Nowadays, the majority of companies have some intangible assets. These assets’ tax treatment may be complicated.
What makes intangible assets so complex?
According to IRS regulations, costs that must be capitalized include:
- Acquiring or creating an intangible asset,
- Creating or enhancing a separate, distinct intangible asset,
- Creating or enhancing a “future benefit” identified in IRS guidance as capitalizable, or
- “Facilitating” the acquisition or creation of an intangible asset.
Capitalized expenses cannot be written off in the year they are paid or incurred. If they are deductible at all, they must be done so ratably over the asset’s lifetime (or, for some assets, over periods specified by the tax code or under regulations). Capitalization generally isn’t required for costs under $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,
What is an intangible asset?
Several things are referred to as “intangibles,” and identifying whether an intangible asset or benefit has been developed or acquired may not always be straightforward. 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 entity (for example, corporations, partnerships, LLCs, trusts, and estates) and other rights, assets, instruments and agreements.
Following are just a few instances of costs for acquiring or creating intangibles that must be capitalized:
- Amounts paid to defend or perfect title to intangible property (such as a patent);
- Amounts paid to acquire, renew, renegotiate, or upgrade a business or professional license;
- Amounts paid to modify certain contract rights (such as a lease agreement);
- Amounts paid to terminate certain agreements, including, but not limited to, leases of the taxpayer’s tangible property, exclusive licenses to purchase or use the taxpayer’s property, and certain non-competition agreements.
According to IRS regulations, a sum is generally considered to have been paid to “facilitate” the production or purchase of an intangible if it was made while a transaction was being investigated or pursued. Any sort of business, as well as several routine business transactions, may be impacted by the facilitation regulations. 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 preparation and filing of trademark, copyright and license applications.
These capitalization restrictions have exceptions, just like most tax laws do. Taxpayers may also choose to capitalize goods that are not typically required to be capitalized by making certain elections. The aforementioned examples are not exhaustive, and given the length and complexity of the regulations, it is important to assess the tax implications of any transaction involving intangibles and associated costs.
To find out if any costs you’ve paid or incurred need to be capitalized or if your company has engaged in activities that would need the application of these rules, get in touch with us to discuss the capitalization requirements.