In PLR 201741011, the IRS determined a taxpayer's safe harbor election for success-based fees under Section 4.01 of Revenue Procedure 2011-29 (safe harbor election) was not valid because the taxpayer's federal income tax return associated with the election was not timely filed. Accordingly, the IRS granted the taxpayer an extension of time to make the safe harbor election, concluding that the taxpayer acted reasonably and in good faith, and granting the extension would not prejudice the government's interests.

Facts

Taxpayer is the parent of an affiliated group that elected to join in the filing of consolidated federal income tax returns (Taxpayer's Consolidated Group). On Date 1, another corporation acquired all of Taxpayer's outstanding stock, causing Taxpayer's Consolidated Group to terminate. The acquisition was a covered transaction described in Treas. Reg. Section 1.263(a)-5(e)(3).

Taxpayer paid or incurred success-based fees under Treas. Reg. Section 1.263(a)-5(f) in the short tax year ended Date 1 in connection with the acquisition. Taxpayer failed to timely file its US federal income tax return for the short tax year ended Date 1 (short tax year return). In the PLR, the IRS states, "since Taxpayer's [short tax year return] was not timely filed, the safe harbor election of Section 4 of Revenue Procedure 2011-29 for the success-based fees associated with the tax return was not timely filed."

Law and analysis

Section 4.01 of Revenue Procedure 2011-29 sets forth a safe harbor election for taxpayers that pay or incur success-based fees for services performed in investigating or pursuing a covered transaction under Treas. Reg. Section 1.263(a)-5(e)(3). Under the safe harbor, instead of maintaining the documentation required by Treas. Reg. Section 1.263(a)-5(f), taxpayers "may elect to allocate a success-based fee between activities that facilitate the transaction and activities that do not facilitate the transaction." Taxpayers must treat 70% of the amount of the success-based fee as an amount that does not facilitate the transaction and capitalize the remaining 30% as an amount that facilitates the transaction.

Taxpayers must attach a statement to their "original federal income tax return" for the tax year in which the success-based fee is paid or incurred, stating that they are electing the safe harbor, identifying the transaction and stating the success-based fees that are deducted and capitalized.

The IRS concluded that Taxpayer acted reasonably and in good faith, and that granting relief will not prejudice the Government's interests. Therefore, the IRS determined that the requirements of Treas. Reg. Sections 301.9100-1 and 301.9100-3 were met and granted Taxpayer a 45-day extension from the date of the ruling to file the mandatory statements required by Section 4.01 of Revenue Procedure 2011-29.

Implications

The IRS's assertion that the safe harbor election was not timely filed because the associated tax return was not timely filed is noteworthy. There is no timeliness requirement in Section 4.01 of Revenue Procedure 2011-29, which requires a taxpayer to attach "a statement to its original federal income tax return for the [tax] year the success-based fee is paid or incurred" (emphasis added). The PLR is difficult to reconcile with the plain language of Revenue Procedure 2011-29, which only references an originally filed tax return. It does not require the originally filed tax return to be timely filed.

In PLR 201741011, the IRS may have taken the view that, despite the language in Revenue Procedure 2011-29, all elections to be effective must be included on a timely filed original return. Alternatively, because taxpayers can elect the safe harbor in lieu of maintaining the documentation required by Treas. Reg. Section 1.263(a)-5(f), it may be that the IRS implicitly incorporated by reference the requirement of Treas. Reg. Section 1.263(a)-5(f) that the "documentation must be completed on or before the due date of the taxpayer's timely filed original federal income tax return (including extensions) for the [tax] year during which the transaction closes" (emphasis added). One may debate the IRS's ability to take such an approach given that the election in Revenue Procedure 2011-29 does in fact constitute its own, independent rule. Yet another alternative is that the IRS, in the spirit of customer service, determined that it was most appropriate to provide the taxpayer with a formal PLR to remediate the error of its tax advisor. Given these various possibilities, it is difficult to say with certainty how taxpayers should address an untimely but original return on which the safe harbor election is made.

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