
corporate restructuring, even if not technically under the guise of Sec. 1982), aff'g, mod'g and rem'g
Cl. Cir. 1968), a bank was allowed to deduct fees (including legal fees, transfer fees, printing costs
and other expenses associated with the distribution of a subsidiary's stock). Reasons cited for
nondeductibility are that such expenses are not ordinary or usual in the life of a corporation
(Missouri-Kansas Pipe Line Company, 148 F2d 460 (3d cir.
Legal and professional fees, including accounting fees, are frequently incurred at various stages of
corporate life--at the commencement or acquisition of the corporate entity, during the course of
daily corporate business, when reorganizing or restructuring and, ultimately, at liquidation. 1935-1
CB 6; Rev. This is good news, but frequently difficult for corporations to prove.
Consistent with this interpretation by the courts, professional expenses incurred in acquisitive
reorganizations are generally viewed as nondeductible because they provide a continuing benefit to
the reorganized or successor corporation and are capital in nature (Woodward, 397 US 572 (1970)).
In INDOPCO, Inc., 112 Sup. Existing assets and rights were merely preserved or protected or the
scope of corporate activities contracted. As in Transamerica, this transaction was treated as a partial
liquidation; expenses incurred to effectuate the spin-off, including accounting fees, were allowed as
a current deduction under Sec. This was despite the fact that the split-off was performed specifically
to comply with a governmental requirement to remedy an antitrust situation.
Sometimes a corporate division/separation can involve both the creation and distribution of stock in
a new corporation. In cases involving the disposition of a subsidiary forced by a court ruling (or
change of law or regulation), the transferor corporation has been allowed to deduct expenses. 1978),
rev'g and rem'g 62 TC 213 (1974), a division was held to be a corporate reorganization rather than a
partial liquidation, when the taxpayer corporation's assets and business were divided between two
equal shareholders. 368(d) reorganization (spinoff). 162. Crum, CPA, Ostrow Reisin Berk & Abrams,
Ltd., Chicago, Ill.
COPYRIGHT 1994 American Institute of CPA's
No portion of this article can be reproduced without the express written permission from the
copyright holder.
Copyright 1994, Gale Group. The corporation divested itself of its banking assets tax free by
transferring them to a new corporation in exchange for stock which was then distributed to
shareholders.
It was similarly ruled in General Bancshares Corp., 388 F2d 184 (8th Cir. Since the reorganization
plan was arranged to produce two viable corporations, the expenses incurred in carrying out the
division (including legal expenses) were nondeductible capital expenditures; they added to the value
of the capital structure of both the original corporation and the successor corporation.
The courts have also allowed "reorganization" expenses when a proposed reorganization was later
abandoned (Sibley, Linsay & Curr Co., 15 TC 106 (1950), acq. 73-580 and 77-204). When a partial
liquidation is accompanied by a recapitalization or reorganization, the transaction "is to be viewed
as a whole and its dominant aspect is to govern the tax character of the expenditures" (Mills Estate,
Inc., 17 TC 910 (1951), rev'd in part, 206 F2d 244 (2d Cir. 67-125). per curiam, a natural gas
pipeline company was entitled to current deductions for legal, accounting, consulting and related
services in order to comply with an antitrust decree requiring it to divest itself of part of its assets.
Ct. And liquidation expenses, exclusive of costs relating to the sale of assets properly charged
against sales proceeds, are deductible as ordinary and necessary business expenses.
Depending on the facts and circumstances, the application of the provisions on the tax treatment of
corporate professional fees can be very complex. 1962). In Dupont, a non-pro rata split-off, the court
ruled that the taxpayer continued the corporate business in a different form and that the expenses
resulted in a benefit that could be expected to produce returns for many years in the future. 162
business expenses. Cir. If the corporate taxpayer did not acquire a capital asset or change the
capital structure as a result of the transaction, but merely preserved or protected existing assets and
rights or contracted the scope of its activities, the transaction may be considered the equivalent of a
partial liquidation rather than a reorganization of the corporate structure.
