Purchase of business- intangibles plus no interest loan

[KJ Judd]

Client purchased competitor's business (fixed assets, customer list & goodwill plus noncompete with former owner, who is now my client's employee). It's been awhile since I did one of these so I want to make sure I'm not missing anything.

1. The intangibles ($100k) are financed by a 10 yr 0% interest loan from seller (now employee). Impute interest at the long term AFR and include the Statement of Below Market loan on the tax return. Also need to issue a 1099-INT.

Question - is the interest calculated on the $100k loan or is the $100k loan discounted to $77k and interest deemed to be a portion of the payments?

2. Form 8594 needs to be filed & should agree with seller's Form 8594.

3. Noncompete, customer list and goodwill are all Sec. 197 intangibles amortize over 15 years. Do I need to do any information reporting (i.e. 1099s) on this or does the Form 8594 take care of that?

Am I missing anything?

[veritas]

Do you need to impute interest

on an asset (the non-compete covenant) that only generates ordinary income?

I can see where you would on the asset if it generates capital gain.

[Bees Knees]

The 8594 and 1099-INT takes care of all reporting requirements.

As to calculating imputed interest, I’m not sure what rule you are referring to when you come up with a $77k loan discount.

As to reporting imputed interest (ordinary income) verses gain on the sale of the non-compete covenant (also ordinary income), the rules were designed to prevent shifting ordinary income to capital gain. Having said that, the imputed interest rules are not limited to long term capital gain property. So even if it comes out the same, I would follow the rules and report the interest income. The buyer actually gets a break being able to deduct interest expense currently verses having to amortize the non-compete covenant over 15 years.

[veritas]

Good Topic

I read the exceptions to unstated interest and you are correct Bees. None of them apply in this case.

You will have to reduce the sales price by the amount of unstated interest.

[KJ Judd]

The $100k intangibles is only $10k noncompete with the remaining $90k for "customer list & goodwill" which is a capital asset. So imputing the interest will affect how it is taxed to the seller.

I did a rough present value of $100k over 10 years at 5% (roughly the long term AFR) and arrived at $77k.

I was confused when I read the imputed interest rules. Do I impute 5% interest on the $100k note? Or do I allocate the $100k total payments to interest and principal ($77k). The second method (allocate payments) seems to make more sense to me. However when I read the Sec. 7872 rules, it seems more like they're suggesting the first method.

[veritas]

I computed

a sales price of 78567.48.

That is 120 monthly payments at 833.33 each using 5% annual rate.

[Bees Knees]

a sales price of 78567.48.

That is 120 monthly payments at 833.33 each using 5% annual rate.

I agree. The imputed interest rules do not require you to pay tax on income you never received. If $100,000 is total cash received in the end, that is the most you will ever pay tax on. The rules simply re-characterize some of the principal sale price to interest.

[KJ Judd]

Thanks! I appreciate confirmation of my thoughts.