In tax law

Tax law

Tax law is the codified system of laws that describes government levies on economic transactions, commonly called taxes.-Major issues:Primary taxation issues facing the governments world over include;* taxes on income and wealth...

, amortization refers to the cost recovery system for intangible property

Intangible property

Intangible property, also known as incorporeal property, describes something which a person or corporation can have ownership of and can transfer ownership of to another person or corporation, but has no physical substance. It generally refers to statutory creations such as copyright, trademarks,...

. Although the theory behind cost recovery deductions of amortization is to deduct from basis

Cost basis

Basis , as used in United States tax law, is the original cost of property, adjusted for factors such as depreciation. When property is sold, the taxpayer pays/ taxes on a capital gain/ that equals the amount realized on the sale minus the sold property's basis.The taxpayer deserves a tax-free...

 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

Depreciation

Depreciation refers to two very different but related concepts:# the decrease in value of assets , and# the allocation of the cost of assets to periods in which the assets are used ....

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

Intangible asset

Intangible assets are defined as identifiable non-monetary assets that cannot be seen, touched or physically measured, which are created through time and/or effort and that are identifiable as a separate asset...

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

United States Congress

The United States Congress is the bicameral legislature of the federal government of the United States, consisting of the Senate and the House of Representatives. The Congress meets in the United States Capitol in Washington, D.C....

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

Intangible property

Intangible property which is subject to amortization must be described in 26 U.S.C. §§ 197(c)(1) and 197(d) and must be property be held either for use in a trade, business, or for the production of income. Before 1993, the United States Tax Code

Internal Revenue Code

The Internal Revenue Code is the domestic portion of Federal statutory tax law in the United States, published in various volumes of the United States Statutes at Large, and separately as Title 26 of the United States 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, 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 15-year period. This is not the best treatment of an intangible where the actual life of the intangible is much shorter than 15-years because the asset would have be amortized over 15-years even if the actual life is, for example, only five 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.

Start-up expenditure

For amortization as it relates to start-up expenses for a new business or activity. Start-up expenditures are defined as investigatory expenses incurred prior to commencing a trade or business activity which would have been deducted had it been paid or incurred when the taxpayer was already engaged in the trade or business activity. Unlike other sections in the tax code which lack in allowing current deductions for most start-up expenses, section 195 allows a taxpayer prorate start-up expenditures over a 180-month period. The policy behind this provision is to encourage taxpayers to explore new business ventures.

Sources

• Samuel A. Donaldson. Federal Income Taxation of Individuals: Cases Problems, and Materials. 2nd ed. 2007.