A Complete Guide on Section 197 Intangibles: Types and Examples

Introduction 

Assets are an important part of a company’s operations and future growth. To ensure security and accelerated growth, a well-balanced combination of both tangible and intangible assets is required. 

While tangible assets are depreciated over a period of time, intangible assets are subject to amortization on the balance sheet. Similar to reporting depreciation for tax deductions, businesses also need to report amortization of intangible assets for effective tax optimization. However, the amortization of intangible assets varies according to their classification especially if they are recognized as Section 197 intangibles as per Section 197 of the U.S. Internal Revenue Code. Businesses need to understand how to amortize the Section 197 intangibles to ensure regulatory compliance and ensure sound financial management.

In this blog, we are going to learn about Section 197 intangibles, the assets that fall under this category, how they are taxed, and how companies can claim amortization for these assets. 

What are Section 197 Intangibles?

Section 197 intangibles are specific intangible assets that are subject to amortization under the U.S. Internal Revenue Code (IRC). A company gains ownership of these assets when they acquire a business that previously owned the said intangibles. Goodwill, patents, trademarks, etc. fall into the section 197 intangibles category. 

Section 197 intangibles must be amortized over a period of fifteen years starting from the month of the acquisition. The cost of the asset should be spread out evenly during this time period, and businesses can claim tax deductions on the amortized amount during the same time period. 

What are the Types of Section 197 Intangibles?

Now that we’ve understood what Section 197 intangibles are, let’s discuss the different types of Section 197 intangibles. There are a lot of intangible assets that come under the Section 197 intangibles category, but the following are the most common: 

Information

Assets such as customer lists, customer information, customer relationships, etc., are categorized as information Section 197 intangibles. Further, in case of larger acquisitions where goodwill is involved then internal processes and training modules are also considered as Section 197 intangibles. 

Rights

In this category, assets such as patents, trademarks, franchises, trade names, copyrights, and government permits and licenses are applicable under Section 197 intangibles. 

Goodwill

Goodwill includes assets that come into existence due to the name and reputation of a company. Consider, for example, the thriving relationship of a company with investors, vendors and customers due to their stellar reputation. 

Example of Section 197 Intangibles

To understand Section 197 intangibles better, let’s take a look at an example. 

Let’s suppose an ABC business acquires XX company. XX had intangible assets, including a patent, a government permit to conduct business at a specific location, customer base, and internal processes and training manuals. 

The collective value of all these assets is determined to be $150,000. After the acquisition, starting with the date of acquisition, the ABC company will amortize these assets using a straight-line amortization method every year for a period of fifteen years. 

For year one, the ABC will amortize $10,000 and can claim a tax deduction on the same. This process will continue for fifteen years until the assets are fully amortized. 

How are Intangible Assets Taxed?

Apart from Section 197 intangibles, businesses could have other intangible assets that they might have created or purchased separately. The tax treatment of intangible assets depends on the nature of their use, how they are acquired, and how they are disposed of or sold off. 

Let’s take a closer look at the tax treatment of intangible assets:

Tax treatment of Section 197 intangibles

In this specific case, the acquired intangibles must be amortized evenly over a period of fifteen years, starting from the month of acquisition, as per the IRC regulations. Businesses can claim tax deductions during this time period for Section 197 tangibles. For example, businesses can claim goodwill amortization tax returns each year for 15 years after acquiring the asset. 

An important thing to note in this specific case is that all the intangible assets that are applicable for Section 197 amortization are grouped, meaning businesses can’t claim tax returns separately on any one of these assets. In case one or more Section 197 intangibles are sold off or disposed of before the fifteen years amortization period, businesses cannot claim a loss deduction, and the assets, along with other Section 197 intangibles, need to be amortized for the remaining period. 

Tax treatment of other intangible assets

For intangible assets that are not applicable for Section 197 amortization, the tax treatment depends on their purchase cost, market value, and the amortization period. The amortization period for these assets can be less or more than fifteen years and depends on their useful life. Based on tax rules and nature of assets businesses can further use accelerated amortization methods, which allows them to deduct larger amounts of assets value in its earlier years of useful life. However, this is not the case for Section 197 intangibles. 

