Trademarks and trade names after the RRA.

Companies with expenditures in connection with trademarks and trade names must determine how to treat such costs in light of Sec. 197, enacted as part of the Revenue Reconciliation Act of 1993 (RRA). Although Sec. 197 is beneficial in most instances, the ability of companies to amortize costs associated with trademarks and trade names is unclear if the trademark or trade name existed before Sec. 197 was enacted, but the costs were incurred afterward. Since guidance on Sec. 197 is not anticipated in the near future, companies must make judgments now about how to treat such costs.

The first step in analyzing the treatment of trademark and trade name costs is to determine whether such costs must be capitalized. Although most costs associated with trademarks and trade names are required to be capitalized, the courts have consistently held that certain expenses are deductible under Sec. 162. It is important to note that the determination of which costs must be capitalized or deducted was not affected by the enactment of Sec. 197. Examples of deductible costs include expansion costs attributable to advertising and promotional expenses, litigation expenses incurred by a losing party, settlement payments for lost profits or past royalties, and contingent serial payments under Sec. 1253(d)(1).

The next step is to determine the treatment of the capitalized costs under Sec. 197. Trademarks and trade names acquired or created after Aug. 10, 1993 are considered Sec. 197 intangibles. Thus, the costs associated with acquiring or creating these trademarks and trade names (i.e., those properly chargeable to a capital account) are subject to amortization over a 15-year period. in addition to these costs, there are many costs associated with trademarks and trade names that are incurred subsequent to the acquisition or initial registration (e.g., renewals, expansion costs and litigation costs).

Federal trademark registrations are renewable for additional 10-year terms, and can be renewed indefinitely. The costs associated with trademark and trade name renewals is one cost that is specifically addressed in Sec. 197. The costs associated with a trademark or trade name renewal are treated as an acquisition of a new Sec. 197 intangible. Thus, the costs associated with such renewals are subject to 15-year amortization. On the trademark or trade name renewal, the costs of original issuance or a prior renewal cannot be written off, but must continue to be amortized over the remaining portion of the amortization period that began at the time of issuance or prior renewal.

Expansion costs and litigation costs associated with trademarks and trade names can be significant. Unfortunately, there currently is no guidance on how such costs will be treated under Sec. 197. As a general rule, costs that relate to a capital asset incurred subsequent to it being placed in service are added to basis and amortized over the remaining useful life of such asset. There is some question, however, as to whether the additional costs relate to an existing capital asset, or whether a new asset is created. In the context of trademarks and trade names, the answer to that question can be beneficial or detrimental, depending on whether the trademark or trade name was in existence before Sec. 197's enactment.

The regulations could take the position (based on prior case law) that legal costs, for example, incurred in connection with the defense of title to a trademark are added to its basis, since the establishment of a company's ownership rights to the trademark increases its value.

Alternatively, the regulations could treat costs incurred in connection with trademarks and trade names in a manner similar to the rule for renewals. in that case, a separate asset would be established and amortized over 15 years.

The alternatives provide differing results depending on when the original trademark or trade name was purchased or acquired. Under prior law, trademarks and trade names were often nonamortizable. For example, the capitalized costs of creating a trademark or trade name incurred after 1986 were nonamortizable unless a useful life could be established. Since trademarks and trade names are subject to indefinite renewals, establishing a useful life was unlikely in most cases. Furthermore, in an outright purchase, in which the transferor did not retain a significant power, right or continuing interest, amortization could only be claimed if a useful life could be established.

The following examples illustrate the importance of the effective date in analyzing the alternatives.

Example 1: Company A develops and registers a trademark in 1990. The development and registration costs are capitalized and no amortization is allowed, since a useful life cannot be established to claim amortization under Sec. 167.

In 1995, A defends the title to its trademark in an infringement suit. The legal fees total $500,000. A receives a favorable judgment and retains its rights to the trademark. Question: Are the legal fees incurred by A amortizable under Sec. 197.2 Alternative 1: The fees would be capitalized as part of the cost of the trademark. The trademark is a pre-Sec. 197 intangible that was not amortizable under See. 167, so no amortization would be permitted. Alternative 2: A treats the fees as a separate Sec. 197 intangible, amortizable over 15 years.

Example 2: Assume the same facts as in Example 1, except that the trademark was developed and registered in 1994. Alternative 1: The $500,000 would be added to the basis of the trademark and amortized ratably over the remaining Sec. 197 amortization period of 14 years. Alternative 2: The $500,000 would be treated as a separate Sec. 197 intangible, amortized over 15 years.

In summary, the costs associated with trademarks and trade names can be significant. Companies must carefully analyze the costs to determine which are deductible which are capitalized. but, clearly amortizable under Sec. 197, and which are capitalized and may be amortizable under Sec. 197. Absent guidance on Sec. 197 from the Treasury, companies must make judgments on how the effective date affects the treatment of the capitalized costs associated with trademarks and trade names.