Amendments to the sec. 1060 and 338(b) regulations conforming allocation of purchase price to the 1993 intangibles legislation.

On Jan. 16, 1997, the IRS issued various amendments (the Allocation Amendments) to the final and temporary Sec. 1060 and Sec. 338(b) regulations, dealing with changes in the method of allocating the purchase price among the assets of an acquired trade or business. Prior to the issuance of these final and temporary regulations, and following the Aug. 10, 1993 enactment of Sec. 197 (and in some cases since 1991), the old regulations were in conflict with the legislative history of Sec. 197 (Legislative History) over the classification of certain intangible assets (other than goodwill and going concern value). With a minor modification, these amendments conform the old regulations with that Legislative History. For acquisition dates before the effective date of the Allocation Amendments (Feb. 14, 1997), taxpayers have three choices: (1) follow the new rules, (2) follow the old rules or (3) allocate purchase price so as to conform to the language in the Legislative History.

Background

Sec. 1060 provides for the allocation of purchase price among assets of a trade or business after an applicable asset acquisition. Sec. 338(b) provides similar rules for allocation in the case of a deemed purchase of assets pursuant to Sec. 338. The old regulations interpreting both sections employed a residual method of allocation, placing each acquired asset into one of four asset classes, with the purchase price then allocated among the classes in priority order. No asset in any class except for the last may be allocated more than its fair market value (FMV). If the aggregate purchase price allocable to a particular class is less than the aggregate FMV of the assets within the class (which would occur in the case of a bargain purchase), each asset is allocated an amount in proportion to its FMV, with nothing allocated to any junior class.

The four classes specified by the old regulations were as follows:

* Class I: Cash and cash equivalents.

* Class II: Certificates of deposit, U.S. government securities, readily marketable stocks and securities, and foreign currency.

* Class III: All assets not in Class I, II or IV.

* Class IV: Intangible assets in the nature of goodwill and going concern value.

Prior to the Omnibus Budget Reconciliation Act of 1993 (OBRA), which enacted Sec. 197, acquired goodwill and going concern value were not amortizable. Other acquired intangible assets were amortizable if they could be separately identified and their useful lives determined with reasonable accuracy; see Newark Morning Ledger Co., 507 US 546 (1993). The old Sec. 1060 and 338(b) regulations placed intangible assets other than goodwill and going concern value in Class III.

1993 Legislation

OBRA allows taxpayers to amortize certain acquired intangible assets over 15 years. These assets are referred to as "amortizable Sec. 197 intangibles." Sec. 197(d) provides a list of "Sec. 197 intangibles." Sec. 197(c) provides the rules for determining whether a "Sec. 197 intangible" is subject to amortization and, hence, is an "amortizable Sec. 197 intangible." Proposed Sec. 197 regulations issued on the same date as the Allocation Amendments further define the terms "Sec. 197 intangible" and "amortizable Sec. 197 intangible."

The House Ways and Means Committee Report accompanying OBRA states that the drafters of Sec. 197 anticipated that the residual method specified in the current Sec. 1060 and 338(b) regulations would be modified to treat all amortizable Sec. 197 intangibles as Class IV assets, and that this modification would apply to any acquisition of property to which Sec. 197 applies. The Allocation Amendments follow the directive in the Legislative History, with minor modifications.

The Allocation Amendments

The Allocation Amendments follow the Legislative History by placing amortizable Sec. 197 intangibles in Class IV, with a slight modification. According to the Allocation Amendments, all Sec. 197 intangibles except goodwill and going concern value (whether amortizable or not) are placed in Class IV, and goodwill and going concern value (whether amortizable or not) are placed in a new Class V.

The rationale for including all Sec. 197 intangibles in Class IV, whether or not they are amortizable, is that, generally, when a buyer purchases assets subject to Sec. 197, those assets can become amortizable Sec. 197 intangibles even though not amortizable in the seller's hands. If the Legislative History were applied literally, in this situation, the seller would include the asset in Class III and the buyer would include the asset in Class IV This rule would result in inconsistent reporting positions between the buyer and the seller. Citing strong policy concerns, including mandatory application of the rule of Danielson, 378 F2d 771 (3d Cir. 1967), the IRS determined, and these amendments will require, that all Sec. 197 intangibles, whether amortizable or not, are to be placed in Class IV.

The rationale for placing goodwill and going concern value in a true residual class, Class V, may be that the IRS was concerned that placing all Sec. 197 intangibles (including goodwill and going concern value) in Class IV would require taxpayers to determine the FMV of goodwill and going concern for purposes of allocating purchase price to all the Class IV assets. The Service also may have been concerned that if all Sec. 197 intangibles were included in the most junior class, an allocation of purchase price could result in allocating more than FMV to each of the intangible assets in that class, possibly resulting in an unwarranted deferral of gain on the sale of one of these assets.

With the enactment of Sec. 197, many people believed that the need to separately determine the FMVs of intangible assets had been eliminated. These Allocation Amendments reintroduce a requirement that separate values be determined--at least with respect to intangibles severable from an ongoing business.

Effective Dates

The effective date of these regulations was Feb. 14, 1997. For acquisition dates before Feb. 14, 1997, if Sec. 197 applies to any asset acquisition or deemed asset acquisition, taxpayers (and all related parties) have three options; they may consistently (in all transactions in which adjusted grossed-up basis, aggregate deemed sale price (ADSP), modified ADSP or consideration must be allocated under Sec. 338 or 1060):

1. apply these new rules in full as written (all Sec. 197 intangibles placed in Class IV except goodwill and going concern value, which are placed in Class V);

2. apply the temporary regulations in effect prior to these amendments (all Sec. 197 intangibles placed in Class III, except goodwill and going concern value, which are placed in Class IV); or

3. apply the rules set forth in the 1993 legislative history (place all amortizable Sec. 197 intangibles in Class IV, including goodwill and going concern value).

Reliance on Legislative History

In the event of a premium purchase, the amount by which purchase price exceeds the FMV of the assets acquired can only be allocated to the residual: class. The old regulations, as well as those incorporating the Allocation Amendments, place intangible assets that are severable from the ongoing business (those other than goodwill and going concern value) in the class of assets immediately senior to the residual class. Thus, taxpayers choosing either of these options will be unable to allocate any premium purchase price to the severable intangible assets.

The Legislative History, however, provides authority for placing all amortizable Sec. 197 intangibles (including intangible assets easily severable from the ongoing business) in a residual class (Class IV); that treatment remains available for transactions occurring before Feb. 14, 1997. That treatment will be beneficial for premium purchases; each asset in the residual class (including those that can be severed from the ongoing business and sold separately) will receive an allocable share of the premium paid (i.e., the amount by which purchase price exceeds the FMV of the assets acquired). As a result, intangible assets that may be sold separately will receive a higher allocation of basis than they would receive using option 1 or 2, and sales of those assets will generate less taxable gain. Loss recognition generally is foreclosed by Sec. 197(f)(1).

Effects on Compliance

In the case of an applicable asset acquisition for which there must be filed a Form 8594, Assets Acquisition Statement under Section 1060, the regulations provide that until such time as Form 8594 is revised to require otherwise, the sum of the amounts allocated to Classes IV and V should be reported on Form 8594 as Class IV assets.

From Andrew M. Eisenberg, CPA, J.D., M., Washington, D.C.