A sale of a corporation under an asset sale arrangement should be carefully planned to establish the personal goodwill that may exist and if it is being sold in a “separate transaction” apart from the sale of the assets of the corporation.
This is particularly true where a closely-held C corporation’s transaction deal is structured as an asset sale. In this situation, the owner may be able to significantly reduce their tax liability on the sale of the business by selling his or her personal goodwill associated with the business separately from the Corporation’s assets.
In an asset deal, the purchaser obtains a stepped-up basis in the acquired assets, equal to the fair market value price paid and any assumed liabilities. The purchaser, therefore, receives a higher depreciation and amortization deduction.
An owner’s sale of personal goodwill can create a significant income tax benefit. A sale of personal goodwill can create a long-term capital gain to the owner, taxable at the long-term capital gains rate, rather than at the higher corporate rate.
Types of Goodwill
There generally are two types of goodwill: (i) business enterprise goodwill sometimes referred to as practice, institutional or business goodwill; and (ii) personal or professional goodwill.
Distinguishing personal goodwill from the business’ goodwill is often difficult and always fact-specific. In addition, goodwill may belong to both the business and its owner, making valuing and supporting the values a challenge.
Three tax court cases have recognized personal goodwill: (i) MacDonald; (ii) Martin Ice Cream Co.; and Norwalk. Courts have followed Martin Ice Cream and Norwalk in recognizing value attributed to the personal abilities and relationships of the owner. The main question that must be answered is “how much influence does the owner have on customer retention?”
Pre-Acquisition of Personal Goodwill
It is important to confirm personal goodwill and its dollar amount assigned to value prior to entering into a noncompete agreement in an asset sale transaction. Goodwill must be both salable and transferable.
Allocations of Personal and Business Goodwill
A portion of the purchase price allocated to goodwill should be the amount of the purchase price that remains after the allocations have been made to all other classes of assets. If both personal and business goodwill exist, determining the allocable share of the purchase price for each should be determined by a qualified business appraiser. Simply declaring $XX is business goodwill and $XX is allocated to personal goodwill will not withstand IRS scrutiny. It is vital to ascertain and support the facts related to the allocation of goodwill belonging to the person versus the corporation.
How Can American Business Appraisers Help?
Personal goodwill may be deemed an asset and must be supported to minimize IRS scrutiny. Call us to discuss any specific valuation needs. Every individual situation is different and not everyone requires our certified appraisal services and sometimes just talking with one of our appraisers is all that may be necessary. With our initial consultation, there is no cost or obligation to you. We promise you two things; first, to invest a reasonable amount of time to gain an understanding of your specific requirements, and second, our communication will be kept confidential.