The tax treatment of intangible assets
Intangible assets, such as patents, trademarks, copyrights and goodwill, play a crucial role in today’s businesses. The tax treatment of these assets can be complex, but businesses need to understand the issues involved. Here are some answers to frequently asked questions.
What are intangible assets?
The term “intangibles” covers many items. Determining whether an acquired or created asset or benefit is intangible isn’t always easy. Intangibles include debt instruments, prepaid expenses, non-functional currencies, financial derivatives (including, but not limited to, 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 any business entities (for example, corporations, partnerships, LLCs, trusts and estates) and other rights, assets, instruments and agreements.
What are the expenses?
Some examples of expenses you might incur to acquire or create intangibles that are subject to the 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, but not limited to, leases of tangible property, exclusive licenses to acquire or use your property, and certain non-competition agreements.
IRS regulations generally characterize an amount as paid to “facilitate” the acquisition or creation of an intangible if it’s paid in the process of investigating or pursuing a transaction. The facilitation rules can affect 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 in 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 can’t be deducted in the year paid or incurred. If they’re deductible, they must be ratably deducted over the life of the asset (or, for some assets, over periods specified by the tax code or under regulations). However, capitalization generally isn’t required for costs not exceeding $5,000 and for amounts paid to create or facilitate the creation of any right or benefit that doesn’t 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 make certain elections to capitalize items that aren’t ordinarily required to be capitalized. The examples described above aren’t all-inclusive. Given the length and complexity of the regulations, transactions involving intangibles and related costs should be analyzed to determine the tax implications.
For assistance and more information
Properly managing the tax treatment of intangible assets is vital 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’ve paid or incurred must be capitalized, or whether your business has entered into transactions that may trigger these rules. You can also contact us if you have any questions.
© 2024