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BY MICHAEL LYNCH

Rating Goodwill

The IRS amended IRC section 197 to provide a ratable 15-year amortization period for goodwill and other intangibles acquired after January 25, 2000. According to the revisions, section 197 intangibles include covenants to compete, franchises, trademarks, trade names, permits, going concern value, customer lists, market share and workforce in place (the portion of the purchase price that represents the costs to retain a business’s highly skilled employees).

The regulations also state that purchased computer software should be amortized over 15 years if section 197 applies and over 36 months if the software is not a section 197 intangible (TD 8865).

Lump Sum Payment Not Tax Exempt

A downsizing program at IBM encouraged workers to voluntarily terminate their employment in exchange for a lump sum payment. The company withheld income and Social Security taxes from the payments. Employees who participated in the program were required to sign releases and covenants not to sue the company.

After electing the termination, several hundred former employees claimed the lump sum payments were personal injury awards and sought refunds of the withheld taxes. The IRS denied their claims so the employees filed a class action suit contending they had suffered emotional injuries as a result of the termination.
A U.S. district court dismissed the suit, finding that the payments were compensation based on the employees’ years of service and salary level. The court held that although IBM had anticipated tort claims when it insisted the employees sign the releases, the lump sum payments had nothing to do with any such claims ( United States v. Marie N. Abbott, N.D. NY, 12-3-99).

Court Denies Bad-Debt Business Deduction

A taxpayer formed a corporation to acquire and rehabilitate financially distressed companies. He lent the corporation millions of dollars, but eventually it became financially distressed. On his personal income tax return, the taxpayer deducted the unpaid loans as a business bad debt. The IRS denied the deduction. It argued the taxpayer was not in the business of lending money. The taxpayer countered that the loans related to his business of “buying, rehabilitating and reselling corporations.”

The circuit court agreed with the IRS, finding that the taxpayer was merely an investor who provided working capital to the corporation. There was no evidence, the court said, that the taxpayer actively managed the corporation or provided any services to the distressed companies. Therefore, the court denied the company’s bad debt deduction and held the loans were nonbusiness debts ( Commissioner v. Melvyn L. Bell, 8th Cir.,1-5-00).

IRS Revises MACRS Depreciation

Taxpayers who exchange modified accelerated cost recovery system (MACRS) property on or after January 3, 2000, through either an IRC section 1031 like-kind exchange or a section 1033 involuntary conversion, now are required to treat the excess basis of the acquired MACRS property as newly purchased. According to notice 2000-4, the new asset will now be treated as two separate properties for depreciation purposes.

—Michael Lynch, CPA, Esq.,
professor of tax accounting at Bryant College,
Smithfield, Rhode Island.

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