42.17 Amortizing Goodwill and Other Intangibles (Section 197)

The costs of intangibles coming within Section 197 are amortized over a 15-year period. The 15-year period applies regardless of the actual useful life of “Section 197 intangibles” acquired after August 10, 1993 (or after July 25, 1991, if elected), and held in connection with a business or income-producing activity.

Generally, the amount subject to amortization is cost. Annual amortization is reported on Form 4562. The 15-year period starts with the month the intangible was acquired.

A “Section 197 intangible” is: (1) goodwill; (2) going-concern value; (3) workforce in place; (4) information base; (5) know-how, but see exceptions below; (6) any customer-based intangible; (7) any supplier-based intangible; (8) any license, permit, or other right granted by a governmental unit or agency; (9) any covenant not to compete made in the acquisition of a business; and (10) any franchise, trademark, or trade name.

Goodwill.

Goodwill is the value of a business attributable to the expectancy of continued customer patronage, due to the name or reputation of a business or any other factor.

Franchises, trademarks, and trade names.

A franchise (excluding sports franchises), trademark, or trade name is a Section 197 intangible. Amounts, whether fixed or contingent, paid on the transfer of a trademark, trade name, or franchise are chargeable to capital account and must be ratably amortized over a 15-year period. The renewal of a franchise, trademark, or trade name is treated as an acquisition of the franchise, trademark, or trade name. Renewal costs are amortized over 15 years beginning in the month of renewal.

Know-how.

A patent, copyright, formula, process, design, pattern, format, or similar item may be a Section 197 intangible. However, the following interests are not Section 197 intangibles unless acquired as part of the acquisition of a business: patents, copyrights, and interests in films, sound recordings, videotapes, books, or other similar property.

Customer-based intangibles.

Customer-based intangibles include the portion of an acquired trade or business attributable to a customer base, circulation base, undeveloped market or market growth, insurance in force, investment management contracts, or other relationships with customers that involve the future provision of goods or services.

Supplier-based intangibles.

The portion of the purchase price of an acquired business attributable to a favorable relationship with persons who provide distribution services, such as favorable shelf or display space at a retail outlet, the existence of a favorable credit rating, or the existence of favorable supply contracts, are Section 197 intangibles.

Going-concern value.

This is the additional value that attaches to property because it is an integral part of a going concern. This includes the value attributable to the ability of a trade or business to continue to operate and generate sales without interruption in spite of a change in ownership.

Workforce in place.

The portion of the purchase price of an acquired business attributable to a highly skilled workforce is amortizable over 15 years. Similarly, the cost of acquiring an existing employment contract is amortizable over 15 years.

Information base.

This includes the cost of acquiring customer lists; subscription lists; insurance expirations; patient or client files; lists of newspaper, magazine, radio, or television advertisers; business books and records; and operating systems. The intangible value of technical manuals, training manuals or programs, data files, and accounting or inventory control systems is also a Section 197 intangible.

Planning Reminder

Covenants Not To Compete

A covenant not to compete is a Section 197 intangible if paid for in connection with the acquisition of a business. Excessive compensation or rental paid to a former owner of a business for continuing to perform services or provide the use of property is considered an amount paid for a covenant not to compete if the services or property benefits the trade or business. But an amount paid under a covenant not to compete that actually represents additional consideration for corporate stock is not a Section 197 intangible and must be added to the basis of the acquired stock.

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Self-created intangibles.

A Section 197 intangible created by a taxpayer is generally not amortizable, unless created in connection with a transaction that involves the acquisition of assets of a business. However, this deduction bar for self-created intangibles does not apply to the following: (1) any license, permit, or other right granted by a governmental unit or agency; (2) a covenant not to compete entered into on the acquisition of a business; or (3) any franchise, trademark, or trade name. For example, the 15-year amortization period may apply to the capitalized costs of registering or developing a trademark or trade name.

A person who contracts for or renews a contract for the use of a Section 197 intangible may not be considered to have created that intangible. For example, a licensee who contracts for the use of know-how may amortize capitalized costs over 15 years.

The following intangible assets are not Section 197 intangibles.

(1) interests in a corporation, partnership, trust, or estate; (2) interests under certain financial contracts; (3) interests in land; (4) certain computer software (42.18); (5) certain separately acquired rights and interests; (6) interests under existing leases of tangible property; (7) interests under existing indebtedness; (8) sports franchises; (9) certain residential mortgage servicing rights; and (10) certain corporate transaction costs.

Loss limitations.

A person who disposes of an amortizable Section 197 intangible at a loss and at the same time retains other Section 197 intangibles acquired in the same transaction may not deduct the loss. The disallowed loss is added to the basis of the retained Section 197 intangibles. The same rule applies if a Section 197 intangible is abandoned or becomes worthless and other Section 197 intangibles acquired in the same transaction are kept. The basis of the remaining intangibles is increased by the disallowed loss.

You may not treat a covenant not to compete as worthless any earlier than the disposition or worthlessness of the entire interest in a business.

Anti-churning rule.

No deduction is allowed for goodwill, going-concern value, or any other Section 197 intangibles acquired by a taxpayer after August 10, 1993, if:

See IRS Publication 535 for the definition of “related persons” and exceptions to the anti-churning rule.

Dispositions.

An amortizable Section 197 intangible is not a capital asset. It is treated as depreciable property, and if held for more than one year, it will generally qualify as a Section 1231 asset (44.1). Amortization claimed on a Section 197 intangible is subject to recapture under Section 1245 and gain on its sale to certain related persons is subject to ordinary income treatment under Section 1239.