Patents, trademarks, copyrights and goodwill, are vital intangible assets in modern businesses. While their tax treatment can be complex, businesses need to have an understanding of the issues involved.
Here are answers to some common questions about these assets.
What are intangible assets?
The term “intangibles” covers a wide range of items and determining whether an acquired or created asset qualifies as intangible isn’t always straightforward. Examples include debt instruments, prepaid expenses, non-functional currencies, financial derivatives (such as options, futures, and foreign currency contracts), leases, licenses, memberships, patents, copyrights, franchises, trademarks, trade names, goodwill, annuity contracts, insurance contracts, endowment agreements, customer lists, and ownership interests in entities like corporations, partnerships, LLCs, trusts and estates.
Other rights, assets, instruments and agreements may also fall under this category.
What are the expenses?
Expenses associated with acquiring or creating intangible assets that fall under capitalization rules include payments made for:
- Obtaining, renewing, renegotiating or upgrading business or professional licenses
- Modifying contract rights like lease agreements
- Defending or securing title to intangible property like patents
- Terminating agreements, including, leases of tangible property, exclusive licenses for your property, and certain non-competition agreements
According to IRS regulations, payments to “facilitate” the acquisition or creation of an intangible are those incurred in the process of investigating or pursuing a transaction. These facilitation rules apply broadly, impacting businesses and everyday transactions. Examples of facilitation costs include payments made to:
- Legal counsel to draft and negotiate lease agreements
- Attorneys, accountants, and appraisers to assess a corporation’s stock value during a minority shareholder buyout
- Consultants to research competitors when preparing a contract bid
- Legal counsel for preparing and filing trademark, copyright, and license applications.
Why are intangibles so complex?
The IRS requires businesses to capitalize costs that:
- Acquire or create an intangible asset
- Develop or enhance a separate and distinct intangible asset
- Establish or enhance a “future benefit” identified as capitalizable under IRS guidelines
- Facilitate the acquisition or creation of an intangible asset
Capitalized costs can’t be deducted in the year they were paid or incurred. If they are deductible, they must spread out over the asset’s lifespan or over a time period specified by the tax code. However, costs under $5,000 and those paid to create or facilitate the creation of a right or benefit that expires within 12 months or by the end of the following tax year do not require capitalization.
Are there any exceptions to the rules?
Yes, there are exceptions. Taxpayers can choose to capitalize items that aren’t typically required to be capitalized. The lists of examples provided above are not exhaustive.
Due to the complexity of the regulations, it’s important to scrutinize transactions involving intangibles and the related costs to understand the full tax implications.
Need support with intangible assets?
For businesses to take full advantage of potential tax benefits and stay compliant with regulations, the tax treatment of these intangible assets need to be properly managed. Contact your Smolin advisor to discuss the capitalization rules and determine if costs you’ve incurred need to be capitalized. We can also help identify potential transactions your business has engaged in that might trigger these rules to keep your business compliant.