In a private letter ruling (PLR 201412002), the IRS ruled that certain costs incurred by a corporate taxpayer to settle a lawsuit, including settlement payments and legal fees, were deductible as ordinary and necessary business expenses under Section 162.
Under the facts of PLR 201412002, the taxpayer (Acquiring), a publicly traded C corporation, acquired all of the outstanding stock of a second publicly traded C corporation (Target) in a stock-for-stock exchange. Acquiring made payments to settle litigation related to alleged securities law violations, including alleged misrepresentations and omissions in securities filings related to the acquisition of Target.
The IRS noted that, in general, a taxpayer must capitalize costs incurred to facilitate a capital transaction. In this instance, however, the litigation related to alleged misrepresentations that occurred after the transaction was consummated and that harmed Acquiring's post-transaction share price. The plaintiffs in the lawsuit did not challenge the amount paid by Acquiring for the Target stock in the transaction itself.
The IRS applied an "origin of the claim" analysis consistent with prior rulings and found that the origin of the settlement payments, legal fees and other payments related to the manner in which and the extent to which Acquiring informed its shareholders about certain aspects of Target in securities filings. As a result, the IRS found that the underlying payments were deductible as ordinary and necessary business expenses under Section 162.
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