tax law Tax law or revenue law is an area of legal study in which public or sanctioned authorities, such as federal, state and municipal governments (as in the case of the US) use a body of rules and procedures (laws) to assess and collect taxes in a ...

, amortization refers to the cost recovery system for intangible property. Although the theory behind cost recovery deductions of amortization is to deduct from basis in a systematic manner over an asset's estimated useful economic life so as to reflect its consumption, expiration, obsolescence or other decline in value as a result of use or the passage of time, many times a perfect match of income and deductions does not occur for policy reasons.

Depreciation

A corresponding concept for tangible assets is

depreciation In accountancy, depreciation is a term that refers to two aspects of the same concept: first, the actual decrease of fair value of an asset, such as the decrease in value of factory equipment each year as it is used and wear, and second, the ...

. Methodologies for allocating amortization to each tax period are generally the same as for depreciation. However, many

intangible asset An intangible asset is an asset that lacks physical substance. Examples are patents, copyright, franchises, goodwill, trademarks, and trade names, as well as software. This is in contrast to physical assets (machinery, buildings, etc.) and ...

s such as goodwill or certain brands may be deemed to have an indefinite useful life, or “self-created” and are therefore not subject to amortization.

In the United States of America

The

United States Congress The United States Congress is the legislature of the federal government of the United States. It is bicameral, composed of a lower body, the House of Representatives, and an upper body, the Senate. It meets in the U.S. Capitol in Washi ...

gives taxpayers larger deductions in the early years of an asset’s useful life.

Intangible property

Intangible property which is subject to amortization is described in 26 U.S.C. §§ 197(c)(1) and 197(d) and must be property held either for use in a trade, business, or for the production of income. Before 1993, the United States Tax Code did not contain provisions for cost recovery of intangible assets; rather, the intangible assets were depreciated under the current provisions for depreciation of tangible assets, 26 U.S.C. §§ 167 and 168. However, the problem before 1993 was that many intangible assets did not meet the burdensome requirements of §§ 167 and 168 because intangible assets can not necessarily be subject to “wear and tear”. This led to taxpayers having the incentive to ignore any basis in the intangible asset until it was sold. Under §197 most acquired intangible assets are to be amortized ratably over a fifteen-year period. This is not the best treatment of an intangible whose actual life is much shorter than fifteen years. Furthermore, if an intangible is not eligible for amortization under § 197, the taxpayer can depreciate the asset if there is a showing of the assets useful life.

Startup expenditure

Startup expenditures are defined as investigatory expenses incurred prior to commencing a trade or business activity which would have been deducted had they been paid or incurred when the taxpayer was already engaged in the trade or business activity. Unlike other sections in the tax code which do not allow current deductions for most startup expenses, section 195 allows a taxpayer to amortize start-up expenditures over a 180-month period.26 U.S.C. § 195. The policy behind this provision is to encourage taxpayers to explore new business ventures.

References

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