Acquiring Companies May No Longer Get Deductions for Options and SARs Held by Target Company Employees

In general legal advice memorandum (GLAM) AM 2012-010 (January 31, 2013), the IRS ruled that acquiring companies will generally not be eligible to take a tax deduction for the spread on stock options exercised pursuant to a change in control. Instead, the deduction would be recorded by the target. The GLAM looked at situations with a short tax year. Under existing practice, the acquirer was able to take a deduction if the deduction was deemed applicable to the next day after the transaction closed. That is important because deductions to the acquirer have fewer limits in a merger, sale, or consolidation than deductions recorded by the target.

In the GLAM, which applied to a specific situation with a triangular merger, the IRS reasoned that the expense (including advisory fees) really was an obligation incurred by the target, and moving the date one day forward or back to change the timing of the deduction was form over substance. While GLAMs do not have legal force, they do indicate IRS reasoning on an issue that may arise in other contexts.

The issue is explained in more detail in a useful article by Todd Reinstein and Ellen McElroy of Pepper Hamilton.