No Tax Break for AOL’s $100b in Goodwill

AOL's massive goodwill write-off stemming from its merger with Time Warner didn't enhance NOL or create an earnings shortfall.
Robert WillensMarch 10, 2003

The goodwill created by the combination of AOL and Time Warner, in substantial part, is “impaired.” And, accordingly, a whopping $100 billion of goodwill was written off by the media giant. The question, however, is does this write-off provide the company with an equivalent reduction in its taxable income? The answer is no.

The write-off does not enhance the company’s already sizable Net Operating Loss (NOL); nor does it create a deficit in earnings and profits, such that distributions made by the company to its shareholders, with respect to their stock, would constitute “returns of capital” (under Sec. 301(c)(2)) rather than dividends.*

The business combination was accounted for as a “purchase” transaction. Hence, the buyer was required to allocate the cost of the acquired entity (the value of the stock issued to effect the business combination) to the assets acquired and liabilities assumed—based on their estimated fair values at the date of the acquisition.

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The excess of the cost over the net of the amounts assigned to (identifiable) assets acquired, and liabilities assumed, is recognized as goodwill. Thus, a substantial amount of the cost was, in this case, allocated to this residual item, goodwill. Furthermore, the write-off of the goodwill reflects the fact that it has become impaired.

For tax purposes, however, the transaction constituted a tax-free reorganization.

In such a reorganization, under Sec. 362(b), the acquired corporation’s basis in its assets will carry over to the acquiring corporation.** The basis, therefore, does not reflect the value of the consideration conveyed. Instead, regardless of the “premium” that is paid (in excess of the target’s tax basis), the acquiring entity is saddled with a “carryover” basis in the target’s assets. (If the transaction is structured as a reverse triangular merger, the target, whose corporate entity is preserved in the transaction, retains its historical bases in its assets, and the acquiring corporation’s basis in the target’s stock is almost always equal to such target’s net basis in its assets).

So, for tax purposes, no goodwill ever arose in the transaction. Since, for these purposes, the asset that was found to be impaired never came into existence, it follows that its write-off—for financial accounting purposes—has no tax significance and cannot, therefore, contribute to an NOL or render a distribution a return of capital.


A distribution is a dividend if it is “out of”: (1)earnings and profits accumulated; or (2)of the taxable year. If a corporation has neither accumulated nor current earnings and profits, a distribution is applied against—and reduces dollar for dollar the basis of the recipient’s stock—and if this “return of capital” distribution is greater than such basis, the excess is treated, under Sec. 301(c)(3), as gain from the sale or exchange of property; a capital gain.

The basis is increased by gain recognized on the transfer by the acquired corporation. Acquired corporations, however, in tax-free reorganizations, almost never recognize gain on the transfer.