15-year amortization for covenant payment in connection with redemption.

• Author: Goldberg, Michael J.
• Position: Non-competition agreements made in connection with stock redemption

The Tax Court ruled that Sec. 197 requires that payments pursuant to a covenant not to compete made in connection with a stock redemption must be amortized over 15 years (Frontier Chevrolet Co., 116 TC No. 23 (2001)). The redemption of one shareholder's stock constitutes an acquisition by the corporation of an "interest in a trade or a business" under Sec. 197.

The case involved the interpretation of Sec. 197(d)(1)(E), which defines a Sec. 197 intangible to include a covenant "entered into in connection with an acquisition (directly or indirectly) of an interest in a trade or business or a substantial portion thereof." In Frontier Chevrolet, the shares of a 75%-shareholder were completely redeemed, which increased the other shareholder's interest in Frontier Chevrolet from 25% to 100%.

Frontier Chevrolet entered into a five-year covenant with the redeemed shareholder and its president, explicitly in connection with the redemption. Frontier Chevrolet originally filed returns amortizing the covenant payments over 15 years, but filed amended returns claiming a five-year amortization period. It claimed that its business had not changed as a result of the redemption and that it had not acquired any interest in a trade or business. The Tax Court, on the other hand, in siding with the IRS, held that the covenant was amortizable over 15 years under Sec. 197.

There was apparently no issue as to whether a 75% interest constituted a substantial portion of Frontier Chevrolet. This is probably because the increase in the 25%-shareholder's interest to that of sole shareholder would necessarily constitute a substantial portion of the business. In analogous cases, an ownership shift of only a few percentage points can be viewed as "substantial" when it causes a...