Q: I purchased a sandwich shop that also sells basic grocery items. I bought the business in March 2019 and operated for about a year before I had to shut down. I reopened but am still struggling and am still reporting a monthly loss from operations. My CPA had me allocate the purchase cost to different assets including goodwill represented by the existing customers. The goodwill was the most significant asset. I showed a profit in 2019 but the 2020 year was a disaster with a large loss. I am allowed to use this 2020 business loss against my prior years’ income and get a tax refund but have not filed the 2020 return yet pending a significant tax question. The loss will be much larger if I write off the goodwill I purchased. The CPA says I cannot write off goodwill except as allowed by the IRS over 15 years. I believe I can prove the goodwill is exhausted. The business was shut down for much of 2020 and when I reopened, I had to work to build up business. Doesn’t it make sense that I can write off the 2019 goodwill of the old business owner? If you can point me to a tax source that says so it would help me with my tax preparer.
A: It sure does make sense that you should be able to write off goodwill that seems to have evaporated during the pandemic. But, you can’t. I will even try to convince you that the no write off makes sense.
Accounting rules generally allow you to write off the cost of a purchased asset that declines in value over time. This is usually called depreciation but is called amortization if the asset is intangible.
The tax law follows this general principle but assigns a different life to the asset than conventional accounting rules might suggest. However, for our purposes the concept is the same.
The IRS historically argued that goodwill could not be amortized for tax purposes. Amortization was allowed only if the taxpayer could show a specific useful life of the goodwill.
Goodwill often grows with the life of a business. Even if it does not grow, it can be very difficult to show the rate at which it declines. Without demonstrating a useful life, amortization could not be justified.
IRS had the upper hand in this argument and won many court challenges. Then almost 30 years ago, the Supreme Court heard the case of the purchaser of the Newark (New Jersey) Morning Ledger newspaper.
The buyer allocated purchase price to customers – customers make a newspaper valuable. The buyer also used past data to show the “useful life” of a customer of that newspaper.
The buyer’s homework project produced strong enough evidence to allow it to amortize the purchased intangible. The Supreme Court decision also offered a road map to others that could support amortization in other purchases.
IRS then supported legislation in Congress to specify a single life for purchased intangibles. That is why 15 years is the period used to amortize goodwill and other intangibles.
However, this legislation also denied an early write off of purchased goodwill provided the business to which it relates is still operating.
You seem quite logical in saying that goodwill that no longer exists should be able to be deducted in full when it is no longer useful.
The post-Newark Morning Ledger statutory rule that supports amortization of goodwill also has a logical reason why you should not be able to write off the goodwill.
The 15-year amortization period set by law is “revenue neutral.” This means it was a Solomon-like decision to split the baby in a way that helped administer the tax laws and avoid disputes over proof of useful life.
To keep it revenue neutral the rule had to ensure that you stayed true to the 15-year write off. The only exception is if the business itself disappears.
Your goodwill may be dead. However, your business is still alive. Because that is the business to which that goodwill attached when you purchased it in 2019, your write-offs must continue for 15 years or until the business dies, whichever is earlier.
James R. Hamill is the Director of Tax Practice at Reynolds, Hix & Co. in Albuquerque. He can be reached at firstname.lastname@example.org.