Matter & Substance
  December 7, 2021

Important Tax Changes for the Search Fund Community

On August 23, 2021, a ruling was made by the Tax Court that may have a significant impact on how entrepreneurs treat expenses incurred during the search phase.

An Examination of Estate of Morgan v. Comm'r of Internal Revenue

 In Estate of Morgan v. Comm'r of Internal Revenue, the Tax Court ruled searching for a business is not recognized as an active trade or business. Therefore, all related expenses within that search fall within Section 195 as “start-up expenses,” not within Section 162, which allows the current deduction of expenses paid or incurred on any trade or business.

What Does This Mean for Me?

 Historically, some taxpayers took the position that expenses incurred during the search phase should be deductible under Section 162, giving investors the benefit of tax deductions.

However, this recent ruling may change our approach. While the facts of Estate of Morgan v. Comm'r of Internal Revenue are not identical to those experienced by the entrepreneurship through acquisition (ETA) community, we do believe this case should be considered in analyzing future tax positions taken for search funds.

For 2021 and beyond, expenses may need to be capitalized instead of deducted as they are incurred. If a fund acquires a business, then most search expenses would be amortized over a period of fifteen years under this approach.

We're Here to Help

The outcome of Estate of Morgan v. Comm'r of Internal Revenue means search funds may need to adjust how investor K-1s are prepared. This may have an immediate impact on your tax planning for your investment holdings.

We encourage you to reach out to your M&S Advisor about this change so that you may understand if and how it will impact your specific situation.

As things continue to evolve, we will be here to guide you through any changes or questions. Our office has started to reopen, and all clients can now safely join us in person if desired. We will also continue to offer remote meeting options. We will ensure your tax planning needs are met on a timely basis.