When a company purchases an intangible asset, it is considered a capital expenditure. Rather than expense the purchase cost all at once, a company must amortize it over the life of the asset. Amortization is the method used to determine how much of the asset’s acquisition cost can be written off annually. This amortized amount is used as a tax deduction to reduce the company’s taxable income.
Amortization of Intangible Assets for Tax Purposes
Although intangible assets are invisible, they add real value to a company. Intangible assets are listed on a company’s balance sheet in the assets section. The value of a corporation’s intangible assets, such as Apple’s logo of an apple with a bite taken out of it, can develop over time. Companies can often buy and sell intangible assets as easily as a physical asset such as equipment or machinery, and intangible assets tax treatment is as real as the tax treatment of a physical asset.
Intangible assets come in two categories: legal intangible assets and competitive intangible assets. Legal intangibles are considered property and a perceived infringement can be defended in court. Apple, Samsung and Google, for example, are known for their patent-infringement lawsuits. Some well-known legal intangible assets are trademarks, patents and copyrights. Competitive intangible assets, due to their nature, are not considered property and cannot be defended in court. Competitive intangibles give one company an advantage over another. Corporate intangible assets include goodwill and privileged knowledge of day-to-day operations.
For corporations to take these tax deductions, the Internal Revenue Service mandates that they amortize their legal and competitive intangible assets over 15 years. This list includes going concern value, patents, copyrights, trademarks or trade names, franchises, noncompete agreements, licenses and permits. If a company uses the straight-line amortization method, the value of each intangible asset is divided over 15 years. For example, if a patent is valued at $50,000, the corporation would divide that amount by 15 years to get the yearly tax-deductible amount of $3,333.
Companies report their intangible asset tax deductible amounts in Part VI of IRS Form 4562, Depreciation and Amortization. The name of each intangible asset along with its tax-deductible amount is listed separately. The total tax deductible amount is carried over to Form 1065, U.S. Partnership Income Tax Return; Form 1120, U.S. Corporation Income Tax Return; or Form 1120-S, U.S. Income Tax Return for an S corporation.
Assets Amortized for Tax, Not Other Purposes
Certain kinds of intangible assets that don't decrease in value over time should not be amortized, according to financial accounting regulations, but they are amortized for tax purposes.
For example, amortization of goodwill for tax is a standard practice, using the 15 year period, but when it comes to financial accounting, amortization of goodwill isn't done. Goodwill represents how much is paid in an acquisition beyond the apparent fair market value of a business.
- Apple: Guidelines for Using Apple Trademarks and Copyrights
- IRS: Instructions for Form 4562, Depreciation and Amortization
- The Motley Fool: How to Calculate the Amortization of Intangible Assets
- Investopedia: How Does Goodwill Amortize?
- FCS Commercial Finance Group: FASB 142 Goodwill and Other Intangibles Assets
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