Although the sale of many closely held corporations generally involves the sale of an S corporation, closely held C corporations still exist. In the process of selling the business of a closely held C corporation, the concept of the sale of personal intangibles should be considered in structuring the transaction.
What Are Personal Intangibles?
Personal intangibles consist of intangible assets owned by an individual shareholder that are held separate from the corporate business. The ability to sell these separate intangibles was addressed in Martin Ice Cream Co., 110 T.C. 189 (1998), in which the Tax Court ruled that the shareholder held distribution agreements, supermarket personal relationships, and ice cream distribution expertise separately from the shareholder’s wholly owned corporation. As a result, at the time when both the assets of the corporation and the personal intangibles were sold, the individual was able to report the gain on the sale of these intangible assets outside of the corporate return and therefore avoid double taxation. It is important to note that in Martin, the Tax Court noted that there was no agreement between the corporation and the individual that “would have caused those relationships to become the corporation’s property.” This is an important issue in the establishment of the existence of personal intangibles, but it is beyond the scope of this item.
Antichurning Regulations
The Sec. 197(f)(9) antichurning rules provide that in certain circumstances goodwill, going concern value, and other intangible assets for which depreciation or amortization previously would not have been allowable and that were held or used by the taxpayer or a related party at any time during the transition period (July 25, 1991–August 10, 1993) cannot be converted into Sec. 197 amortizable intangible assets. Regs. Sec. 1.197-2(h)(2) outlines three scenarios where intangible assets acquired after the effective date of the antichurning rules do not qualify for amortization:
- The taxpayer or related person held or used the intangible or an interest therein at any time during the transition period;
- The taxpayer acquired the intangible from a person that held the intangible at any time during the transition period and, as part of the transaction, the user of the intangible does not change; or
- The taxpayer grants the right to use the intangible to a person that held or used the intangible at any time during the transition period (or to a person related to that person), but only if the transaction in which the taxpayer grants the right and the transaction in which the taxpayer acquired the intangible are part of a series of related transactions.
The definition of “related person” for purposes of Regs. Sec. 1.197-2(h) (2) is a person that bears a relationship specified in Sec. 267(b) and, by substitution, Sec. 267(f)(1), if those sections were amended by substituting 20% for 50%, or Sec. 707(b)(1), if that section was amended by substituting 20% for 50%. It is important to note that the relationship is measured, in the case of a single transaction, immediately before or immediately after the transaction in accordance with Regs. Sec. 1.197-2(h)(6)(ii)(A) or, in the case of a series of related transactions, immediately before the earliest transaction or immediately after the last transaction in accordance with Regs. Sec. 1.197-2(h)(6)(ii)(B). These measurement dates of the relationship between two parties have the potential to result in the antichurning rules being applicable to a stock sale accompanied by the sale of personal intangibles.
Antichurning Implications in a Stock Sale
Whether parties are related is determined immediately before and immediately after a sales transaction (or series of transactions) under the antichurning rules. As a result, the effectiveness of selling personal intangibles may be questionable for the parties to a stock transaction. Regs. Sec. 1.197-2(h)(2)(i) would appear to subject personal intangibles (in existence during the transition period) to the antichurning rules in a situation in which personal intangibles are sold to a closely held C corporation as part of a sale of the C corporation to an unrelated third party. To be subject to the antichurning rules in Regs. Sec. 1.197-2(h) (2)(i), the individual selling the personal intangibles would need to be a related party to the C corporation, which would occur if the individual was a greater than 20% owner (measured by value or voting power) of the corporation being sold in conjunction with the sale of the personal intangibles.
Field Service Advice 200106006 (revised) also provides some insight into the IRS’s position on the applicability of the antichurning rules to the sale of personal intangible assets along with stock. The FSA involved the sale of personal intangible assets to a corporation by a 10% shareholder, along with the sale of the 10% interest to the 90% owner. The FSA concluded that the transferred intangible assets were indeed amortizable. More important to the potential antichurning issues discussed earlier in this item is the indication in the FSA that if the individual selling the intangible assets had owned greater than 20% of the corporation purchasing the intangibles (in conjunction with the sale of the stock), the corporation would not be able to amortize the purchased intangibles, which is consistent with the above discussion.
Note: Regs. Sec. 1.197-2(h)(2)(i) is unclear as to whether the antichurning rules would be applicable to the sale of personal intangibles to a corporation (such as a holding company) that is acquiring the closely held C corporation and the personal intangibles from the same party because the term “taxpayer” is not defined in Regs. Sec. 1.197-2(h)(2). The term “related party” should not apply to the holding company and the individual seller under Regs. Sec. 1.197-2(h)(6) unless the selling individual owns greater than 20% of the acquiring holding company. As a result, it would appear that the holding company would need to be considered the taxpayer for the antichurning rule of Regs. Sec. 1.197-2(h)(2)(i) to apply. If the undefined term “taxpayer” was determined to be broad enough to include an affiliated group, the personal intangibles sold to a corporation acquiring the stock of the closely held C corporation may be subject to the antichurning rules of Regs. Sec. 1.197-2(h)(2)(i).
Another potential concern is that Regs. Sec. 1.197-2(h)(2)(ii) may create antichurning issues if the user of the intangible is deemed to have not changed as a result of the transaction. Sec. 197(f)(9) (A) indicates that “the determination of whether the user of property changes as part of a transaction shall be determined in accordance with regulations prescribed by the Secretary.” However, no such regulations have been issued to date. The idea that the closely held corporation was the user of the intangible would appear to be at odds with Martin. In Martin, the court ruled that the intangible asset was in fact not possessed by the corporation but by the individual; as a result, using the logic of Martin, any potential antichurning issues created by Regs. Sec. 1.197-2(h)(2) (ii) may not be applicable.
Contrasting the logic of Martin to the plain meaning of “user,” defined as “one who uses,” and “use,” defined as “the act or practice of employing something,” may result in a different conclusion. Using the plain meaning of “user,” the user of the intangible could be considered unchanged when personal intangibles are sold along with the stock of a closely held C corporation because the C corporation could be viewed as a user of the intangibles both before and after the sale, which would result in the applicability of Regs. Sec. 1.197-2(h)(2)(ii). Regs. Sec. 1.197-2(h)(2) (iii) creates similar concerns.
Application of the Antichurning Rules to an Asset Sale
In contrast to the above discussion of the effects that Regs. Sec. 1.197-2(h)(2) can have on personal intangibles combined with a stock sale, there generally should not be similar effects on an asset sale by an individual that is combined with the sale of personal intangibles. Assuming the acquirer is not a related party (i.e., the seller will not have a greater than 20% actual or constructive ownership interest in the acquirer), the acquired intangible asset should be amortizable under Sec. 197.
It should be noted that there also is no antichurning issue in a Sec. 338 transaction if the acquiring corporation is not a related party because Regs. Sec. 1.197- 2(h)(8) provides special rules for Sec. 338 deemed-asset acquisitions. In the case of a qualified stock purchase that is treated as a deemed-asset sale, the corporation treated as purchasing the assets is not considered the person that “held or used the assets during any period in which the assets were held or used by the corporation treated as selling the assets” (Regs. Sec. 1.197-2(h)(8)).
EditorNotes
Frank O’Connell Jr. is a partner in Crowe Horwath LLP in Oak Brook, IL.
Unless otherwise noted, contributors are members of or associated with Crowe Horwath LLP.
For additional information about these items, contact Mr. O’Connell at (630) 574-1619 or frank.oconnell@crowehorwath.com
