According to Tucker, Section 197 -- Amortization of Goodwill and Certain other Intangibles -- does define "intangible," and covenants not to compete indeed are enumerated with the other intangibles of Section 197. Says Tucker, "The only real difference with a covenant not to compete as opposed to the others is that you have to have acquired this covenant not to compete in the context of an acquisition of a business, either direct or indirect. That is the difference, and there's been some litigation over exactly what that means. The bottom line is that once you've identified it as a 197 asset, you amortize it over 15 years," as required by the Tax Code.

 

Recent cases brought before the Tax Court, however, have allowed companies to argue that it had not created the intangible when it acquired any interest in a trade or business. For instance, a car dealership in Montana argued the intangible was created when it redeemed stock, not when it acquired interest in the business, and was amortizing the intangible over 60 months. The Tax Court disagreed, however, and the car dealership was told it should amortize its payments over the longer, 15-year period.

 

This situation, says Tucker, is a common one, especially for many closely held businesses. And it makes advisers think twice on what tax strategy to recommend to a client that is acquiring a business. 

 

In the end, Tucker approaches the controversy with a common sense solution. He emphasizes "the bottom line: Don't let these tax issues wag this big dog. When these people decide to come together, this is an economic deal, and we will facilitate that economic deal by telling them 'This is the way you can structure the deal as opposed to another way.' There are various alternatives, but the deal has to make economic sense. It makes no sense to put that tax structure before the economic deal."

 

The entire interview with Michael Tucker is available through the The CPA Report segment, Amortizing Covenants Not to Compete. Access the multi-media presentation and transcript free of charge, or earn NASBA-approved CPE credit for the one-hour segment.