Rev. Rul. 67-125

Advice has been requested whether legal fees incurred by a corporation in securing advice on the Federal tax consequences of the following transactions before they are consummated can be deducted as ordinary and necessary business expenses under section 162 of the Internal Revenue Code of 1954: (1) A merger, (2) a stock split, and (3) a proposed distribution in redemption of outstanding stock under section 302 of the Code (which distribution would not qualify as a partial liquidation under section 346 of the Code).

The legal fees in this case were incurred in connection with the merger of one corporation into another, followed by a split of the stock of the surviving corporation. It was also proposed that the surviving corporation would distribute property acquired in the merger in redemption of a portion of its stock to meet certain anticipated conditions in connection with the future operations of the surviving corporation. Since these conditions did not materialize, the planned redemption was tentatively abandoned for the year of the merger and the stock split. However, no final decision has been made as to whether the redemption will be made or finally abandoned.

Section 162(a) of the Code allows as a deduction all the ordinary and necessary business expenses paid or incurred during the taxable year in carrying on a trade or business. Section 263 of the Code precludes a deduction for capital expenditures.

It is well established that expenditures incident to the alteration of the capital structure of a corporation are to be capitalized. See Mills Estate, Inc. v. Commissioner , 206 Fed.2d 244 (1953), and Missouri-Kansas Pipe Line Co. v. Commissioner , 148 Fed.2d 460 (1945). Thus, legal fees incurred for services performed in drafting a corporate merger agreement are to be capitalized as incident to the reorganization since the effect of a merger is to change the capital structure of the surviving corporation.

The basic question then in this case is whether the legal fees incurred for tax advice on the corporate activities involved are considered to be incident to the alternation of the corporation's capital structure or are ordinary and necessary business expenses.

The probable tax consequences resulting from various kinds of reorganizations or other changes in a corporation's capital structure are instrumental in determining the type of reorganization or other change in the capital structure of the corporation. Thus, legal fees for advice as to the tax significance of a particular type of reorganization are considered to be just as necessary in effecting a reorganization as those for the actual drafting of the reorganization agreement. See Standard Linen Service, Inc. v. Commissioner , 33 T.C. 1 (1959), acquiescence, C.B. 1960-2, 7.

The split of the stock of the surviving corporation and the proposed redemption of a portion of its stock operate to change the capital structure of the corporation for a period of indefinite duration. Thus, the legal fees incurred for tax advice on these transactions represent expenditures incident to the change of the capital structure of the surviving corporation. However, if the taxpayer can subsequently establish that it has made a final decision not to carry out the redemption, the costs attributable to the proposed redemption may be deducted in the taxable year in which such a decision was made. See Doernbecher Manufacturing Co. v. Commissioner , 30 B.T.A. 973 (1934), acquiescence, C.B. XIII-2, 6 (1934), appealed on other grounds.

Accordingly, the legal fees incurred prior to the transaction in securing advice on the tax consequences of the merger, stock split, and proposed distribution in redemption represent capital expenditures incurred in connection with the change of the capital structure of the surviving corporation and are therefore not deductible as ordinary and necessary business expenses. However, in the event the proposed redemption of stock is subsequently abandoned, the capitalized fees attributable to such proposed redemption are deductible in the taxable year of abandonment.