Sec. 197 antichurning implications for partnerships.
In January 1997, the Treasury issued proposed regulations under Sec. 197, explaining its application to certain transactions. When a taxpayer enters into a joint venture with another taxpayer by contributing cash or otherwise paying for its share of equity (a portion of which pays for goodwill) of an existing business contributed to the venture by the other party, the proposed regulations clarify the availability of tax deductions Tax deduction
An expense that a taxpayer is allowed to deduct from taxable income.
See deduction. to the new party related to the goodwill. Unfortunately, the proposed regulations can trap the unwary, denying them amortization deductions for which they seemingly seem·ing
Outward appearance; semblance.
seeming·ly adv. paid.
Generally, Sec. 197(a) and (c) provide that goodwill and certain other intangibles acquired by a taxpayer after Aug. 10, 1993 and held in connection with the conduct of a trade or business will be amortizable am·or·tize
tr.v. am·or·tized, am·or·tiz·ing, am·or·tiz·es
1. To liquidate (a debt, such as a mortgage) by installment payments or payment into a sinking fund.
2. over 15 years. Sec. 197(f)(2) provides that, in carry-over basis transactions, a transferee will be treated as the transferor; thus, the transferee "steps into the shoes" of the transferor. Under this rule, the carry-over basis for a contributed intangible is not amortizable unless it was amortizable in the transferor's hands.
Sec. 197 also has an antichurning rule that prevents nondeductible non·de·duct·i·ble
Not deductible, especially for income-tax purposes.
Adj. 1. nondeductible - not allowable as a deduction
deductible - acceptable as a deduction (especially as a tax deduction) goodwill from being "refreshed re·fresh
v. re·freshed, re·fresh·ing, re·fresh·es
1. To revive with or as if with rest, food, or drink; give new vigor or spirit to.
2. " into deductible That which may be taken away or subtracted. In taxation, an item that may be subtracted from gross income or adjusted gross income in determining taxable income (e.g., interest expenses, charitable contributions, certain taxes). goodwill. Generally, Sec. 197(f)(9)(A) provides that goodwill is not amortizable if it was held or used at any time on or after duly 24, 1991, and on or before Aug. 11, 1993 (the transition period) by the taxpayer or a related person. A related person is generally defined by Sec. 197(f)(9)(C) by reference to Secs. 267(b), 707(b)(1) and 41 (f)(1). For purposes of applying Secs. 267(b) and 707(b)(1), those sections are modified by using a 20% rather than a 50% threshold.
When a partner or limited liability company member (X) wants to obtain the benefit of tax basis for cash equity acquired in a new partnership (Z) to which the other partner (Y) is contributing an existing business, there are generally four ways to attempt to provide X with appropriate tax deductions:
1. X may contribute cash that Z will use in its ordinary course of business, end Y may contribute its operating business. Income and deduction deduction, in logic, form of inference such that the conclusion must be true if the premises are true. For example, if we know that all men have two legs and that John is a man, it is then logical to deduce that John has two legs. allocations may be made under Sec. 704(c) to provide X with the benefit of its contributed tax basis.
2. X may contribute cash to Z, which is then distributed by Z to Y in a transaction treated as a disguised dis·guise
tr.v. dis·guised, dis·guis·ing, dis·guis·es
a. To modify the manner or appearance of in order to prevent recognition.
b. To furnish with a disguise.
2. sale of a portion of Y's business to Z in exchange for cash (Sec. 707(a)(2)(B)). Generally, X will obtain the benefit of a stepped-up basis in Z's assets for the portion of assets deemed purchased by Z from Y.
3. X may purchase an undivided interest undivided interest n. title to real property held by two or more persons without specifying the interests of each party by percentage or description of a portion of the real estate. in Y's business (including goodwill) from Y; X and Y may then contribute their respective portions of the business to Z. X's contributed assets (including goodwill) will be stepped up to fair market value (FMV FMV - full-motion video ) based on the purchase price prior to contribution; the benefit of this basis (i.e., deductions) will generally be allocated to X.
4. Y (and a related party) may form Z with the contribution of Y's business assets;Y may then sell a partnership interest in Z to X. If Z elects to step up X's tax basis in Z assets under Sec. 754, X will have the benefit of an FMV tax basis and associated tax deductions.
Generally, but for the antichurning provisions of Sec. 197(f)(9), any of these methods of forming Z would provide X with the benefit of an FMV tax basis (either through specially allocated tax deductions or an actual tax basis step-up) in its share of partnership assets (including goodwill), and X would obtain the benefit of associated amortization expense relating to relating to relate prep → concernant
relating to relate prep → bezüglich +gen, mit Bezug auf +acc acquired goodwill.
