September 1, 2011
A recent Ninth Circuit case (Larry E. Howard v. U.S., (CA 9 8/29/2011) 108 AFTR 2d ¶ 2011-5226)confirms that if there is a non-compete agreement between the company and the owner, then the IRS will argue there is no personal goodwill. Having an employment agreement between the employee/owner and company also hurts the personal goodwill argument but still allows an argument without the non-compete.
If there is no employment agreement and no non-compete, then the personal goodwill argument definitely has merit. The benefit of selling personal goodwill is that the income is taxed only once to the owner and is long-term capital gain taxed very favorably under current law. If the corporation is a C corporation, then double taxation occurs if corporate goodwill is sold versus personal goodwill.
It is a slippery slope on whether to have employment agreements and non-competes since this does protect the company from the employee leaving and then competing. However, in this case below, since it was a one owner employee dentist, it seems he really did not need the employment agreement or non-compete, thus was hurt tax-wise on the sale.