CONTRACT CANCELLATION PAYMENTS can normally be deducted, but the IRS told one US company on audit that it had to treat such a payment as a cost of a new contract the company signed around the same time.

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.

Keith Martin