Personal goodwill: Tax court provides a victory for taxpayers
TAX ALERT |
As confirmed in a recent Tax Court decision, personal goodwill, as an asset separate from corporate-owned goodwill, remains alive and well as a planning tool for taxpayers. In Bross Trucking, TC Memo 2014-107, the Tax Court found that no or very minimal corporate goodwill existed that could have been transferred to the shareholder. Rather, any goodwill associated with the business was that of the shareholder and, thus, "personal goodwill."
After a series of IRS wins against taxpayers, this decision provides support that personal goodwill is alive and well if the facts and circumstances support it. This is good news because the presence of personal goodwill can provide tax-efficient opportunities in merger and acquisition (M&A) transactions by alleviating corporate-level tax upon a sale or transfer while still providing an acquirer with an amortizable tax asset. Further, the gain on a sale of personal goodwill is generally considered capital gain and receives a preferential capital gains tax rate, as opposed to the higher ordinary income tax rate associated with the receipt of compensation.
Personal goodwill gained momentum with Martin Ice Cream Co., 110 T.C. 189, which shares similar characteristics with the instant case and the resulting opinion. In both cases, the shareholder's reputation and skills contributed heavily to the business, and there was no transfer of such goodwill via an employment contract or non-compete agreement. The lack of such agreement indicated no transfer of rights occurred between the shareholder and the corporation. It was the shareholder's personal relationship and reputation alone that created value in the goodwill asset.
Bross Trucking exemplifies the idea that facts and circumstances will carry the day. Since Martin Ice Cream Co., a slew of additional case decisions have shown the facts and circumstances will determine if goodwill is that of the shareholder's (personal goodwill) or the company's (corporate goodwill). In this case, the facts supported the taxpayer position that there was no significant corporate goodwill distributed, and in fact, the business at issue was going through significant difficulties and embodied what the Tax Court referred to as the antithesis of goodwill. This case is in clear contrast to recent IRS victories involving purported goodwill where the facts and circumstances were clearly in favor of the IRS. These judicial precedents have provided a roadmap to follow when considering the existence of personal goodwill in a transaction. This roadmap includes documenting (1) the value of personal goodwill, (2) evidence supporting the ownership of that goodwill outside of the corporation (i.e., lack of an employment contract or non-compete agreement prior to any sale or transfer of goodwill, as seen here with Bross Trucking), and (3) the traits and characteristics of personal goodwill utilized in the operation of the business. Taxpayers wishing to assert personal goodwill need to assure they have properly documented their positions, with the appropriate defenses ready if the IRS seeks to challenge them.
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