June 04, 2012 The Tax Lawyer

West Covina Motors, Inc. v. Commissioner: The Limits of Section 1060’s Fair Market Value Limitations

Vol. 65, No. 1 - Fall 2011

Chelsea Hunt Overhuls

Abstract

    On December 16, 2009, the United States Tax Court issued a surprising opinion when it held that the legal fees incurred in an applicable asset acquisition were not consideration and therefore not subject to section 1060’s fair market value limitations. In West Covina Motors, Inc. v. Commissioner (West Covina II), West Covina, a Dodge dealership and corporate taxpayer, acquired the assets of a Chevrolet dealership under an agreement that stipulated the cost of each asset. As a consequence of consummating the agreement, the Chevrolet dealership incurred acquisition-related legal fees, which the taxpayer paid. Additionally, the taxpayer paid its own legal fees pertaining to the acquisition, document review, and other inventory financing services. The taxpayer deducted these legal fees on its Federal Income Tax Return. Subsequently, the Service examined the taxpayer’s return and determined a deficiency on the basis that the legal fees relating to an applicable asset acquisition must be allocated according to the fair market value limitations of section 1060. The Service argued that under the residual value method of section 1060, the legal fees should be allocated to goodwill and going concern value. However, the Tax Court held that because the parties had stipulated the cost of each asset and the legal fees were not consideration, section 1060 did not apply. Instead, the Tax Court held that the legal fees should be allocated pro rata among the assets acquired under the purchase agreement.

    This Note will argue that the legal fees incurred by West Covina were consideration under section 1060. Moreover, this Note will demonstrate that the Tax Court erred by failing to explain the new regulation regarding transaction costs. Part II will give a brief overview of section 1060 and describe the general allocation procedures contained in the regulations. Part III will provide the facts of the case in detail and present the two separate West Covina II holdings. Part IV will describe the temporary regulations effective at the time of the West Covina acquisition and demonstrate that the West Covina II court failed to apply those regulations. Specifically, this Part will argue that the legal fees incurred by West Covina were consideration subject to section 1060’s fair market value limitations. Additionally, Part IV will explain how the final regulations that would control a current acquisition implement a more practical and precise rule for the future.

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