Tangible, and legal, tax breaks exist for intangibles

Any veterinarian willing to look for them can find any number of legitimate tax breaks.

But who among us has searched among the intangible assets of the practices for similar tax deductions? Last year, the Internal Revenue Service (IRS) issued guidelines for expenditures related to intangible assets, such as the practice's good will, licenses, leases, patient/client lists and the like. More recently, the IRS issued guidance relating to tax deductions for the costs of acquiring, creating or enhancing those intangible assets.

The new guidelines might herald the beginning of a crackdown in this area. Those guidelines should remind every veterinarian that tax deductions exist for more than the basic cost of the asset. Under these guidelines, for example, special tax treatment for the costs of acquiring, creating and enhancing intangible assets is required.

Today, every veterinary practice must continue to capitalize the costs of acquiring intangible business assets. The veterinarian and the practice also must capitalize expenditures made to facilitate the acquisition or creation of assets for the practice or business.

Legal expenses generally are considered legitimate, immediately deductible business expenses. If, however, those legal expenses are for services to negotiate an intangible asset, such as a lease, arrange financing, sell or buy an interest in a practice or obtain necessary licenses or permits, then they must be labeled differently under the new guidelines. After all, legal expenses are expenditures made to acquire, enhance or maintain intangible assets.

Intangible but valuable

Making the most of the practice's assets has a great deal to do with its success. Fully using those practice assets involves reaping the most from the tax rules. But how can you use those confusing and complex tax rules to benefit from the intangible assets of your veterinary practice?

The tax laws permit any veterinary practice to offset its income with deductions for operating expenses. Capital expenditures for fixtures, equipment and other longer-lived practice assets may be recovered using depreciation deductions spread over the "useful lives" of those assigned by our lawmakers. The practice's intangible assets—the goodwill built-up over the years, its patient or client list, trade name, leases, licenses, permits and the like—are another story.

What's an asset?

At its most basic, the tax law denies a tax write-off for any asset, tangible or intangible, to which a value cannot be assigned or does not have a clearly identifiable "life." The land where the practice's office sits is a good example of a practice asset that has no tax deduction. A value often can be placed on that land, but how can anyone say that the land will not be there 10, 20, 30 or more years from now. Without a definite life, the cost of land is a non-deductible practice or business asset.

In a similar vein, how can you place a value on the good will you've built-up in your practice over the years? How can you say with any degree of certainty that your patient list only will contribute to the practice's success for a specific period of time?

There is a notable exception to the tax rules that allows a tax write-off for some intangible assets, even those to which no useful life can be assigned. Section 197 of the tax law creates a special tax break for intangible assets that are acquired rather than created. Purchased or acquired Section 197 intangibles may be written-off over a 15-year period, no questions asked.

Acquire and create

Under the new guidelines, every veterinarian must capitalize amounts paid to another party to, among other things, create, originate, enter into, renew or renegotiate with that party certain financial interests. That can mean capitalizing, rather than immediately writing-off or deducting amounts paid in connection with obtaining an ownership interest in a corporation, a partnership, a limited liability company or other practice entity. Or, it can mean capitalizing amounts paid to others in connection with acquiring or creating a debt instrument such as a loan agreement.

Similarly, a veterinarian also must capitalize prepaid expenses. Amounts paid to an organization to obtain, renew, renegotiate or upgrade a membership or privilege from that organization also must be capitalized. Certain rights obtained from a governmental agency, such as a license, patent, copyright, permit and the like, also must be capitalized.

Although the publication of these guidelines might herald the IRS' intent to look more closely at all intangible-related expenditures, they are not all-inclusive. That is, the regulations are quite specific, but only those expenditures covered must be capitalized.

The final rules do not require, for example, capitalization of amounts that are paid to facilitate a "restructuring or reorganization" of the veterinary practice's business entity, borrowing or re-capitalization. Those, as well as other, similar transactions, already are governed by other provisions contained in the tax code.

Fortunately under the new guidelines, many veterinarians can avoid the complex capitalization requirements for expenditures to acquire or create — or to facilitate the creation or acquisition — of intangible assets. Under a so-called "12-month" rule, for instance, a veterinary practice does not have to capitalize amounts paid to create (or facilitate the creation of certain rights or benefits with a brief duration.

The final rules also retain the $5,000 "de minimis" threshold as proposed earlier. Thus, expenditures to create, or facilitate the creation of, certain rights and benefits that are of limited duration or less than $5,000 paid to acquire or create other intangibles need not be capitalized.

That useful, unuseful asset: land

Under our tax laws, the cost of land is a capital expense for which no tax deduction can be taken. Taxes, interest and other expenses of maintaining that land as a capital asset are legitimate expenses of the practice, deductible on the annual tax return. Improvements made to that land, whether adding a building to house the veterinary practice, a parking lot or trees, shrubs and landscaping, also are capital expenditures. For the most part, however, improvements to land have a readily determinable life over which those costs can be written-off or deducted.

The zoning necessary for that land to be used by the practice is another capital asset, this time an intangible asset. Like the land itself, establishing a life for that zoning is difficult.

As the IRS recently has illustrated, the tax rules require that a separate capital asset be created for the expense of acquiring, creating or enhancing capital assets — tangible or intangible. Under the IRS' guidelines, the cost of acquiring permits, business licenses or even the cost of obtaining zoning are capital expenditures treated in the same manner as the capital asset they have acquired, maintained or enhanced. Similarly, legal fees and other expenses that many veterinarians think of as immediately deductible business expenses are required to be capitalized if for the purpose of acquiring, maintaining or enhancing land or another practice asset.

The new guidelines also require expenditures made to facilitate the acquisition of business assets be capitalized. Payments made to facilitate a loan, lease or other intangible assets are capitalized similarly. Capital expenditures can be defending a zoning variance to operate the veterinary practice, the amounts paid to a tenant to vacate the property needed to expand the practice, or improvements to that land made to acquire zoning, zoning variances, business licenses or the like.

It is increasingly more common to see a veterinary practice foot the bill to erect traffic lights, a turning lane or widen the access road leading onto the land where the practice operates. That is considered to be facilitating the use of that land, the zoning variance, business permit or license. Most of those land improvements are, however, usually turned over to the municipality or governmental unit that required them as a condition for granting the zoning variance, business permit or the like. Although they no longer are owned by the practice, the cost of those capital assets must be accounted for. Thus, a capital asset composed of the costs made to facilitate the acquisition of zoning, variances, business permits and the like is created.

Generally, the new guidelines do not require the costs associated with employees who might be involved in facilitating, acquiring or creating assets to be capitalized. Amounts that our lawmakers have labeled as "de minimis," generally may be ignored insofar as capitalizing is required.

The IRS release of these new guidelines outlining the tax treatment for the practice's assets, especially intangible assets, also apply to tax deductions for the costs of acquiring, creating or enhancing those practice assets. The release of these guidelines also might herald an IRS crackdown directed at veterinary practices and businesses that overlook, ignore or fail to properly account for these costs. Will the tax treatment of your practice's intangible assets and the costs associated with them help your practice grow or will it attract the unwelcome attention of the IRS?