Planning for the sale of personal business assets should begin well in advance of the sale of the target business. All of the company`s records must be carefully reviewed to ensure that shareholders have not transferred ownership of their personal customer base to the target company through a capital injection or through the conclusion of long-term employment or non-compete agreements with the target company. Of course, if such agreements exist, the consultant must check whether they can actually be terminated. The two main methods of assessing a company`s goodwill are: In 2002, Howard and Howard Corp. sold the firm to Dr. Brian Finn and his personal services company, Brian K. Finn, DDS, PS (Finn Corp.). In the asset purchase agreement, Howard received $549,900 for his personal goodwill and $16,000 for a commitment not to compete with Finn Corp. Howard Corp. received $47,100 for its assets. In contrast, personal goodwill belongs to the shareholders of the target company and exists when a shareholder`s reputation, expertise, skills and knowledge, as well as the shareholder`s contacts and relationships with customers and suppliers, give a company its intrinsic value.
In other words, personal goodwill exists when the shareholders of a target company are critical to its success and the loss of those shareholders would significantly reduce the value of the company. There are generally two types of goodwill. Goodwill is hereinafter referred to as goodwill, practical or institutional goodwill. Personal, professional or practical goodwill is hereinafter referred to as personal customers. While double taxation can be avoided if the transaction is structured as a stock transaction, with shareholders selling their shares in the target company, a buyer may prefer an asset transaction for at least three reasons, including: Using the excess profit approach to assess a company`s goodwill can be inaccurate because future profits are so uncertain. Since a contract transfers ownership of a company and the goodwill of that company, the person selling the company has the legal right to compete with the company, unless a non-compete clause is expressly included in the agreement. A taxable sale of assets by company C, company S with income and profits, or company S subject to integrated income tax (each, a “target company”), followed by the liquidation or distribution of the proceeds of the sale to shareholders, generally results in double taxation at the level of the company and shareholders. This article provides practical guidance for practitioners to help clients use this effective tax strategy early in tax planning by explaining the importance of identifying the goodwill associated with the business, determining its ownership and value, and negotiating its sale and transfer. By reviewing court decisions, this article also helps practitioners avoid potential planning pitfalls.
Potential buyers and sellers need to be aware of the various aspects of goodwill. Not all of them apply to all companies, but aspects of goodwill include: In subsequent decisions, the courts followed martin ice cream and norwalk and recognized that the value of goodwill, which is due to the personal skills and relationships of a company`s shareholders and employees, is not the property of the company, unless there is a contractual obligation such as an employment contract or a non-compete agreement, which transfers these intangible assets to the company. However, if the obligation not to compete is concluded in the context of the sale of an ongoing business and is mainly intended to ensure the buyer`s economic enjoyment of the goodwill acquired, the agreement is considered unreasonable in terms of customers and without distinct value. 18 Consequently, all amounts received by shareholders as a result of the sale of their personal goodwill should be taxed at the rate of capital gains, irrespective of the fact that those shareholders have given undertakings not to compete with the buyer. 11 For example, the court found `no convincing evidence that the name and place of the company had any value other than its association with the accountants themselves`. Id. at *18. In other words, goodwill is an intangible asset of a company. If a buyer is interested in the business, any amount in excess of that company`s calculated book value will be considered goodwill. Some of the factors that could help a company stand out and become more dominant in its sector are: In addition to the obligations not to compete, the way in which personal goodwill is transferred depends on its composition.
If the shareholder`s contacts or relationships with customers or suppliers constitute personal goodwill, the shareholder should be required to present and, in general, facilitate a smooth transition of such relations with the buyer. On the other hand, if the expertise, knowledge or skills of the shareholder constitute personal goodwill, the shareholder should be required to provide the buyer with those skills or knowledge. In both cases, the shareholder must be under contract for a sufficient period of time to obtain a significant transfer of personal customers to the buyer. To illustrate the problem of pre-existing non-compete agreements, look no further than the 2010 Howard District Court decision. 13 Dr. Larry Howard began practicing dentistry in 1972. In 1980, he established his practice as sole shareholder, officer and director of Larry E. Howard, DDS (Howard Corp.). Also in 1980, Howard entered into an employment contract and an agreement not to compete with Howard Corp.
The pact stipulated that as long as Howard held shares in the company and for three years thereafter, he would not operate in any capacity in a competing dental practice within 50 miles of the company`s location in Spokane, Washington, or hold a financial interest in it. All parties acknowledged that Howard, as the sole shareholder, director and officer of the Company, may modify or terminate the employment contract at any time and that he was bound by the terms of the agreement and agreed not to compete with Howard Corp. during the relevant period of this case. Finally, a careful examination of existing employment contracts is necessary. A shareholder who is bound by the terms of a long-term employment contract with the company may be effectively prevented from competing with the company, even if that agreement does not contain non-compete obligations. There are several complex methods by which goodwill can be calculated, so it is important to involve a highly competent business lawyer in the negotiation process. Randall P. Brett`s law firm can help you determine the best value for goodwill, whether you`re the seller or the buyer. Howard and his wife filed a federal tax return in 2002 that reported $320,358 as a long-term capital gain from the sale of goodwill to Finn Corp. In a review of Howard`s statement in 2002, the IRS again referred to the sale of goodwill as the sale of the company`s assets and treated the amount howards had received from the sale to Finn Corp.
such as a dividend of $320,358 from Howard`s Professional Service Corporation. The Howards paid the full amount charged by the IRS and then filed a claim to reimburse that amount with interest from the date of payment. These factors are usually included in the total value of goodwill, although it is difficult to allocate an exact dollar amount to each. They add value because they can help reassure a potential buyer that the business will remain successful. In order to possess personal goodwill, a shareholder must be closely involved in the target company. Otherwise, any goodwill acquired by the target company would be largely due to the work of others. Thus, the target company is almost always kept nearby. In addition, personal goodwill is often found in highly technical, specialized or professional companies. In addition, shareholders of companies with few customers or suppliers can possess personal goodwill through the development of close relationships. If a target company is heavily dependent on a small number of customers or suppliers, its shareholders must maintain these relationships to ensure the company`s survival. Finally, personal goodwill is more likely to be found if a target company`s employment contracts with its shareholders are cancellable at will or do not contain automatic renewal provisions and if there are no restrictive non-compete obligations between the company and its shareholders.
Selling a business may require some of the most important tax planning an owner may need. This is particularly the case where a company has operated as a narrowly held Company C and the proposed structure of the business is a sale of assets. In this situation, the owner can often significantly reduce their tax liability for the sale of the business by selling their personal goodwill associated with the business separately from the assets of the business. However, to ensure that a sale of personal goodwill is respected, an owner should take steps before or during the sale transaction to prove the existence of a personal business and its separate transfer. Even in the best-case scenario, it is crucial to establish facts that can support the conclusion that goodwill belongs to the shareholders and not to the target company. .