Personal goodwill: alive and well indeed!

• Author: Gruidl, Nick

Recent Tax Court decisions in Bross Trucking, Inc., T.C. Memo. 2014-107, and Estate of Adell, T.C. Memo. 2014155, illustrate that with the right facts, the sale of personal goodwill, as an asset separate from corporate-owned goodwill, should withstand challenge. A previous article by one of the co-authors (see Gruidl, "Personal Goodwill: Alive and Well?" 41 The Tax Adviser 202 (April 2009)) addressed a pair of court decisions from 2008 and 2009 that called into question whether the sale of personal goodwill remained a viable tax planning strategy and concluded that, with the appropriate set of facts and proper planning, a business owner could successfully effectuate a sale of personal goodwill. The Tax Court decisions in Bross Trucking and Estate ofAdell further support that conclusion.

Why Care About Selling Personal Goodwill as an Asset Separate From the Business?

The presence of personal goodwill can provide tax-efficient opportunities in merger-and-acquisition transactions by lowering corporate-level tax upon a sale or transfer of goodwill. Further, the gain on a sale of personal goodwill is generally considered capital gain and receives a preferential capital gains tax rate (assuming the goodwill has been held by the taxpayer for more than 12 months), as opposed to the higher ordinary income tax rate for the receipt of compensation. With current federal corporate tax rates as high as 35%, a selling shareholder's direct sale of personal goodwill can often generate significant tax benefits. In addition, the buyer in such a transaction receives an amortizable step-up in asset basis upon acquiring personal goodwill from the seller, which would not occur if all the amounts paid were considered paid for the corporation's stock.

Because it is more likely that personal goodwill exists in a closely held business and the effect of double taxation on corporate earnings is a concern for those businesses, identifying personal goodwill as a separate asset occurs most often with the sale of closely held C corporations and with closely held S corporations still within the Sec. 1374 built-in gain recognition period. In addition, owners of personal goodwill who receive stock consideration in a transaction may argue that they have transferred personal goodwill to an entity in a tax-deferred exchange under Sec. 351 as opposed to having received equity-based compensation. This is most often seen when an entrepreneur receives stock in a corporation but does not transfer any property (other than personal goodwill) to the entity. Whether such a transaction represents compensation for "sweat equity" or a tax-deferred transfer of personal goodwill is subject to the same questions as an outright sale of the goodwill.

For an individual to sell personal goodwill, the asset must (1) meet the definition of goodwill from a tax perspective and (2) be owned by an individual outside of the legal business entity. After providing an overview of the Bross Trucking and Estate ofAdell decisions, this item examines three distinct hurdles to meeting these requirements in fight of a long history of case law, including these most recent decisions.

Bross Trucking and Estate of Adell

The main issue in Bross Trucking was the IRS's contention that Bross Trucking Inc. distributed appreciated intangible assets (including goodwill) to its sole shareholder, Chester Bross, who then transferred those intangibles to a newly created trucking entity his sons owned. In holding for the taxpayer, the court found that Bross Trucking had no corporate goodwill at the time of the alleged distribution, that Bross's goodwill constituted all of Bross Trucking's goodwill, and that Bross did not transfer any of his goodwill to the company. In this taxpayer-favorable case, the Tax Court relied heavily on the precedent in Martin Ice Cream Co., 110 T.C. 189 (1998), and distinguished the case from...