Allocation of Purchase Price for Tax Purposes
By Robert F. Reilly
Merger and acquisition activity continues to pose tax accounting challenges. In February 2001, the IRS issued final regulations related to purchase price allocations for qualified stock purchases deemed asset acquisitions under IRC section 338 and actual asset acquisitions under IRC section 1060. These final regulations apply to both qualified stock purchases and actual asset purchases occurring after March 16, 2001.
Asset Class Allocations
Under both IRC sections 338 and 1060, the calculated total purchase price is sequentially allocated among specifically identified categories—or classes—of acquired assets. A semi–final asset category captures acquired identified intangible assets, while the final asset category consists of acquired goodwill. The amount of the transaction purchase price allocated to goodwill is based on the residual method, which assigns to goodwill the transaction purchase price remaining after all allocations to acquired financial assets, personal property, real estate, and identified intangibles.
Treasury Regulations section 1.338-6 describes the classes of acquired assets to which the total transaction purchase price, referred to as the adjusted deemed selling price (ADSP) and as the adjusted grossed-up basis (AGUB), is allocated. Exhibit 1 provides a summary of the Treasury Regulations section 1.338-6 asset classes.
The total transaction price is allocated based on the fair market value of the acquired assets. Under Treasury Regulations section 1.338-6, the total transaction price is allocated sequentially to the following seven asset classes: 1) cash and general deposit accounts, 2) actively traded securities, 3) other securities and accounts receivable, 4) inventory, 5) tangible personal property and real estate, 6) Section 197 intangible assets except for goodwill, and 7) goodwill and going concern value.
Treasury Regulations section 1.1060-1(c) describes the asset classes that are used to allocate the total consideration paid in a business combination structured as an asset acquisition. Basically, section 1.1060-1(c)(2) refers to the same asset classes described under the IRC section 338 purchase price allocation regulations, but section 1.1060-1(d) also provides a simple, but informative, example of an IRC section 1060 purchase price allocation. Exhibit 2 provides a summary of the Treasury Regulations section 1060-1(c) asset classes.
On January 1, 2001, S, a sole proprietor, sells to P, a corporation, a group of assets that constitutes a trade or business under Treasury Regulations section 1060-1(b)(2). S, who plans to retire immediately, also executes in P’s favor a covenant not to compete. P pays S $3,000 in cash and assumes $1,000 in liabilities. Thus, the total consideration is $4,000.
On the purchase date, P and S also execute a separate agreement which states that the fair market values of the Class II, III, V, and VI assets S sold to P are as follows:
|Asset Class||Asset||Fair Market Value|
Actively traded securities
Total Class II
Total Class III
|V||Furniture and fixtures||$800|
|Total Class V||$2,200|
|VI||Covenant not to compete||$900|
|Total Class VI||$900|
P and S each allocate the consideration in the transaction among the assets transferred under Treasury Regulations section 1060-1(c) in accordance with the agreed-upon fair market values of the assets, so that $500 is allocated to Class II assets, $200 is allocated to the Class III assets, $2,200 is allocated to Class V assets, $900 is allocated to Class VI assets, and $200 ($4,000 total consideration minus $3,800 allocated to assets in Classes II, III, V, and VI) is allocated to the Class VII assets (goodwill and going concern value).
IRC Section 197 Rule
IRC section 197 provides the following general rule related to the amortization of intangible assets acquired in a taxable M&A transaction:
A taxpayer shall be entitled to an amortization deduction with respect to any amortizable section 197 intangible. The amount of such deduction shall be determined by amortizing the adjusted basis (for purposes of determining gain) of such intangible ratably over the 15-year period beginning with the month in which such intangible was acquired.
Section 197(d) provides the following list of purchased intangible assets that qualify for 15-year amortization deductions:
Under IRC sections 338 and 1060, all IRC section 197 intangibles except goodwill and going concern value are considered class VI acquired assets. Also, under sections 338 and 1060, section 197 intangibles’ goodwill and going concern value are considered class VII acquired assets.
Edwin B. Morris, CPA
Rosenberg Neuwirth & Kuchner
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