The ins and outs of sec. 197.

• Author: Bayer, Paul
• Position: Acquired intangibles

Sec. 197 covers the proper tax treatment for most acquired intangible assets. Prior to its enactment in 1993, entities that acquired another trade or business faced the heavy burden of a two-pronged test to amortize acquired intangibles. The taxpayer had to estimate the intangible asset's useful life and ascertain a value; see Newark Morning Ledger Co., 507 US 546 (1993). There was no concrete definition of an intangible asset, nor guidance on estimated useful life.

For intangibles assets acquired after Aug. 10, 1993, Sec. 197 removed the uncertainty, by promulgating a list of intangibles that can be amortized for tax purposes over a 15-year life. Certain intangibles are outside Sec. 197's scope and are subject to pre-Sec. 197 treatment.

Inclusions

The following intangible assets are covered by Sec. 197:

* Goodwill and going-concern value (Sec. 197(d)(1)(A) and (B));

* Workforce in place (Sec. 197(d)(1) (C)(i));

* Customer-based intangibles (Sec. 197(d)(1)(C)(iv));

* Supplier-based intangibles (Sec. 197(d)(1)(C)(v));

* Information base, know-how, patents and copyrights, including the costs incurred in package design (Sec. 197(d)(1)(C)(iii));

* Other similar items (Sec. 197(d) (1)(C)(vi));

* Covenants not to compete and similar arrangements entered into in connection with an acquisition (directly or indirectly) of an interest in a trade or business or substantial portion thereof (See. 197(d)(1)(E));

* Franchises, trademarks and tradenames (See. 197(d)(1)(F));

* Licenses and permits granted by governmental units (See. 197(d) (1)(D));

* Certain contracts for the use of, and term interests in, Sec. 197 intangibles (Sec. 197(e)(4)(D)); and

* Intangibles leased to tax-exempt entities (Sec. 197(f)(10)).

When to Use

In many instances, tax professionals mistakenly believe that all intangible assets fall under Sec. 197. However, a Sec. 197 intangible asset is only one that is acquired in connection with the taxpayer's trade or business, not necessarily all intangibles newly acquired; see Sec. 197(c)(1).

Example 1: D Co. entered into a five-year noncompete agreement with a former employee. For D, the agreement is outside the ambit of Sec. 197, because it was not acquired as part of the acquisition of a trade or business or a substantial portion of one. Accordingly, D can amortize the agreement over its five-year life.

Example 2: R Co. acquires D's assets, including the five-year noncompete agreement. The agreement is an intangible asset acquired by R...