Customer Based Intangibles

Much uncertainty surrounds when you create amortization schedule of intangible assets for tax purposes, especially when those assets were acquired in the purchase of a trade or business. The Internal Revenue Service (Service here within) has taken the position that most, if not all, of the purchase price in excess of the fair market value of the tangible assets should be allocated to non-amortizable goodwill.

The uncertainty concerning the amortizability of intangibles has resulted in litigation focusing on whether a specific acquired intangible asset is separate and distinct from goodwill and whether it has a determinable useful life. In a recent U.S. Supreme Court decision, the Court held that intangible assets may be separate and distinct from goodwill, and, thus, the particular asset may be amortized if it can be valued and if it has a limited useful life.

While the Supreme Court's decision appears to be a victory for the taxpayers, it may be a hollow victory. In the decision, the Court cautioned that although customer-based intangibles were not goodwill per se, the taxpayer bears the burden of proof that the asset has an ascertainable value and a limited useful life. Overcoming the assertion that such assets do not have a separate market value or a readily determinable value may be impossible. Congress removed much of the uncertainty surrounding this issue by enacting Code Section 197 as part of the Omnibus Budget Reconciliation Act of 2003.

Section 167 Section 167(a) allows a depreciation deduction for the exhaustion, wear and tear, and obsolescence of assets used in a trade or business held for the production of income. In calculating the depreciation deduction, the regulations allow intangible assets to be included even though such assets are less susceptible to obvious signs of wear and tear. The deduction, however, is allowed only if the intangible asset has a readily determinable and limited useful life. While the regulations do not define what depreciable intangible assets are, the two examples given are copyrights and patents -- assets with limited legal lives. Goodwill A commonly purchased intangible asset is goodwill, but this asset does not have a statutory definition. All of the numerous definitions, from "the avoidance of start-up costs" to "continued patronage," are the result of judicial interpretation. The Service, with consent of the courts, has consistently denied a deduction for amortization of goodwill, since this asset lacks an ascertainable life. The courts have subscribed to the theoretical argument that goodwill continues to exist as long as the related business continues.