This reasoning, coupled with the "dominant aspect" theory, was applied in Gravois Planing Mill Co.,
299 F2d 199 (8th Cir. Familiarity with the relevant Code provisions is a necessary prerequisite to
strategic tax planning in this area.
With few exceptions, the deductibility of professional fees begins and ends with Sec. In El Paso, of
three different proposals for corporate reorganization, the taxpayer was able to adopt the last one;
therefore, the other two were not deemed to be abandoned. 1945)) or that such expenses are capital
in nature as they provide a continuing benefit to the surviving corporation (Mid-State Products, Co.,
21 TC 696 (1954)).
Additionally, reorganization expenses have been held nondeductible if they contribute to creating or
enhancing a long-term asset (the corporation) or produce significant benefits lasting beyond the
current tax year (Rev. When the amounts of these fees are significant, their deductibility (or
nondeductibility) can become an important tax consideration. Gale Group is a Thomson Corporation
Company.
. Proper documentation will prove helpful when determining whether tax rulings or advice received
can be deducted currently. If reorganization plans are later abandoned, this should be clearly
documented in the corporate minutes to better support the deductibility of related expenditures.
From Cynthia A. This division was accomplished by transferring half of the corporate assets to a new
corporation in exchange for stock held by one of the existing shareholders. 162. 263 capital
expenditures are generally deductible Sec. 1039 (1992), aff'g 918 F2d 426 (3d Cir. In determining
whether such expenditures produce future benefits or enhance corporate assets, courts have
focused on certain factors--the type of expense, the relationship and proximity of the expense to the
reorganization, the person who incurred the expense, the form and structure of the particular
transaction, whether the transaction was completed and the ability of the taxpayer claiming the
deduction to reasonably identify to which phase of the reorganization proceedings the expenditures
relate and for whose benefit the expenditures were incurred.
The courts have been slightly more receptive to the deductibility of reorganization expenses
incurred to effectuate a tax-free divisive reorganization. Ruls. 1953)). Rul. Conversely, expenses
incurred to organize a subsidiary corporation, obtain Federal approval of corporate operations and
obtain IRS rulings that the transfers of property constituted a tax-free reorganization were required
to be capitalized.
These decisions have been largely based on the fact that the taxpayer did not acquire an asset or
change the capital structure as a result of the transaction or produce a future benefit for the
corporation. 1990), a deduction for expenses incurred by a target corporation acquired in a
transaction (not a reorganization) was denied; the expenses could be expected to produce a benefit
to the corporation that extended beyond the year in which they were incurred. In contrast, in Sibley,
there was no corporate subsidiary organized for later use as part of the adopted plan of
reorganization.
It is important to structure an anticipated reorganization correctly and to plan the timing of its
execution appropriately in order to take full advantage of the deductibility of any professional
expenses, including legal and accounting fees. Typically, new organizational expenses are
nondeductible but amortizable; any remaining expenses (attributable to stock distribution) are
subject to the general capitalization rules. 248, organizational expenses incurred incident to the
creation of a corporation may be amortized over 60 months or more. If a corporation makes an
election under Sec. In a divisive reorganization, a currently existing corporation splits up or spins off
some of its assets into a new corporation; the remaining assets are retained by the corporation in
existence prior to the division. Although this theory has been extended to reorganization expenses, a
valuable exception appears to have resulted. However, in certain cases involving spin-offs, the
courts have ruled that the transferor corporation may deduct costs to complete the divisive
reorganization when the costs were not involved in the issuance of stock or the creation of a new
corporation. The court ruled, however, that the expenses incurred in creating a change in name
were nondeductible because they were incurred to create a capital asset--the corporate name.
In El Paso co., 694 F2d 703 (Fed. Professional fees incurred in the ordinary course of business that
do not fall within the realm of Sec. Ct. In any reorganization, taxpayers should take steps to secure
detailed invoices for legal and accounting services provided. 368, are usually nondeductible. 1982)).
Legal fees and other expenses incurred by a corporation in connection with a partial liquidation
were deductible as ordinary and necessary business expenses, even though there was a change in
the corporate structure (reduction in stated capital) and continuing corporate activity