Amortization of goodwill?

[RodBurnsKS]

In 1996, I bought into an LLC for a business that provides personal services.  At that time, there were two other partners who had been running the business prior to that date.  On the date I joined, they valued the firm at an amount that included Goodwill, based on our existing client base, and I contributed cash to purchase a share of that firm.  Over the years, this Goodwill has been on our balance sheet and has never changed.  During this time, we were an LLC, filing a Form 1065

In 2016 I bought out the other two partners, leaving just myself as a sole proprietor LLC.  At that time I switched from filing a Form 1065, to filing Schedule C on my form 1040.  As a result of their retirement, I had to sell off approximately 50% of the business's client base due to not having the staff to continue servicing all of our clients.  Another firm purchased these clients from me and I used that money, along with personal funds, to help buy out the two retiring partners.

My question is this - the Goodwill from the original purchase is still on the books but the business is not worth anywhere near that much any more (due to having a smaller client base since 2016).  Should we have been amortizing that Goodwill over the years?  Is there a way to catch it up now?  Or is there a way I can write-down the Goodwill amount now to remove the 50% that was sold back in 2016?

How would I show this in TurboTax, or does it even affect my taxes?

[Rick19744 · Accepted solution]

While your "books" may have goodwill recorded, the only time you have goodwill for tax is if it was purchased.

When you acquired your interest in 1996, and based on your facts you paid more than book value, the LLC should have made a Section 754 election along with a Section 743 adjustment at that time.

This adjustment, depending on the assets involved, would have been amortized over the years and specially allocated to you on your K-1.

Since there are a number of questions and unknown facts, I recommend you meet with a tax professional where you can have a one on one to straighten this out.  You have a mess based on the limited facts, and the length of time that has passed is not in your favor.

[RodBurnsKS]

Thank you for the quick reply.  I was afraid that might be the case.

[Mike9241 · Accepted solution]

in my opinion that goodwill they booked had a zero tax basis and should never have been booked. your tax basis is what you paid +/- the income and expenses reported on the k-1s over the years. since they booked GW they could have amortized it for book purposes but it would have had no effect on your tax reporting since its tax basis is zero.  when you bought out those two partners you paid more or less than the tangible value of their interests (ignoring that old goodwill)  say you paid 60K when the tax basis of their share of the assets was 50K in effect you paid 10K in goodwill eligible for amortization. at this point your tax basis would be your partnership basis + what you paid then to buy out their interests.  then you sold approxomately 50% of the business which would result in a recognized gain of proceeds less a portion of the amount you paid for goodwill when you bought out the partners.    now your tax basis is the partnership basis+ what you paid the partners less a reduction for the tax basis in the portion of goodwill sold.  you can write off the original goodwill but because it has zero tax basis you get no deduction.  what you have is a tax basis that probably exceeds the tax basis of the net assets. should you sell the business for less than your tax basis you will have a capital loss  

here's an example of how things could have been recorded when you originally bought in. say the FMV of the entity is $90K and your getting a 1/3 interest so you pay $30K  debit cash $30K credit your capital account 

$30K. now let's say their capital accounts were $15K each so now the partnership has $60K in net assets (your $30K plus $15K for each of them) that's $30K short of FMV so they debit Goodwill $30K and credit each of their capital accounts $15K. That $30K is purely a bookkeeping entry that has a zero tax basis. your tax basis after this is $30K and theirs is still $15K each.    

[RodBurnsKS]

Thank you!  So what it sounds like is I should probably just write off the Goodwill that's on the books and then if I eventually sell the business, I will have a gain/loss based on the actual amount I paid in cash vs. what I sell it for?

[Rick19744]

The goodwill that was "booked" could have been internal book goodwill for GAAP and not amortized.

[Rick19744]

No.

You need to meet with a tax professional before writing anything off.

You most likely have book to tax differences as a result of booking goodwill on the balance sheet.

You most likely have tax basis as a result of the original purchase price and with the multi-member LLC becoming a SMLLC, you need to look at the impact of not making a Section 754 election with a Section 743 adjustment with annual deductions.

While I don't know the $$ involved, you don't want to be penny wise and pound foolish and miss out on a potential tax loss, so meeting with a tax professional who can get all the facts will be worth your time and $$.

[RodBurnsKS]

I am scheduling an appointment - thanks everyone for the advice