On May 15, 2020, the IRS released a legal advice memorandum holding that taxpayers may not deduct previously capitalized costs incurred in connection with an Initial Public Offering (IPO) when the corporation later ceases to be a public company. While capitalized IPO costs are written-off in the event of an abandoned IPO,1 the IRS’ view is that once the IPO occurs, the costs are an offset to the stock issuance proceeds.2 The memorandum argues primarily that since the costs offset the proceeds, there is not an asset to write-off, but backstops its disallowance by arguing that a write-off would circumvent section 265.
In the facts of the memorandum, the taxpayer was a privately-held company that incurred various costs in connection with its IPO and capitalized those costs as a separate and distinct asset in the year they were incurred, instead of netting the costs against the proceeds received in the IPO. In the subsequent year, the taxpayer ceased to be a public company and sought to deduct those costs as an abandonment loss under section 165. The taxpayer argued that the U.S. Supreme Court case of Indopco v. Commissioner,3 by holding that costs incurred in an acquisition must be capitalized, overturned the IRS’ historical position regarding IPO costs, because the IPO costs should be viewed as similar to the costs incurred in the purchase of an asset, and therefore capitalized as a separate and distinct asset. However, the Service found that neither Indopco nor the capitalization regulations4 requiring capitalization of the costs are inconsistent with its historical position that costs are capitalized by netting the costs against the proceeds.
The Service further supported its position, pointing to sections 1032 and 265. Pursuant to section 1032 a corporation does not recognize taxable gain or deductible loss upon the exchange (e.g., issuance) of its stock for money or other property, while section 265 provides that no deduction is allowed for any amount otherwise allowable as a deduction and allocable to one or more classes of income (other than interest) that is exempt from taxes. The Service reasoned that by recognizing this benefit of excluding the proceeds from income under section 1032, the taxpayer should not later be allowed to recover the costs through a deduction, because to do so would circumvent the purposes of section 265.
In conclusion, while taxpayers may not fully agree with the IRS’ position, the memorandum serves an important role in confirming the IRS’ view that, outside a worthlessness event for a failed IPO, capitalized IPO costs are not eligible for abandonment or worthlessness since the capitalized costs offset the proceeds from the stock issuance. Further, even if a separate and distinct asset was created, the IRS’ position is that section 265 would disallow a deduction.
1Rev. Rul. 79-2, 1979-1 C.B. 98.
2The Service cites to McCrory Corp. v. United States, 651 F.2d 828 (2d Cir. 1981), Davis v. Comm’r, 151 F.2d 441 (8th Cir. 1945), and Rev. Rul. 79-2 in support of its historical position.
3503 U.S. 79 (1992).
4Reg. section 1.263(a)-5.