Can You Deduct Worthless Goodwill on
Your Tax Return? Internal Revenue Code Section 197 Creating Ill Will
There is a lot of discussion about goodwill nowadays. And it is
generating a lot of ill will among accountants. There is good
reason. FASB now requires a write down of goodwill for any
impairment. On the other hand, the Internal Revenue Code, Section 197,
requires the systematic amortization of goodwill on a straight-line
basis over fifteen years.
But what happens if you discover that your company has no goodwill from
a financial accounting standpoint. Can you then write off the
goodwill
on your tax return and take the deduction?
In order to address this puzzling question, let's first review the
relevant portions of Internal Revenue Code Sec. 197, dealing with the Amortization of Goodwill and Certain Other
Intangibles:
(a) General rule
A taxpayer shall be entitled to an amortization deduction with respect
to any amortizable section 197 intangible. The amount of such deduction
shall be determined by amortizing the adjusted basis (for purposes of
determining gain) of such intangible ratably over the 15-year period
beginning with the month in which such intangible was acquired.
(b) No other depreciation or amortization deduction allowable
Except as
provided in subsection (a), no depreciation or amortization deduction
shall be allowable with respect to any amortizable section 197
intangible.
And then the Code discusses the treatment of intangibles that become
worthless:
(f) Special rules
(1) Treatment of certain
dispositions, etc.
(A) In general
If there is
a disposition of any amortizable section 197 intangible acquired in a
transaction or series of related transactions (or any such intangible
becomes worthless) and one or more other amortizable section 197
intangibles acquired in such transaction or series of related
transactions are retained -
(i) no loss shall be
recognized by reason of such disposition (or such worthlessness), and
(ii) appropriate adjustments to the adjusted bases of such retained
intangibles shall be made for any loss not recognized under clause (i).
The
above section states that if there were any
other intangibles acquired in the same or related transaction, then the
amortizable section 197 intangible (for example, goodwill) deemed
worthless could not be written off as a loss for tax purposes; rather,
the tax bases of other amortizable section 197 intangibles—acquired in
the same or related transaction as that in which the amortizable
section 197 intangible deemed worthless was acquired—would be
adjusted. Presumably, if goodwill were the worthless intangible,
and if any other intangibles were purchased along with goodwill, then
the bases of the other intangibles would have to be increased in
amounts totaling the basis of the disposed goodwill.
Consequently, no immediate loss of the entire amount of the worthless
goodwill would be allowed to be recognized. Instead, by
increasing the bases of the other associated amortizable section 197
intangibles, the impairment of goodwill, in effect, would be recognized
over their remaining amortizable lives.
What does this all mean? Assume on December 31, 2006, you
purchased all the assets of a business, and recognized two amortizable
section 197 intangibles: $15,000 goodwill; $30,000 going concern
value. Under section 197, you would be allowed to amortize these
amounts over 15 years, resulting in annual amortization of $1,000 of
goodwill and $2,000 of going concern value, for a total section 197
amortization expense of $3,000 each year. Now assume on December
31, 2009, you deem goodwill to have a zero value. Under section
197, you would be required to increase the basis of going concern value
by $12,000, resulting in an adjusted basis of $36,000. On
December 31, 2010, you would still amortize $3,000 in total section 197
amortization expense. In essence, the amount of worthless
goodwill continues to be amortized, but under the guise of another
related intangible (here, going concern value), without any change to
the total amount of amortization nor the period of amortization.
However, what section 197 fails to address is a not too uncommon
situation: what if there were no
other intangibles in the purchase transaction?! What if goodwill
were the only amortizable section 197 intangible acquired and then it
was deemed worthless? Since there would be no other retained
intangibles whose bases could be adjusted, would it then be permissible
to recognize a loss? In the Internal Revenue Code's own
inimitable,
customary, mysterious manner of exposition, IRC Sec. 197 is
suspiciously silent on that situation.
Federal
Regulation §1.197-2 provides a little more detail and insight regarding
the Internal Revenue Service's treatment of losses on the disposition
of amortizable section 197 intangibles:
g) Special rules.
(1) Treatment of certain
dispositions.
(i) Loss
disallowance rules.
