Covenant not to compete must be amortized over 15 years.

• Author: Bakale, Anthony

In Frontier Chevrolet Co., 116 TC No. 23 (2001), the Tax Court held that a company had to amortize a covenant not to compete that was entered into in conjunction with a redemption of its stock over 15 years. The court, agreeing with the IRS, considered a redemption to be an acquisition of an interest in a trade or business under Sec. 197 and therefore the noncompete agreement was a Sec. 197 intangible.

Frontier Chevrolet was in the business of selling and servicing new and used vehicles. Roundtree Automotive Group was a corporation in the business of purchasing and operating car dealerships, along with providing consulting services to the dealerships. In 1987, Roundtree purchased all of Frontier's stock. Stinson was involved in the operations of Roundtree from 1987-1994 and was president in 1994. Menholt, a long-time Roundtree employee, was executive manager in Frontier's dealership. Menholt was allowed to purchase 25% of Frontier's stock between 1987 and 1994. In 1994, Menholt owned 25% of Frontier's stock and Roundtree owned the rest. Stinson participated in the management of Frontier's car dealership and Roundtree received monthly payments of $22,000 for management services.

Seven years after the original acquisition, Frontier entered into a stock sale agreement with Roundtree. Effective Aug. 1, 1994, Roundtree's stock was redeemed for $3.5 million; after the redemption; Menholt was Frontier's sole shareholder. Frontier also entered into a noncompetition agreement with Stinson and Roundtree, effective Aug. 1, 1994. The covenant provided that Stinson and Roundtree would not compete with Frontier in the car dealership business in Yellowstone County for five years. As consideration, Frontier agreed to pay Stinson and Roundtree $22,000 per month for 60 months. Frontier amortized the monthly payments over 15 years, but subsequently filed a claim for refund, on the basis that the noncompetition payments should be amortized over the life of the agreement (60 months).

Frontier's argument was that it did not acquire an interest in a wade or business; therefore, Sec. 197 did not apply. The taxpayer stated it was in the same business before and after the redemption and did not acquire any new assets. The IRS's position was that Frontier's redemption of its stock was an acquisition of an interest in a wade or business within the meaning of Sec. 197.

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