Navigating the Complexities of Tax Treatment for Intangible Assets
Posted by Douglas Muth on December 16, 2024
Intangible assets, such as patents, trademarks, copyrights, and goodwill, are important elements in today's businesses. The tax treatment of these assets can be complex, so it is essential for businesses to understand the associated issues. Below are answers to frequently asked questions.
What are Intangible Assets?
The term "intangibles" encompasses various items. Determining whether an acquired or created asset or benefit is intangible can sometimes be difficult. Intangibles include debt instruments, prepaid expenses, non-functional currencies, financial derivatives (such as options, forward or futures contracts, and foreign currency contracts), leases, licenses, memberships, patents, copyrights, franchises, trademarks, trade names, goodwill, annuity contracts, insurance contracts, endowment contracts, customer lists, ownership interests in business entities (such as corporations, partnerships, LLCs, trusts, and estates), and other rights, assets, instruments, and agreements.
What are the Expenses?
Examples of expenses incurred to acquire or create intangibles subject to capitalization rules include amounts paid to:
- Obtain, renew, renegotiate, or upgrade business or professional licenses;
- Modify certain contract rights (such as a lease agreement);
- Defend or perfect title to intangible property (such as a patent); and
- Terminate certain agreements, including leases of tangible property, exclusive licenses to acquire or use property, and non-competition agreements.
IRS regulations generally classify an amount as paid to "facilitate" the acquisition or creation of an intangible if it is paid during the investigation or pursuit of a transaction. These facilitation rules can impact any business and many ordinary business transactions. Examples of costs that facilitate the acquisition or creation of an intangible include payments to:
- Outside counsel to draft and negotiate a lease agreement;
- Attorneys, accountants, and appraisers to establish the value of a corporation's stock in a buyout of a minority shareholder;
- Outside consultants to investigate competitors when preparing a contract bid; and
- Outside counsel for preparing and filing trademark, copyright, and license applications.
Why are Intangibles so Complex?
IRS regulations require the capitalization of costs to:
- Acquire or create an intangible asset;
- Create or enhance a separate, distinct intangible asset;
- Create or enhance a "future benefit" identified in IRS guidance as capitalizable; or
- "Facilitate" the acquisition or creation of an intangible asset.
Capitalized costs cannot be deducted in the year they are paid or incurred. If deductible, they must be ratably deducted over the life of the asset or over periods specified by the tax code or regulations. However, capitalization is generally not required for costs not exceeding $5,000 and for amounts paid to create or facilitate the creation of any right or benefit that does not extend beyond the earlier of 1) 12 months after the first date on which the taxpayer realizes the right or benefit or 2) the end of the tax year following the tax year in which the payment is made.
Are There any Exceptions to the Rules?
Like most tax rules, these capitalization rules have exceptions. Taxpayers can also elect to capitalize items that are not ordinarily required to be capitalized. The examples provided above are not all-inclusive. Given the length and complexity of the regulations, transactions involving intangibles and related costs should be analyzed to determine their tax implications.
For Assistance and More Information
Properly managing the tax treatment of intangible assets is crucial for businesses to maximize tax benefits and ensure compliance with tax regulations. Contact us to discuss the capitalization rules and determine whether any costs you have paid or incurred must be capitalized, or whether your business has engaged in transactions that may trigger these rules.
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Doug is a partner in Lumsden McCormick’s accounting and auditing department and has been with the Firm since 2008. Prior to joining the Firm, he worked at KPMG for three years. Doug is responsible for the supervision of staff and planning and completion of client engagements including audits, reviews, compilations, and other bookkeeping and consulting engagements. He has prepared financial statements, coordinated and reviewed work performed by internal auditors, and presented audit findings to management and boards. Doug has experience providing services to financial institutions, workers’ compensation trusts, employee benefit plans, and other commercial businesses, including those in manufacturing, construction, and general service industries. Additionally, he has experience working on SEC engagements. Doug is a member of the Firm’s recruiting team and chairs the Firm’s Accounting & Auditing Technical Committee.