Buyers and sellers of businesses often face conflicting tax, financing and planning considerations when structuring a business sale. These considerations impact structure, choice of entity, pricing, and a variety of other matters. Identifying personal goodwill related to business activities, and allocating a portion of the price to personal goodwill, may provide a structure that maximizes pricing, eliminates the need for deferred payments, and provides tax benefits to both the seller and the buyer.
A seller-owner who is actively engaged in a business may possess personal goodwill derived from business relationships with clients, customer, suppliers or employees. Because these relationships are personal to the seller, at least in the context of small- to mid-range operations where there may be close and long-term connections, or in situations involving professional practices, the seller possesses an asset that may be separated from those sold by the company and sold separately by the seller as an individual.
The sale of personal goodwill is generally taxed to the seller at favorable capital gain rates, unlike payments made as consulting fees or other forms of compensation, such as payments made in exchange for a covenant-not-to-compete, which are taxed at higher rates as ordinary income. In addition, payments allocated to the purchase of goodwill are not subject to FICA and Medicare, unlike payments made as consulting fees or other forms of compensation. Payments made to buy personal goodwill also avoid the double taxation that may result where goodwill is attributed to the company and taxed at the corporate level, followed by assessment of an additional tax when distributed to the shareholder-owner.
Payments allocated to personal goodwill are deductible by the buyer over 15 years. This is true regardless of the payment period and is consistent with the tax treatment of other intangible assets, such as non-competition agreements, customer lists, going concern value, or company goodwill. Although parties may disagree over how much to allocate to personal goodwill and other company assets which may be depreciated over periods shorter than 15 years, their negotiated allocation will be upheld for tax purposes if reasonable. Since the buyer has the same 15-year deduction period for all intangibles, there may be little resistance to allocate payments to items that may be identified as personal, as opposed to company, goodwill, so as to benefit the seller.
The parties’ ability to allocate payments to personal goodwill may be restricted by non-competition or employment agreements. If such agreements exist between the seller and the seller’s company, or are executed as part of the transaction with the buyer, they effectively negate the seller’s ownership of the intangible asset or at least provide an argument that there can be no substantial value attributed to the intangible asset as a consequence of such agreements. Obviously, the seller may need to eliminate restrictive agreements before attempting a sale. In addition, an independent valuation should be obtained to support any substantial value allocated to an item identified as personal goodwill.
Personal goodwill is a valuable tool for tax planning and structuring of business sales and can be used in other contexts such as shareholder buy-outs. If you desire additional information regarding use of the personal goodwill concept, please contact us.