IRS rules INDOPCO does not require employee bonuses be capitalized.

The employer in Letter Ruling (TAM) 9527005 underwent a leveraged buyout (LBO). As a result of the LBO, employees were forced to exercise outstanding incentive stock options (ISOs). Because the employees' ISO stock was immediately cashed out as part of the LBO, they suffered "disqualifying dispositions" of their stock, causing them to be taxed on the option spread as ordinary income rather than as capital gains (which would have been the case had they held their stock for one to two years after exercise of the option). Consequently, the employer gave bonuses to affected employees to cover any extra taxes. On audit, an IRS field agent took the position that the employer had to capitalize the bonus payments because they were related to the LBO. The agent relied on INDOPCO, 112 Sup. Ct. 1039 (1992), in which the Supreme Court held that professional fees incurred as part of a friendly takeover must be capitalized because of the significant longerm benefits of the business combination. The IRS National Office declined to apply INDOPCO to the employee bonuses. Rather, the Service ruled that the payments were deductible because they arose from a longstanding employer-employee relationship. The IRS position in this ruling is similar to sits position in Letter Ruling (TAM) 9326001, which held that golden parachute payments did not have to be capitalized as part 6of the merger that triggered the payments; they arose from a long-standing employment relationship and did not have their origin in the merger.

From Barbara J. Young, J.D. Washington, D.C.