We have, by now, grown accustomed to the mixed blessing of Internal Revenue Code Section 197 governing the amortization of many intangible assets.  Purchasers of the assets of a business are thankful for the ability to write-off (albeit over 15 years) payments to acquire goodwill and other previously non-amortizable assets.  Purchasers wince at being required to spread deductions over 15 years for payments under non-compete agreements and certain other short-term assets. 

Amortizing Payments for Trademarks, Trade Names and Franchises.  These “Trade Names” are Section 197 intangibles; and, for income tax purposes, a purchaser generally must amortize over 15 years its payments to acquire Trade Names.  If the payments are to be made over a term exceeding 15 years, then Section 197 treatment may be desirable. 

However, many agreements call for payments over a shorter period (or simply have a shorter term).  Under a significant exception to Section 197, a purchaser may deduct when paid certain contingent payments made in acquiring Trade Names.  To qualify, the contingent payments must be: 

• Made in a series of payments, at least annually, throughout the term of the transfer agreement;
• Based upon productivity; and
• Payable either (a) in substantially equal amounts; or (b) based upon a “fixed formula.”

Purchasers have wide latitude in determining a “fixed formula,” and should be creative in designing one.  Certainly, the formula may provide for annual payments of a fixed percentage of receipts.  However, the formula could also contain a series of increasing or decreasing percentages up to, or in excess of, specified levels of productivity (i.e., variable percentages with ceilings or floors). 

There are two main restrictions: the formula cannot “potentially distort” the purchaser’s taxable income (translation: no front- or back-loading) or vary during any given year. 

Keep it in mind in your next negotiation.  It often beats 15 years.