IRS Says Breakup Fee Is Taxable

A spurned bidder that receives a breakup fee may be well advised to just take the money and move on – without trying some fancy tax tricks to juice up the payment. That is the apparent warning from the IRS, which recently shot down an effort by a losing bidder to take the fee without paying taxes on it. The service ruled in a Technical Advice Memorandum that the fee represented ordinary income and was taxable. In the case, reported by Robert Willens, a Managing Director and corporate tax expert at Lehman Brothers, two companies agreed to merge but the target was given the right to shop the bid. A third company apparently outbid the original suitor, sealed the agreement, and paid the breakup fee. The losing bidder claimed it should not include the breakup fee in its gross income because it represented “replacement of capital” destroyed or injured, or a return of capital. The opposing view, which the IRS took, is that the fee constitutes “damages for lost profits,” which is a function of ordinary income. Besides categorizing the fee as taxable income, Willens said, the IRS added contract law principles to support its denial. He said the service ruled that “the fee provided for expectancy damages,'” which are “equated with lost profits, and there is ample authority to support the proposition that a recovery for loss of anticipated profits is simply ordinary income.” Copyright 2004 Thomson Media Inc. All Rights Reserved. http://www.thomsonmedia.com http://www.majournal.com