In order to claim tax deductions, businesses need to value their intangible assets. The following valuation methods can be used for the same:

1. Market value approach: This method determines the value of an asset by comparing it with another comparable asset. 
2. Income approach: Businesses can use this valuation method if the asset is generating income. Under this approach, the potential revenue that an asset is capable of producing is considered to determine its value. 
3. Cost approach: The cost approach takes into consideration the cost that would be required to create a similar intangible asset. The estimated cost is then regarded as the value of the current asset. 

Once the value of the asset is determined, businesses can amortize the asset accordingly and claim tax returns each year on the amortized value. 

In case the intangible asset is sold before its useful life, the tax treatment will depend on the capital gain and loss. In cases of impairment, businesses can claim tax returns on the loss; however, the tax rules regarding such cases could vary depending on the type of the asset. 

How do you claim amortization on your tax return?

To claim tax returns on amortized intangible assets, businesses need to report the deduction on Form 4562 (depreciation and amortization). Section 6 of Form 4562 is specifically for amortization, where businesses need to provide detailed information regarding the intangible asset. These include the description of the asset, cost of the asset, the date at which the asset was created or acquired, and amortization amount for the current fiscal year. 

How HighRadius Can Help?

HighRadius offers a cloud-based Record to Report Solution that helps accounting professionals streamline and automate the financial close process for businesses. We have helped accounting teams from around the globe with month-end closing, reconciliations, journal entry management, intercompany accounting, and financial reporting.

Our Financial Close Software is designed to create detailed month-end close plans with specific close tasks that can be assigned to various accounting professionals, reducing the month-end close time by 30%.The workspace is connected and allows users to assign and track tasks for each close task category for input, review, and approval with the stakeholders. It allows users to extract and ingest data automatically, and use formulas on the data to process and transform it. 

Our Account Reconciliation Software provides an out-of-the-box formula set that can configure matching rules and match line-level transactions from multiple data sources and create templates to automate various transaction processing required for month-end close. Our solution has the ability to prepare and post journal entries, which will be automatically posted into the ERP, automating 70% of your account reconciliation process. 

Our AI-powered Anomaly Management Software helps accounting professionals identify and rectify potential ‘Errors and Omissions’ throughout the financial period so that teams can avoid the month-end rush. The AI algorithm continuously learns through a feedback loop which, in turn, reduces false anomalies. We empower accounting teams to work more efficiently, accurately, and collaboratively, enabling them to add greater value to their organizations’ accounting processes.

FAQs

Q1. Can you sell intangible assets?

Yes, intangible assets can be sold and bought in the marketplace. Assets such as patents, copyrights, trademarks, customer lists, franchises, and goodwill, can be sold or acquired by other business entities. The assets need to be valued for the process, and businesses further need to consider tax implications. 

Q2. Is amortization tax deductible?

Yes, by amortizing intangible assets, businesses can claim tax deductions. An intangible asset is amortized on an yearly basis until its useful life is over. Therefore, businesses can claim tax deductions annually at the end of the fiscal year for the amortized amount of the intangible asset.

Q3. What is the recovery period for Section 197 intangibles?

As per the Internal Revenue Code, Section 197 intangibles must be amortized over 180 months or 15 years using the straight line amortization method. This is regardless of the useful life of the asset. The amortization of Section 197 intangibles starts in the same month as the acquisition. 

Q4. How are Section 197 intangibles taxed when sold?

The tax treatment of Section 197 intangibles depends on capital gain or capital loss when the asset is sold. The company will need to calculate the adjusted basis and the sale price of the asset. Once these values are calculated, the company can report capital losses or gains on the tax forms. 

Q5. Which tax form is used for section 197 intangibles?

Tax Form 4562 is used to report depreciation and amortization of assets. The section of the form is particularly for amortization. To claim amortization on Section 197 intangibles, businesses need to fill out the details of the asset, including description, date of acquisition, cost, etc., on Section 6 of Form 4562.