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The Supreme Court of the United States recently held in Newark Morning Ledger Co. v. United States(1) that customer-based intangible assets, such as newspaper subscription lists, can be depreciated for federal tax purposes.(2) In a 5-4 decision, the Court held that an intangible asset is depreciable if two conditions are met: (i) the asset has a limited life that can be reasonably estimated; and (ii) the asset can be valued. This decision thus rejects the Internal Revenue Service's per se rule that customer-based intangibles acquired in the purchase of a going concern are indistinct from (non-depreciable) goodwill. The decision in Newark Morning Ledger will directly affect the disposition of many intangible asset disputes currently under audit or in litigation. According to a recent General Accounting Office report, in 1989 the IRS's open cases on customer-based intangibles alone accounted for proposed adjustments of more than $4 billion.(3) Newark Morning Ledger, however, will not summarily resolve these disputes. Indeed, the Court's opinion emphasizes the heavy burden a taxpayer must carry in establishing that the two-part test for depreciation is satisfied.
When the assets of a going concern are acquired by purchase (either outright or by way of a stock acquisition followed by liquidation), the "residual method" is used to allocate the purchase price to the various acquired assets.(4) Under this method, the total purchase price is allocated to assets other than goodwill to the extent of their fair market values and any residual cost basis is allocated to goodwill. In an effort to allocate as little cost basis as possible to the residual goodwill, purchasing companies have argued for the existence of various acquired (non-goodwill) intangible assets to which a portion of the purchase price can be allocated and recovered through depreciation. The GAO report indicated that the value of non-goodwill intangibles reported by taxpayers increased from $45 billion in 1980 to $262 billion in 1987. To support both an limited life and ascertainable value of these acquired intangibles, taxpayers have made extensive use of modern statistical methodologies. Customer-based intangibles (e.g., customer lists, newspaper and magazine subscription lists, and bank core deposits) have attracted much of the attention surrounding the issue of intangible asset depreciation, but taxpayers' overall ingenuity in this area has been impressive. Exhibit...