Loan fees in LBOs.

In a leveraged buyout (LBO), the debt incurred to finance the payments to the target company's shareholders almost always is assumed by the target company. The Internal Revenue Service treats the transaction as a redemption--the target company is considered to have redeemed its own stock.

For redemption treatment, Internal Revenue Code section 162(k) disallows a deduction for amounts paid by a corporation in connection with the reacquisition of its own stock, including loan acquisition costs and advisory fees. Accordingly, these expenses, normally deducted through amortization over the term of the loan, would not be deductible at all. In Fort Howard v. the Commissioner (107 TC no. 12, 1996), the Tax Court supported the IRS's position.

Now, under the Small Business Job Protection Act of 1996, Congress has overturned the IRS's position. Moreover, it has done so retroactively to the 1986 inception of section 162(k). Loan fees and other amounts properly allocable to indebtedness can be amortized over the term of the loan notwithstanding IRC section 162(k).

Observation: In the case of Fort Howard and for other taxpayers in this situation, loan fees can be deducted in an LBO without a challenge by the IRS.

--Robert Willens, CPA, managing director at Lehman Brothers, New York City.