Ninth Circuit Reverses Tax Court on Including Stock Option Costs in Cost-Sharing Agreement: A Tale of Two Regulations

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On May 27, in a 2-1 panel decision, the Ninth Circuit Court of Appeals reversed the United States Tax Court in Xilinx, Inc. v. Commissioner and remanded on two specific issues. The Ninth Circuit held that, under Treasury Regulations in effect during 1997 – 1999, related companies engaged in a joint venture to develop intangible property must include the value of certain employee stock option compensation in the pool of costs to be shared under a cost sharing agreement, even if companies operating at arm’s length would not do so. Barring a successful petition for rehearing or petition for certiorari to the Supreme Court, this will become the rule for litigation in the Tax Court for taxpayers whose appeals lie to the Ninth Circuit, but not for other taxpayers for whom the Tax Court holding is still valid. The Ninth Circuit also remanded the case to the Tax Court (i) to determine whether the IRS’s proposed allocation of costs accurately reflects stock option costs for employees involved in the joint venture and (ii) to determine whether accuracy-related penalties are appropriate.

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