Settling pending intangibles disputes - IRS guidance.

The IRS continues efforts to reduce the backlog of intangibles disputes that arose before the application of the uniform 15-year amortization rules provided under Sec. 197 (enacted in the Revenue Reconciliation Act of 1993).

Some taxpayers have received offers to resolve pending disputes under a nationwide intangibles settlement program unveiled by the Service earlier this year, which generally would require the taxpayer to reduce the basis or extend the useful life of acquired intangible assets for which amortization was claimed on their original tax returns. For taxpayers that do not receive settlement offers - or for those that declined such offers - the usual avenues for contesting or settling tax disputes remain available.

The IRS National Office has given field agents informal guidance as they continue their case-by-case examination of intangibles acquisitions. An in-house "handbook" outlining the settlement program also provides a capsule description of items IRS examining agents are instructed to look for in evaluating the taxpayer's treatment of intangibles when the settlement offer is rejected. The Service's approach highlights the importance of detailed workpapers and other documentation to support reason able valuation methodologies an assumptions.

For example, for acquisitions of customer-based intangibles (such as customer lists), the handbook confirms that the IRS recognizes that the tax savings realized from ownership of an amortizable intangible - the so-called "tax shield" - may be included in the intangible's fair,market value when calculated using the income approach. The handbook also confirms that the Service will accept accelerated amortization methods, so long as the method is consistent with the rate at which the asset was projected to waste for valuation purposes.

"Potential flaws" and difficulties that may arise as taxpayers attempt to value acquisitions of assembled workforce also are noted. The IRS handbook treats the presence of assembled workforce as an element of going concern value, indicating that some portion of the purchase price represents nonamortizable goodwill. Agents are directed to reallocate any value assigned to employment contracts if there is no substantial business reason, other than the acquisition, for the target to have entered into the contract.

The handbook reveals that the National Office is exploring an alternative approach of requiring capitalization of postacquisition hiring and training costs associated with the acquired assembled workforce.

The value and life of market-based intangibles - such as competitive market position, network affiliations, premium shelf space agreements and projected growth of a favored or protected market - are speculative in nature and amortization will not be allowed. Any value associated with future customers will be considered to represent a part of acquired goodwill.

An allocation to nonamortizable going concern value or goodwill is required, the handbook suggests, if the acquired business is profitable or includes any element the Service considers goodwill. While recognizing it is appropriate to use the residual method to determine going concern value, the handbook cautions agents to treat situations in which the residual method allocates nothing to goodwill as an indication that other assets have been overvalued.

The handbook does not provide guidance on the development of issues relating to covenants not to compete, franchises, trademark's, computer software or other types of intangibles.