Q: I bought a sandwich shop that also sells basic groceries. I bought the business in March 2019 and ran it for about a year before closing. I’ve reopened but I’m still having issues and am still reporting a monthly loss from operations. My CPA let me allocate cost to various assets, including goodwill represented by existing customers. Goodwill was the most significant asset. I made a profit in 2019, but 2020 was a disaster with a big loss. I am allowed to use this business loss in 2020 against my income from previous years and receive a tax refund, but I have not yet filed the 2020 tax return as a significant tax issue is pending. The loss will be much greater if I write off the goodwill I have acquired. The CPA says I cannot write off goodwill unless the IRS allows it over 15 years. I think I can prove that goodwill is exhausted. The business was closed for much of 2020 and when I reopened I had to work to build the business. Doesn’t it make sense that I can write off the old business owner’s 2019 goodwill? If you can name a tax source that says this, it would help me with my tax preparer.
A: It certainly makes sense that you can write off goodwill that seems to have evaporated during the pandemic. But you can’t. I’ll even try to convince you that not copying makes sense.
Accounting rules generally allow you to write off the cost of an acquired asset that depreciates over time. This is usually known as depreciation, but is known as amortization when the asset is intangible.
Tax law follows this general principle, but assigns a different lifespan to the asset than conventional accounting rules suggest. For our purposes, however, the concept is the same.
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The IRS has argued in the past that goodwill could not be written off for tax purposes. A depreciation was only permitted if the taxpayer could prove a certain useful life of the goodwill.
Goodwill often grows with the life of a company. Even if it doesn’t grow, it can be very difficult to show the rate at which it is going back. Without proof of a useful life, depreciation would not be justified.
The IRS prevailed on this argument and won many legal challenges. Then, nearly 30 years ago, the Supreme Court heard the Newark, New Jersey-based purchaser of Morning Ledger newspaper.
The buyer allocates the purchase price to the customer – customers make a newspaper valuable. The buyer also used past data to show a customer’s “usage time” of this newspaper.
The buyer’s homework project provided strong evidence that enabled them to amortize the purchased intangible asset. The Supreme Court decision also provided others with a roadmap that could aid amortization on other purchases.
The IRS then endorsed a bill in Congress establishing a single lifespan for purchased intangible assets. For this reason, 15 years is used to amortize goodwill and other intangible assets.
However, that law also denied early amortization of acquired goodwill provided the business to which it relates is still in operation.
Your statement that goodwill that no longer exists should be fully deductible appears logical to you if it no longer makes sense.
The Newark Morning Ledger government that encourages goodwill amortization also has a logical reason why you shouldn’t be able to write off goodwill.
The legally prescribed 15-year depreciation period is “sales-neutral”. This means that it was a Solomonic decision to split the baby up in a way that would manage tax laws and avoid disputes over proof of useful life.
To keep it sales neutral, the rule had to make sure you were sticking to the 15 year depreciation. The only exception is when the business itself disappears.
Your goodwill can be dead. However, their business is still alive. Since that goodwill is tied to this company when purchased in 2019, your depreciation will need to continue for 15 years or until the end of the company, whichever comes first.
James R. Hamill is the Director of Tax Practice at Reynolds, Hix & Co. in Albuquerque. He can be reached at [email protected].