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taxes. Currently, 31 international social agreement to terminate a contract for
security agreements, often referred the sale of certain of the taxpayer’s assets.
to as “totalization agreements,” are in The taxpayer deducted the termination
place to address employment and self- fees as ordinary Sec. 162 expenses on its
employment arrangements for social Form 1120, U.S. Corporation Income Tax
security taxation. These agreements are Return. On audit, the IRS sought to dis-
separate from the income tax treaties. allow the deductions and characterize all
U.S. Social Security applies to all U.S. or part of the amounts as capital losses
citizens and residents, whether their under Secs. 165 and 1234A.
work is performed inside or outside the
United States. By virtue of being a U.S. The termination fees and
resident and resident of another country capitalized transaction expenses
while living and working there, an indi- were Sec. 165 losses
vidual may find that he or she has paid In the CCA, the IRS held that the ter-
social security taxes to both countries. mination of the agreements resulted in
In the case of self-employed in- dispositions under Sec. 1001, which gave
dividuals, the applicable totalization rise to losses under Sec. 165 rather than
agreement between the United States to business expenses under Sec. 162.
and the other country should be re- In support of its conclusion, the IRS
viewed to determine which country is cited multiple authorities that require a
entitled to assess social security taxes taxpayer’s facilitative costs to be recov-
on self-employed earnings. Though the termination fees and capitalized transac- ered as Sec. 165 losses if an acquisition
details of each client situation must be tion expenses paid in connection with a is terminated or abandoned (see Rev.
confirmed by reviewing the agreement, terminated merger agreement were capi- Rul. 73-580; Regs. Sec. 1.263(a)-5(l),
often the United States will permit tal losses to the extent the merger prop- Examples (3) and (4); Santa Fe Pacific
an exemption from self-employment erty consisted of capital assets. Generally, Gold Co., 132 T.C. 240 (2009); Federated
taxes where a taxpayer is resident in the such capital losses may only be deducted Department Stores, Inc., 171 B.R. 603
other country and subject to the other by a corporate taxpayer to the extent of (S.D. Ohio 1994); and A.E. Staley Man-
country’s self-employment tax system. In capital gains, with any excess loss carried ufacturing Co., 119 F.3d 482, 490–92
this instance, no self-employment taxes over or back for a limited period. (7th Cir. 1997)).
would be assessed on the individual’s Regs. Sec. 1.263(a)-5(a) generally
federal income tax return. Facts of the CCA requires capitalization of costs that
According to the heavily redacted CCA, facilitate capital transactions, including
Mistakes can be expensive the taxpayer entered into a merger an acquisition of assets that constitute
The U.S. worldwide system of taxing its agreement to acquire the assets of a a trade or business. Significantly, the
citizens and resident aliens creates prob- target entity in an “A reorganization” IRS noted that the regulations under
lems for those who live outside of the under Sec. 368(a)(1)(A). Under the Sec. 263(a) do not require or imply
United States. The rules are complex, arrangement, the taxpayer or target that transaction expenses are deduct-
and foot faults can be expensive. The could terminate the agreement if the ible as Sec. 162 expenses if they are not
better you know the rules, the better you acquisition was not consummated by a required to be capitalized under these
can serve your clients. specified date. In the event a termination regulations as facilitating the transac-
From Kelly Young, CPA, Philadelphia
tion. Rather, the taxpayer must look to
was triggered and certain other circum-
IMAGE BY STEVEN PUETZER/GETTY IMAGES Gains & Losses to pay the target a termination fee. Prior the law to determine the appropriate
stances existed, the taxpayer was required other potentially applicable sections of
treatment of the costs (e.g., capitaliza-
to completion of the transaction, the
taxpayer and target agreed to terminate
tion provisions under Sec. 195, 263(g),
Capital loss rules limit
the merger agreement, and the taxpayer
263(h), or 263A). Accordingly, the IRS
deduction of fees paid to
rejected the taxpayer’s interpretation of
paid the termination fee to the target.
terminate merger agreement
the “mutual exclusivity” rule in Regs.
Additionally, the taxpayer paid a second
Sec. 1.263(a)-5(c)(8). Under this rule,
In Chief Counsel Advice (CCA)
termination fee to another transaction
202224010, the IRS concluded that
October 2022 15
www.thetaxadviser.com party (buyer) pursuant to a separate termination payments are generally