Master accounting topics that pose a particular challenge to finance professionals.
Goodwill: Differences Between GAAP and Tax Accounting
Goodwill represents the excess of purchase price over the fair market value of a company’s net assets:
If a business is simply a collection of assets, why would an acquirer pay more than the fair market value of that collection of assets?
There are two good reasons:
- The value of a business can be greater than the sum of the fair value of each of its individual assets. For example, Pepsi's brand is valuable on its own, and is far more valuable when combined with its distribution system.
- Synergies (cost savings) for strategic deals. (Note that overpayment due to a misestimation of synergies is also a common reason an M&A deal can fail.)
If you aren't familiar with the basic calculation of goodwill, please read our M&A accounting primer before moving on.
A challenge of goodwill accounting is that it's treated one way under tax accounting and another under GAAP (“book”) accounting. Below, we lay out the basic differences:
M&A transactions can be structured as either a stock sale or an asset sale/338(h)(10) elections. The structure determines goodwill's tax implications:
- Any goodwill created in an acquisition structured as an asset sale/338 is tax deductible and amortizable over 15 years along with other intangible assets that fall under IRC section 197.
- Any goodwill created in an acquisition structured as a stock sale is non tax deductible and non amortizable.
At the risk of stating the obvious, tax-deductible goodwill is attractive to an acquirer because it will reduce acquirer taxes going forward after the acquisition. So, all else being equal, acquisitions structured as asset sales/338 elections are more attractive to acquirers.
Under GAAP (“book”) accounting, goodwill is not amortized but rather tested annually for impairment regardless of whether the acquisition is an asset/338 or stock sale.
A caveat is that under GAAP, goodwill amortization is permissible for private companies. The purpose of this accommodation is to reduce the costliness of annual impairment testing on private companies that lack the internal accounting resources needed to perform the tests. It’s important to note that not all private companies take this election because they’d have to restate all of their financials if they ever went public.
GAAP vs tax treatment of goodwill
|Stock sale||Asset sale/338 (h)(10)|
|Tax accounting||Goodwill not tax deductible and not amortized||Goodwill amortized over 15 years and tax deductible|
|GAAP accounting||Goodwill tested annually for impairment for public companies. Private companies may choose to amortize goodwill over a period not to exceed 10 years instead|
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