Contract Cancellation Payments
The IRS action is described in a “technical advice memorandum,” or ruling, that the agency released in March. The ruling is TAM 200512021.
Inability to deduct a cancellation payment makes terminating a contract more expensive. As a general rule, payments to get out of a contract can be deducted, but not if the payment is to modify the contract or replace it with another agreement. In the case under audit, a company entered into a merger agreement to be sold to a suitor, but later changed its mind after receiving a better offer from another suitor. It paid to terminate the original merger agreement and signed a new agreement to be bought by the new suitor. The IRS said the termination payment could not be deducted as it was a cost of the new agreement.