The following article is adapted and reprinted from the M&A Tax Report, Vol. 9, No. 10, May 2001, Panel Publishers, New York, NY.
TO DEDUCT OR CAPITALIZE OPTION DEAL COSTS
By Robert W. Wood, San Francisco In this post-INDOPCO era, it hardly takes a microscope to spot deduction
vs. capitalization issues in any acquisition. One fear is always that a
variety of types of costs will be required to be capitalized rather than
deducted. In the context of stock options that are canceled as part of
the deal (either ISOs or NSOs), one question is whether the payment attributable
to such a cancellation is deductible.
The amount at stake would be the amount of cash or property used
to cancel the options. Assuming that the company issues a W-2 form (treating
the cancellation payment as wages) to each pertinent employee, there is
little question that the payment is properly deductible. Happily, the gremlins
of INDOPCO have apparently not reached this particular area.
Indeed, in a surprising show of largesse, the IRS even has ruled
in letter rulings that the following items can also be deducted notwithstanding
INDOPCO:
a bonus paid to optionholders to compensate them for the loss of ISO
status as a result of the deal; the cancellation of unvested options; the portions of any cancellation payment attributable to a premium paid
for stock of the Target. All these result in deductible expenditures (not capital expenditures).
Of course, don't get carried away with this logic. If the options were
issued as a result of the sale or acquisition of the business, or in connection
with some other transaction that is by its nature capital, then the payments
may not be currently deductible. This is our old friend the origin of the
claims doctrine (which applies in litigation recoveries, among other areas)
raising its head again. See, e.g., U.S. v. Gilmore, 372 U.S. 39 (1963).
To Deduct or Capitalize Option Deal Costs, Vol. 9, No. 10,
M&A Tax Report (May 2001), p. 3.