(A) In general. No loss is
recognized on the
disposition of an amortizable section 197 intangible if the taxpayer
has any retained intangibles. The retained intangibles with respect to
the disposition of any amortizable section 197 intangible (the
transferred intangible) are all amortizable section 197 intangibles, or
rights to use or interests (including beneficial or other indirect
interests) in amortizable section 197 intangibles (including the
transferred intangible) that were acquired in the same transaction or
series of related transactions as the transferred intangible and are
retained after its disposition. Except as otherwise provided in
paragraph (g)(1)(iv)(B) of this section, the adjusted basis of each of
the retained intangibles is increased by the product of—
(1) The loss
that is not recognized solely by reason of this rule; and
(2) A
fraction, the numerator of which is the adjusted basis of the retained
intangible on the date of the disposition and the denominator of which
is the total adjusted bases of all the retained intangibles on that
date.
(B) Abandonment or worthlessness. The abandonment of an
amortizable section 197 intangible, or any other event rendering an
amortizable section 197 intangible worthless, is treated as a
disposition of the intangible for purposes of this paragraph (g)(1),
and the abandoned or worthless intangible is disregarded (that is, it
is not treated as a retained intangible) for purposes of applying this
paragraph (g)(1) to the subsequent disposition of any other amortizable
section 197 intangible.
Herein, the Regulation details how the basis of the retained
amortizable section 197 intangibles would be adjusted: i.e., by
allocating the worthless or disposed intangible's basis to those of the
retained intangibles on a pro-rata basis. And reading below
that section, buried deeper in the Regulation, you would discover that
the regulation then goes on to say the following regarding worthless or
disposed amortizable section 197 intangibles where other retained
intangibles from the purchase transaction were not present:
(ii) Separately acquired property.
Paragraph (g)(1)(i) of this section
does not apply to an amortizable section 197 intangible that is not
acquired in a transaction or series of related transactions in which
the taxpayer acquires other amortizable section 197 intangibles (a
separately acquired intangible). Consequently,
a loss may be recognized
upon the disposition of a separately acquired amortizable section 197
intangible [my italics].
In
other words, if goodwill were the only amortizable
section 197 intangible acquired in the transaction or series of related
transactions, then, theoretically,
if it were deemed worthless, it could be written off, since there would
be no bases to adjust of other existent amortizable section 197
intangibles from that same purchase transaction.
At this point, you may wonder what evidence is needed to demonstrate
that goodwill is
worthless? Good question.
Apparently, if you file bankruptcy or go out of business, you would
presume that would constitute sufficient evidence of the worthlessness
of goodwill. But can goodwill be written off before the
occurrence of those
events or in their absence? You could not simply try
to sell goodwill on ebay, and
then claim to the IRS
that since you had no buyers, it is worthless. Could you simply
undertake
the Goodwill Impairment Test of SFAS No. 142 to demonstrate its
worthlessness? That is, could you
estimate the
fair values of all identifiable assets and liabilities, then estimate
the fair value of the company, and if the fair values of the net assets
equal or exceed the fair value of the company, claim that there is no
goodwill? Although this approach might be a hard sale to make to
an
Internal
Revenue Service agent, nevertheless, at least theoretically,
it appears to have some validity, because it is precisely the approach
recognized
by the Financial Accounting Standards Board to measure any impairment
of goodwill!
And in the absence of any other specific guidance from the Internal
Revenue Service, it may be the most authoritative approach available to
the taxpayer.
Since the Goodwill
Impairment Test of SFAS No. 142 is relatively recent, it will be
interesting to follow the findings of any future tax court cases
involving the
Internal Revenue Service's challenge to this FASB approved method of
measuring goodwill as well as to any other taxpayer's method of
substantiation of the worthlessness of goodwill.
This article is provided for informational purposes and is
not intended to be construed as legal, accounting, or other
professional advice. For further information, please consult
appropriate
professional advice from your attorney and certified public
accountant.
Have a tax or an accounting question? Please feel free to submit
it to William Brighenti,
Certified Public
Accountant, Hartford CPA Accountants. For information
and assistance on
any tax and accounting issue, please visit our website, Accountants CPA
Hartford, and our blog, Accounting and Taxes
Simplified.
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