However, when Y acquires a greater-than-20% interest in Z, the antichurning rules may apply to deny Z (and therefore X) amortization of acquired goodwill. The proposed regulations specifically address the four circumstances CIRCUMSTANCES, evidence. The particulars which accompany a fact.
2. The facts proved are either possible or impossible, ordinary and probable, or extraordinary and improbable, recent or ancient; they may have happened near us, or afar off; they are public or outlined above:
* When X relies on deductions allocated to it under the curative curative /cur·a·tive/ (kur´ah-tiv) tending to overcome disease and promote recovery.
1. Serving or tending to cure.
2. or remedial REMEDIAL. That which affords a remedy; as, a remedial statute, or one which is made to supply some defects or abridge some superfluities of the common law. 1 131. Com. 86. The term remedial statute is also applied to those acts which give a new remedy. Esp. Pen. Act. 1. allocation methods of Sec. 704(c) to obtain the benefit of its cash equity relating to goodwill, Prop. Regs. Sec. 1.197-2(g)(2)(vi) notes that curative or remedial allocations made to a partner that does not contribute goodwill will be treated in the same manner as the tax basis of contributed goodwill. Thus, under the "step-into-the-shoes" rue of Sec. 197(f)(2), the curative or remedial allocations will not be "amortizable" if the goodwill basis contributed by Y is not amortizable. If the regulations are adopted as proposed, X will not be able to rely on Sec. 704(c) to recover the basis of its share of the goodwill. Note: It appears that this rue applies regardless of whether the antichurning rues apply to the transaction. Thus, this is the least desirable manner in which to attempt to obtain the benefit of tax basis for X for its share of Z's goodwill.
* In the context of a disguised sale under Sec. 707(a)(2)(B), Z is treated as if it purchased a portion of the goodwill of Y's business in exchange for cash that had been contributed to Z by X. Generally, Z would take a basis in such purchased asset equal to the asset's FMV and would be able to amortize amortize
To write off gradually and systematically a given amount of money within a specific number of time periods. For example, an accountant amortizes the cost of a long-term asset by deducting a portion of that cost against income in each period. or depreciate depreciate v. in accounting, to reduce the value of an asset each year theoretically on the basis that the assets (such as equipment, vehicles or structures) will eventually become obsolete, worn out and of little value. (See: depreciation) it. However, if Y acquires a greater-than-20% interest in Z, Prop. Regs. Sec. 1.197-2(k), Example (15), illustrates that X will not receive the benefit of amortization deductions with respect to purchased goodwill. Under Sec. 197(f)(9), Y and Z will be related parties; because Y held the goodwill during the transition period, Z will be unable to amortize the purchased goodwill for X's benefit.
* To avoid the limitations described, X may try to purchase its share of Z's goodwill from Y before forming Z. Clearly, such a purchase by a party unrelated toY generally provides amortizable basis to X. Under Sec. 197(f)(2), one would expect X would obtain amortizable tax basis relating to the goodwill.
Prop. Regs. Sec. 1.197-2(h)(10) provides that, if both the antichurning rules of Sec. 197(f)(9) and the "step-into-the-shoes" rue of Sec. 197(f)(2) apply, the antichurning rues control. Thus, although the goodwill is amortizable in X's hands, if X contributes its purchased goodwill to Z and Z is related to Y because Y has a greater-than-20% interest in Z, the goodwill contributed by X will cease to be amortizable goodwill; X, thus, will not obtain the benefit of amortizable tax basis. Prop. Regs. Sec. 1.197-2(k), Example (16), illustrates the application of this provision.
If Y forms Z with a related party, contributes the intangible to Z and then sells an interest in Z to X (in an unrelated transaction), Z will be treated as owning two assets. X's proportionate pro·por·tion·ate
Being in due proportion; proportional.
tr.v. pro·por·tion·at·ed, pro·por·tion·at·ing, pro·por·tion·ates
To make proportionate. share of Y's contributed goodwill is one asset, and it is not amortizable by Z for X's benefit. X's step-up in goodwill under either Sec. 734(b) or 743(b) will be the second asset; this basis will be amortizable by Z for X's benefit (assuming X and Y are not related). Even in this case, although X has achieved amortizable basis for the step-up in goodwill, the portion of basis that Y contributed that was essentially purchased by X is not refreshed into amortizable basis for X's benefit; see Prop. Regs. Sec. 1.197-2(g)(1)(B) and 1.197-2(k), Example (17).