How Accountants Can Use Amortization to Reduce Taxable Income When Buying a Practice

Can an accountant who purchases an accounting business amortize intangible assets from the transaction and use the resulting deductions to reduce ordinary income from the business?

Yes.

• Intangible assets such as goodwill, client lists, non-compete agreements, trade names, and covenants not to solicit can be amortized over 15 years, providing consistent tax deductions.

• Amortization expenses are deducted as ordinary business expenses, directly reducing taxable income from the accounting business. For example, a $300,000 allocation to intangible assets results in $20,000 annual deductions over 15 years.

• Proper allocation of the purchase price and compliance with tax laws, such as IRS Section 197, are critical for maximizing tax benefits, making professional advice essential.

1. Intangible Assets Eligible for Amortization:

When purchasing an accounting business, the purchase price is generally allocated to tangible and intangible assets. The intangible assets that can be amortized include:

• Goodwill:

  • The portion of the purchase price exceeding the value of tangible assets is classified as goodwill.

  • For U.S. tax purposes, goodwill is amortized over 15 years under IRS Section 197.

• Client Lists:

  • The value of the client base acquired as part of the transaction is amortizable over 15 years.

  • This represents the future economic benefits derived from retaining those clients.

• Non-Compete Agreements:

  • Payments for a non-compete agreement, if included in the purchase, are amortized over the term of the agreement (or 15 years if part of Section 197 intangibles).

• Trade Names or Branding:

  • If acquiring a recognized business name or branding, the cost is amortized over 15 years.

• Covenants Not to Solicit:

  • Agreements where the seller promises not to solicit former clients may also be amortized.

2. Amortization Against Ordinary Income:

• The annual amortization expense is deducted as an ordinary business expense.

• This directly reduces taxable income from the accounting business, offsetting ordinary income generated by the business.

Example:

An accountant purchases an accounting firm for $500,000:

• $200,000 is allocated to tangible assets (equipment, furniture).

• $300,000 is allocated to goodwill and client lists.

The $300,000 is amortized over 15 years, resulting in an annual deduction of $20,000. This deduction lowers the accountant's taxable income.

3. Benefits for the Accountant:

• The amortization deduction provides consistent tax savings over the 15-year period, helping offset ordinary income (e.g., fees earned from clients).

• It aligns with other business expenses like salaries, rent, and office supplies, cumulatively reducing the accountant's overall tax liability.

4. Important Considerations:

1. Proper Allocation:

   • A detailed purchase agreement and valuation are critical to properly allocate the purchase price among amortizable and non-amortizable assets.

2. Compliance:

   • The accountant must comply with tax laws (e.g., IRS Section 197 rules in the U.S.) to ensure the amortization deductions are valid.

3. Professional Advice:

   • A tax advisor or CPA should be consulted to structure the deal and optimize tax benefits while ensuring proper reporting.

Bottom Line:

Yes, the amortization deductions from the intangible assets of a purchased accounting business can typically be applied to reduce ordinary income, making this a powerful tax benefit for accountants acquiring practices.