Pub. 2 2020 Issue 5

25 nebraska society of cpas W W W . N E S C P A . O R G 800-397-0249 www.APS.net Trent Holmes Trent@APS.net STARTING your practice? GROWING your practice? SELLING your practice? Whatever stage you’re in... Our Best-in-class Brokers will help you achieve YOUR goal! $1 Billion+ in Deals Closed off-balance-sheet to ensure that no tax deduction is recognized for this amount. At the end of 2017, the $750,000 increase in the reserve ($2 million to $2.75 million) would be disallowed as a deduction for tax purposes and there would be no change to the floor. This assumes the increase relates to new reserves recorded as a debit to warranty expense of $750,000 and a credit to warranty reserve of $750,000. As of the end of 2018, the net balance decreased by $350,000 ($2.75 million to $2.4 million), which included an increase of $150,000 in new liabilities and a $500,000 payment against the target’s floor amount. As a result, $150,000 is disallowed as a current deduction and the floor is reduced to $1.5 million due to $500,000 of payments against Target’s reserve balance. So, what happens to the $500,000 in payments against Target’s reserve? The $500,000 would not be deductible, but rather would increase the tax basis in goodwill and would be amortized over the remaining life of the original goodwill—in this case 13.5 years. Let’s take it a step further and look at what would occur in 2019 based on the facts above. The ending reserve balance decreased by $1.4 million in 2019 ($2.4 million to $1 million); however, based on additional information obtained from the accounting department, it was determined that the remaining assumed warranty reserve of $1.5million was paid out in full as of December 31, 2019. Therefore, the remaining assumed warranty balance of $1.5 million was reduced to zero, and a new reserve amount (unrelated to Target Corp.) was recorded in the amount of $100,000. As a result, there would be a disallowance of the $100,000 as an unfavorable book- to-tax adjustment in 2019 for not meeting the requirements of Section 461(h) for deductibility in 2019. In addition, the floor is completely gone at the end of 2019 since it was actually paid out, and the payout would be treated similarly to the prior year—an increase in the tax basis of the original goodwill. The $1.5 million increase to goodwill would then be amortized over the remaining life of the original goodwill or 12.5 years. Setting up and the subsequent tracking of floors can be tedious and burdensome tomost taxpayers. Therefore, keeping accurate records on day one following a completed transaction is vital to handling it properly. In the previous example, ABC was able to directly trace payments against old and new liabilities. If tracking payments is not practical, a reasonable approach could be made, such as assuming payments will be applied against the assumed liability first. A taxpayer should not assume that the tax treatment of a liabilitywill follow books. Without a proper process for tracking floors there is a potential for inadvertently taking a “double-deduction” or taking deductions in the wrong tax periods, which could lead to amending tax returns as well as FASB Interpretation No. 48 (FIN 48) reserves, penalties, and interest. Having a clear understanding of what is being recorded in purchase accounting and determining its tax sensitivity will not only make the tax accountant’s job easier, but also will safeguard the company from potential problems down the road. t James P. Swanick, CPA, is managing director in Global Tax Management Inc.’s Wayne, Pa., office. He can be reached at jswanick@gtmtax.com . Michael J. Tighe, CPA, is associate director with Global Tax Management Inc. He can be reached at mtighe@gtmtax.com . This article has been reprinted with permission of the Penn- sylvania Institute of CPAs.