Category: Accounting Periods & Methods Copyright 1998, The Tax Resource Group. All rights reserved. Telephone 800-578-3498. Internet: www.taxresourcegroup.com Prior to 1990, the taxpayer (TP) purchased the assets of several insurance agencies. The purchase contracts allocated the purchase price to A) covenant not to compete, and B) insurance expirations. The examining agent contends that much of the purchase price should have been allocated to goodwill. The agent further contends that any reallocation of the purchase price resulting from the examination is a change in accounting method; accordingly, the cumulative adjustment related thereto should be made for the 1993 tax year, the year under examination. The regulations at Section 1.446-1(e)(2)(ii)(b) provide as follows. "...a change in method of accounting does not include adjustment of any item of income or deduction which does not involve the proper time for the inclusion of the item of income or the taking of a deduction." Rev. Proc. 92-20, 1992-1 CB 685, provides as follows. SEC. 2. BACKGROUND .01 Change in method of accounting defined. Section 1.446-1(e)(2)(ii)(a)
of the regulations provides that a change in method of accounting includes
a change in the overall plan of accounting for gross income or deductions,
or a change in the treatment of any material item. A material item is any
item that involves the proper time for the inclusion of the item in income
or the taking of a deduction. In determining whether a practice involves
the proper time for the inclusion of an item in income or the taking of
a deduction, the relevant question is generally whether the practice permanently
changes the amount of taxable income over the taxpayer's lifetime. If the
practice does not permanently affect the taxpayer's lifetime taxable income,
but does or could change the taxable year in which taxable income is reported,
it involves timing and is therefore considered a method of accounting. See
Rev. Proc. 91-31, 1991-1 C.B. 566. [Emphasis added.] As I understand it, the issue is whether the amount the taxpayer paid for a business should be allocated to goodwill (which would not give rise to any amortization deduction); or in the alternative, the purchase price should be allocated to covenant-not-to-compete or insurance expirations. Both these items should give rise to amortization deductions. It seems clear that the adjustment the IRS proposes would change TP's lifetime income by recharacterizing an amortizable asset as an unamortizable one; accordingly, by virtue of the IRS's own definition as set forth in Rev. Proc. 92-20, the reallocation of purchase price cannot be a change in accounting method. The IRS could possibly counter with the argument that since goodwill is deductible if the business were ever sold, whether purchase price is allocated to amortizable intangibles or goodwill (deductible on sale) is indeed a timing question and is thus a method of accounting. I would counter that it is not a foregone conclusion that a business will be sold. Accordingly, the ultimate deduction for goodwill cannot be counted upon. As such, the allocation as between goodwill and other amortizable intangibles is not a timing issue, but rather one of deductibility now versus possibly permanent nondeductibility. Finally, I ran various word searches across all federal income tax cases, published rulings, and private rulings in an attempt to locate an instance in which this issue has been raised. My search was by no means exhaustive and further efforts could possibly bear fruit; however, my search did not locate any occurrence of this issue. |
