Deducting the Cost of Intangibles
Distinguishing the intangible asset from goodwill is only one hurdle a taxpayer must overcome to obtain a deduction. The tax treatments of tangible and intangible assets differ. Tangible assets are presumed to waste away, so only the length of the asset's life is a tax issue. Expenditures relating to certain intangibles must be permanently capitalized and are deductible only on disposing of the asset. To obtain a tax deduction for amortizing an intangible, a taxpayer must prove the asset is not goodwill, which is nondeductible. This creates a heavy burden of proof. To avoid the nondeductible category, taxpayers also must prove the asset has a limited and determinable useful life. The facts and circumstances of the acquisition and the nature of the intangible asset govern this determination. The tax treatment of certain intangibles (such as research and development expenditures) is specifically prescribed by statute. For most intangibles, however, taxpayers must rely on case law and administrative rulings to determine the tax treatment. Acquisition of multiple assets, such as purchase of a business enterprise, is particularly troublesome. Case law supports the notion some goodwill is present in almost every business acquisition. Since it's likely some portion of the purchase price must be allocated to goodwill, accurate appraisals of both tangible and intangible assets are essential to obtaining a tax deduction for the cost of intangibles. The statutory and administrative tax treatments of intangibles often are vague and inconsistent, leaving taxpayers little guidance on when to take a deduction. This article discusses tax laws relevant to deducting the cost of intangibles and explores the problems practitioners may encounter in seeking deductions. APPLICABLE TAX LAW Most intangible assets are expected to benefit more than one year, so their cost is a capital expenditure under Internal Revenue Code section 167 (depreciation), the primary authority for deducting intangibles. However, section 167 is a catchall for the tax treatment of intangibles not specifically covered elsewhere and offers little guidance on whether or when a deduction is available. The section 167(a) general rule allows a depreciation deduction for the wear and tear, exhaustion and obsolescence of property used in a trade or business or in the production of income. Other IRC sections deal with specific intangibles, including section 174 (research and experimental expenditures) and section 195 (start-up expenditures). Authority and limited guidance for deducting the costs of most intangibles are found in Treasury regulations. Section 167(a) implies that "property" includes both tangible and intangible assets, but the regulations contain restrictive language on depreciating intangibles. Regulations section 1.167(a)-3 excludes goodwill by saying "no deduction for depreciation is allowable" for it and also says no deduction is permitted merely because the taxpayer believes the intangible asset has a limited life. Thus, the regulation forces the taxpayer to prove an intangible asset is not goodwill and has a limited life before section 167(a) can be considered. The regulation requires that an asset's estimated useful life be determinable with reasonable accuracy. Unfortunately, this complicates tax deductions for amortizing intangibles. The Internal Revenue Service commonly argues certain intangibles such as customer lists and human resources have indefinite or indeterminable lives. Before the determinable useful life of an asset can be considered, however, the taxpayer must prove an identifiable intangible exists. Exhibit 1, page 87, lists court cases that have focused on the separability of the intangible from goodwill. ESTABLISHING AN IDENTIFIABLE INTANGIBLE ASSET To deduct an intangible asset's cost, a taxpayer must demonstrate the amount paid relates specifically and only to the asset. …