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Client purchase

Margaret CPA in OH

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A new client of mine does writing for advertising, etc. She 'purchased' a client (not a client list, just one) from another such agency for $3165. This is new to me so not sure if just an expense or needs to be capitalized and, if so, for how long. I think it would be a customer based intangible, just not certain. Any guidance greatly appreciated!

Edited by Margaret
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>>It isn't a client list<<

It doesn't matter what you call it--account, relationship, access--it is a customer-based intangible asset.

However, I regret to inform you that these are not (N-O-T) amortizable unless they are part of acquiring an entire business. Since that isn't your scenario, the $3165 must stay on the books unrecovered until the asset is disposed of.

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Thanks, jainen, for chiming in. That term, customer based intangible, came right out of my handy dandy Quickfinder section on intangible assets-section 197, where it states this intangible (IF that is what a single client is) is subject to the 15 year amortization. I do, however, also see that it refers to acquiring assets that make up a trade or business or a substantial part of same.

So should my client contact the seller to see if this single client is a substantial (whatever that means) part of their business? I wonder what constitutes disposition of this asset. Would that be a formal termination of a business relationship from my client or from this purchased client? This seems a kind of crazy situation. Would you happen to have handy some additional references to substantiate this so that I can report same to this client (who won't be too happy, for sure)? I will research on my own in a few weeks but do appreciate this direction, even if it doesn't seem 'fair.'

Thanks again - always learning....

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Whatever you decide, maybe your client needs to evaluate this from a business perpective and not get too hung up on the tax side.

Assuming a 40% tax rate, if it turns out that the acquisition cost could be written off in the year of acquisition, his net cost would be $1,900.

If it can be amortized over 15 years, he will realize the tax-deduction difference of $1,265 at an average of $84 per year.

If it isn't amortizable, he paid $3,165 for whatever revenue stream he is getting from the client.

Given those relatively small differences, I'm guessing that if the new client isn't worth $3,165, they probably aren't worth $1,900 either.

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Thanks, John, for chiming in and the calculations. I have no fear of losing this new client, a woman, by the way. I just want to be sure to do the correct treatment of this purchase, whether amortizing over 15 years, expensing or leaving on the books until disposition. I still don't know what would constitute disposition. She is just beginning this business and will be lucky to be in the 15% tax bracket.

I do like the comment about a revenue stream from the acquisition for however long my client retains her purchased client. What would disposition look like, though? As I asked, would my client have to send her purchased client some sort of termination letter at some point (or vice versa)? Would my client have to 'resell' this purchased client to another agency?

Clearly I have more questions than answers. One thing I intend to do is question my new client about 'industry norms.' Is it common to purchase a single client or a few from another agency? It seems a bit strange to me but that may be a very common occurrence. Stay tuned!

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>>it states this intangible (IF that is what a single client is) is subject to the 15 year amortization<<

No it doesn't. Get out your magnifying glass and see the itty bitty #1 there, with the footnote below. It doesn't matter whether it becomes a substantial part of her business, because she is not acquiring a business in this transaction. Oh, I suppose you could do some research on this point, but as John points out it couldn't possibly be cost effective.

Intangibles can be disposed of in all the same ways as tangible assets--sell, or trade, convert to personal, suffer a casualty loss, make a gift or donate to charity, abandon as worthless, etc. Generally a disposition involves an identifiable event that can be documented in support of the tax treatment.

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I know I'm not addressing your tax question directly, but that usually doesn't stop me from chiming in anyhow, especially in the off-season. Two points come to mind:

1) What assurances could she possibly have that she will retain the customer? Unless the customer is bound by the agreement, this "customer purchase" is nothing more than an expensive paper snowflake. If the customer has agreed to keep using your client's services for a period ot time, maybe there's something you could hang your hat on.

2) In the advertising business, 3 years is a long time to retain a customer. So the hard fact is that this likely won't matter much beyond 2-3 years anyhow, regardless of what your final decision may be regarding how to handle the purchase price. When the customer bolts, there's the deduction because jainen's last paragraph would kick in.

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Thanks again, jainen, but I think I will need more than a magnifying glass to see the verbiage to which you refer. I'm looking on page 10-23, 4562 Depreciation Section 179, of the Premium Quickfinder Handbook for 2011 tax year, left column, center, titled Intangible Assets-Section 197. I honestly do not see a little bitty #1 or a footnote of any kind on the page.

The paragraph reads: Fifteen-year amortization beginning with the month the asset is acquired applies to the following intangible assets that are purchased by a taxpayer (not self-created) in connection with acquiring assets that make up a trade or business or a substantial part of a trade or business: [iRC Sec 197(a)]

Goodwill, going-concern value or workforce in place.

Covenant not to compete.

Copyright or patent.

Franchise, trademark or trade name.

Customer based intangible (for example, composition of market or market share).

Supplier based intangible (for example, favorable contracts or shelf space at retail outlet).

License, permit or other right granted by a government unit.

Business books and records, operating systems or any other information base.

Computer software acquired in connection with the purchase of a business and not available to the general public.

The 15-year write-off period does not apply to movie or book rights that are not included in the purchase price of a business. Purchased mortgage servicing right can be amortized over nine years. [iRC Sec 167(f)(3)]

So I don't see an itty bitty #1 or a footnote but thought that the 'substantial' referred to the asset purchased as being a substantial part of the seller's business, not the buyer's. Regarding disposition, how would my client know for sure that this purchased client was no longer an asset (and therefore a disposition identifiable for documentation) without some sort of termination letter?

Just trying to do the right thing. Thanks again - I'll keep looking for it.

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Update: my client described the transaction.

And, the purchase of the single client: I used to work as managing editor at XYZ up until 2008. After I left, clients began to dwindle, which probably had something to do with the economic downturn. In the fall of last year, I heard from XYZ's owner, who said he was down to two clients, both accounts which I used to manage. He wanted to shut down the publishing side of the business and concentrate on the entrepreneurial training side and asked me if I wanted to purchase the clients. I said that I did. One of those two clients ended up falling through because he did not contact them to tell them what was going on. The other was ABC Insurance, which transitioned successfully at the beginning of this year.

The names have been changed....

I believe Section 197. I don't believe the client filed Form 8594, I have recommended it be filed and I doubt the seller filed. I have booked it on the balance sheet and will amortize as it clearly was that portion of the business and all of it.

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