What expense category is Amortization Expense?

When a business invests in long-term assets, it can't deduct the entire cost in the year of purchase. Instead, it recovers the cost over time. For tangible assets, such as machinery or buildings, this process is known as depreciation. For natural resources, it's called depletion. And for intangible assets, it's called amortization.

Amortization is the method of deducting the capitalized cost of certain intangible assets in equal amounts over a set period. Understanding which costs must be amortized is crucial for any business that invests in assets such as startup activities, intellectual property, or franchise rights. This guide explains what amortization is, the costs it applies to, and how to report it correctly for tax compliance purposes.

The Amortization Expense Category

Amortization is not a direct expense category that you choose for a specific payment. It is a calculated, non-cash deduction that represents the annual write-off of a previously capitalized cost. The costs that are amortized are capital expenditures for intangible assets that provide a benefit to the business for more than one year.

The annual amortization deduction is calculated on Form 4562, and the total is then carried to your main business tax return.

Important Considerations for Amortization

The key to amortization is identifying which business costs must be capitalized and recovered over time, rather than deducted immediately.

What Costs Must Be Amortized?

IRS Publication 535 outlines several types of costs that must be amortized over time. These include:

• Business Startup Costs: You can deduct up to $5,000 in the first year; however, any costs exceeding that amount must be amortized over 180 months (15 years).
• Section 197 Intangibles: This is a major category of assets that must be amortized over a 15-year period. It includes:
  
  • Goodwill
  • Franchises, trademarks, and trade names
  • Covenants not to compete
  • Patents or copyrights acquired from another party
• Costs to Obtain a Lease: Fees and commissions paid to secure a business lease must be amortized over the term of the lease.
• Research and Experimental Costs: Costs to develop software or obtain a patent must be amortized over a 5-year period.
• Certified Pollution Control Facilities: These specific capital improvements are amortized over a 60-month period.
• Reforestation Costs: Costs over the initial $10,000 deduction limit are amortized over 84 months.

The Amortization Period

Unlike depreciation, which has various recovery periods, amortization periods are generally fixed by the tax code. For example, Section 197 intangibles have a mandatory 15-year (180-month) amortization period, regardless of their actual useful life.

Tax Implications and Reporting

How to Report the Deduction

The annual amortization deduction is calculated and reported on Form 4562, Part VI, Amortization. The total from this form is then carried to the appropriate line on your business tax return (e.g., Schedule C, Line 13, for a sole proprietor).

What Records to Keep

To substantiate your amortization deductions, you must have clear records of the initial capitalized cost. This includes:

• Invoices, contracts, and proof of payment for the intangible asset (e.g., the franchise agreement, the bill from your patent attorney).
• Documentation showing the date the asset was placed in service or when your business began, which determines the start of the amortization period.

How Fyle Can Automate Tracking for Amortizable Costs

Fyle is essential for the first, most critical step of amortization: capturing and correctly categorizing the initial capital expenditure.

• Capture the Initial Cost: Instantly capture the invoice for a major intangible purchase, like a franchise fee or patent legal fees.
• Centralize Key Documents: Attach the underlying legal documents (franchise agreement, patent filing) directly to the expense record in Fyle.
• Categorize for Capitalization: Code the initial cost as a capital asset, which signals to your accountant that it needs to be amortized, not expensed.
• Automate Your Accounting: Fyle syncs the capitalized cost to the correct intangible asset account in QuickBooks, Xero, NetSuite, or Sage Intacct, ready for the amortization schedule to be set up.