Avoiding the “Mutually Exclusive” Deal Trap

It's important to understand what the IRS says about deal transaction costs with respect to pursuing more than one strategy.
Robert WillensJune 21, 2010

Whether or not your company is ready to jump into a new restructuring deal, it’s prudent to examine how the Internal Revenue Service views transaction costs, especially with regard to “mutually exclusive” transactions. Consider a case in which a U.S. corporation (USCorp) hires a consultant to provide advice with respect to “restructuring.”

For three months starting in January, USCorp investigates a variety of proposals to restructure its business. The officers and board look into (1)  maintaining the status quo, (2) a leveraged recapitalization or full recapitalization with a spin-off of the “lesser business divisions”, and (3) the divestiture of the lesser business divisions by means of either an offering of “tracking” stock, or an initial public offering (IPO) and a split-off or spin-off.

On April 9, the board of USCorp votes to eliminate consideration of maintaining the status quo and of a recapitalization, and as of that date, only the divestiture proposal remained under active consideration. About two months later, on June 1, the board votes to eliminate consideration of a spin-off or a tracking stock offering, leaving only an IPO with a split-off under consideration.

Drive Business Strategy and Growth

Drive Business Strategy and Growth

Learn how NetSuite Financial Management allows you to quickly and easily model what-if scenarios and generate reports.

Another months passes, and USCorp completes an IPO its subsidiary Alpha Co, which files a statement with the Securities and Exchange Commission covering a split-off. But within a short time after that, USCorp abandons the split-off, and not long after, the board approved a spin-off. Finally, by the end of the year, the spin-off of Alpha Co is completed.

The IRS auditor examining USCorp’s income tax return contends that the various proposals were mutually exclusive. Accordingly, the auditor maintains that the costs of investigating and pursuing all of the proposals must be capitalized as part of the transactions actually completed. USCorp balks, claiming that the various proposals were not mutually exclusive, and therefore it is entitled to a tax deduction, under the Internal Revenue Code (Section 165) for the costs of any proposals that were abandoned.

Willens 06-21-10.

Single Divestiture Transaction

If a taxpayer investigates and pursues multiple separate transactions, costs properly allocable to any abandoned transactions are deductible even if some transactions are completed.1 By contrast, if the proposals are mutually exclusive alternatives only one of which can be completed, then no abandonment loss is proper unless the entire transaction is abandoned. Indeed, the costs of pursuing any alternatives not consummated must be capitalized as part of the cost of the completed alternative.2  The national office of the IRS, in a Technical Advice Memo (LTR 200749013, August 14, 2007) awarded each of the auditor and the taxpayer – USCorp — a partial victory.

The national office agreed with USCorp that options 2 and 3 —  a leveraged or full recapitalization and a spinoff, respectively — were not mutually exclusive and that USCorp could have engaged in some type of recapitalization and one or more of the divestiture transactions. As a result, USCorp is entitled to a deduction for costs associated with the recapitalization because there is “clear evidence” of abandonment when the board voted to eliminate consideration of the option on April 9.

However, the facts amply demonstrate that USCorp pursued a single divestiture transaction beginning on June 1. Accordingly, on June 1, USCorp pursued only one divestiture option that included an IPO and split-off.

However, USCorp did not complete the split-off, and the company claims that it abandoned the split-off and “went back to the drawing board” and reconsidered all of its divestiture options. The IRS did not see things quite that way.

The national office said that it believed that the more accurate description is that USCorp (merely) modified the divestiture transaction, from a split-off to a spin-off, and completed the spin-off less than two months later. Accordingly, the National Office concluded that USCorp pursued a single divestiture transaction, beginning on June 1, which consisted of (1) the transfer of assets and liabilities by USCorp to its subsidiary Alpha Co, (2) an IPO of the stock of Alpha Co, (3) consideration and pursuit of a split-off and, finally (4) reconsideration and pursuit of a spin-off.

Therefore, the IRS concluded that any costs in consideration or pursuit of an IPO, split-off, andspin-off must be capitalized as part of the restructuring that was eventually accomplished.

Contributor Robert Willens, founder and principal of Robert Willens LLC, writes a weekly tax column for


1 See Sibley, Lindsay & Curr Co. v. Commissioner, 15 T.C. 106 (1950).
2 See United Dairy Farmers, Inc. v. United States, 267 F.3d 510 (6th Cir. 2001).