Category: Miscellaneous Copyright 1998, The Tax Resource Group. All rights reserved. Telephone 800-578-3498. Internet: www.taxresourcegroup.com Background Taxpayer, an S corporation, purchased in June 1991 a bundle of intangible assets related to the right to sell a certain product. The purchased assets included a customer list, goodwill, a trademark, and certain warranties. There was no allocation of cost as between the various separate intangible assets. The taxpayer has not claimed any amortization with respect to these assets. It appears that a considerable portion of the value of the assets acquired relates to a customer list. Only one-third of the original list is now in use. Although sales of the product related to these rights continue, the volume of such sales has declined to the point that the profitability of continuing to sell the product has diminished significantly. The taxpayer ultimately expects to discontinue sales at some point in the future. The taxpayer wishes to write off all or a portion of the cost of these rights. Comments The intangibles in question are not Section 197 intangibles because the purchase date was prior to July 25, 1991. The intangibles were not amortized. Perhaps it is arguable that they should have been, but let us assume for the moment that the assets are non-amortizable. The cost of a non-depreciable/non-amortizable asset used in a trade or business can be written off if the asset becomes completely obsolete or is completely abandoned. Reg. Section 1.165-2. Of course, complete obsolescence or complete abandonment is a question of fact. In this case, it appears that the assets in question have neither been abandoned nor have they completely lost their usefulness. In fact, the taxpayer is still using a portion of these assets to this day even thought the profitability of that use has declined considerably over time. With respect to amortizable or depreciable assets, there is some indication that a partial write off--or an acceleration of depreciation or amortization--is allowable if the value of the asset is significantly diminished by obsolescence caused by a change in technology, business practices, consumer habits and preferences, etc. See Regulation Section 1.167(a)-9. Because there is very little in the way of interpretive court decisions to provide guidance in this area, the circumstances under which a taxpayer can reliably write off a portion of an asset (or accelerate depreciation or amortization) on account of obsolescence is unclear. More importantly, there appears to be no parallel rule allowing a partial write off for non-depreciable or non- amortizable assets. It is clear that a mere decline in the profitability of an asset is not sufficient to warrant a deduction of any sort. For example, see Watson Land Co., (1983) TC Memo 1983-187, PH TCM ¶83187, 45 CCH TCM 1206, affd on this issue(1986, CA9) 58 AFTR 2d 86-5783, 799 F2d 571, 86-2 USTC ¶9679. It seems to me that this is the only thing that has really occurred up to the present time. The taxpayer has stated the intention of completely discontinuing sales of the product to which the intangible assets relate at some point in the future. It seems to me that when complete discontinuance occurs, there is a strong argument for a deduction equal to the cost of these various intangible assets. I believe that an attempt to take even a partial deduction prior to the point of total discontinuance would be unsustainable if the matter were scrutinized. In addition, I think there is significant risk that the IRS could take the position that the assets, particularly the customer list, should have been amortized in the past. It is rather well accepted in the business world that a customer list is a wasting asset. Prior to Section 197, it became well accepted in the tax world as well with the advent of the Newark Morning Ledger case. It is inevitable that over time, some customers will move away from the geographic area served by the owner of the customer list, die, retire, change buying preferences, become alienated from the vendor, etc. Thus, a specific group of customers in place at a particular moment in time will necessarily dissipate over time. The rate of dissipation, of course, varies significantly from business to business, but dissipation is inevitable and is fairly predictable in most cases. When the taxpayer in this case ultimately abandons and writes off the intangible assets in question, the IRS could take the position that the amount of any such deduction should be limited to the unamortized cost that would have remained if "proper" amortization deductions had been claimed over time. The IRS could, in their infinite wisdom, attempt to assign a useful life to the customer list. This would then establish the remaining unamortized cost available to be written off when the assets are ultimately abandoned. |
