What Is Tax Amortization Benefit

What Is Tax Amortization Benefit

What Is Tax Amortization Benefit adjustment is a critical element in assessing the present value of federal income tax savings derived from amortizing an acquired intangible asset over a specified period. Internal Revenue Code Section 197 allows certain intangible assets to be amortized for federal income tax purposes, but not all acquired intangible assets qualify for these deductions. It is essential for analysts to apply the TAB adjustment judiciously in intangible asset valuation analyses. This discussion offers insights into the considerations analysts should keep in mind when incorporating the TAB adjustment.

Introduction

What Is Tax Amortization Benefit
What Is Tax Amortization Benefit

In the realm of U.S. federal income tax, companies acquiring assets under Internal Revenue Code Section 1060 often require valuation analysts to perform purchase price allocations. Such allocations can also be relevant in specific stock acquisitions if the acquirer entity makes specific elections under Section 336(e) or 338(h)(10). The Financial Accounting Standards Board Accounting Standards Codification (ASC) Topic 805 outlines Generally Accepted Accounting Principles (GAAP) related to business combinations, instructing acquirers to recognize identifiable intangible assets separately from goodwill. ASC Topic 805-20 presents criteria for recognizing identifiable intangible assets in business combinations, emphasizing separability or contractual-legal aspects. GAAP employs fair value as the standard for financial accounting in business combinations, defined in ASC Topic 820 as the price in an orderly transaction between market participants at the measurement date.

ASC Topic 805-20 classifies identifiable intangible assets into various categories, including marketing-related, customer-related, artistic, contract-related, and technology-related intangible assets. For federal income tax purposes, acquirers can amortize the cost of many acquired intangible assets (Section 197 intangible assets) over a 15-year statutory period, resulting in tax deductions and savings.

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Application of TAB Adjustment 

What Is Tax Amortization Benefit
What Is Tax Amortization Benefit

Analysts can incorporate the TAB adjustment into intangible asset valuations using the income approach. The TAB adjustment considers factors like qualifying assets, appropriate valuation methods, transaction taxability, and the applicability of Section 197 in international business combinations. The application of the TAB adjustment may vary in practice, and analysts should carefully assess its suitability.

History of the TAB 

Section 197 was enacted to address historical disputes over the allocation of purchase prices in taxable business combinations, specifically for acquired intangible assets. It standardized income tax treatment for most acquired intangible assets, establishing a uniform 15-year cost recovery period. Section 197 encompasses various intangible assets, including goodwill, going-concern value, workforce, patents, copyrights, customer-based intangibles, licenses, permits, covenants not to compete, franchises, trademarks, and trade names. Self-created intangible assets, except for specific categories like licenses, permits, covenants not to compete, franchises, trademarks, and trade names, are generally excluded from Section 197’s amortization provisions.

TAB Adjustment Example 

What Is Tax Amortization Benefit
What Is Tax Amortization Benefit

The TAB adjustment enhances the income approach’s implied value of an intangible asset by considering the present value of future income tax savings from asset amortization. It involves variables like the present value discount rate, income tax rate, and the number of years for the tax deduction. A formula is often used to calculate the TAB adjustment factor. In an example, a TAB adjustment factor of 1.10316 corresponds to a 10.3% income approach value adjustment. The adjusted value is obtained by multiplying the unadjusted income approach value by the TAB adjustment factor.

Guidance on TAB Application 

What Is Tax Amortization Benefit
What Is Tax Amortization Benefit

The TAB adjustment should be applied judiciously, considering factors such as the type of valuation approach, taxability, and international implications. The Mandatory Performance Framework (MPF) recommends documenting the appropriateness of applying the TAB and assumptions used. While the TAB may be appropriate in an income approach for a taxable transaction, it is generally not suitable for cost or market approaches. Consideration of foreign transactions should also account for varying income tax rules.

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Summary and Conclusion 

Valuation analysts play a crucial role in assessing intangible assets’ value in taxable business combinations under Section 197. The application of the TAB adjustment, which allows for tax savings through asset amortization, should be considered carefully in valuation analyses. Analysts must evaluate qualifying assets, suitable valuation methods, transaction taxability, and international implications to ensure accurate and supported applications of the TAB adjustment.

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