Page 58 - Business Valuation for Estates & Gift Taxes

Goodwill is also included in the definition of intangible assets in the International Glossary of Business
Valuation Terms:

Non-physical assets (such as franchises, trademarks, copyrights, goodwill, equities, mineral
rights, securities, and contracts, as distinguished from physical assets) that grant rights, privileg-
es, and have economic benefits to the owner.

A secondary issue related to this is whether a covenant not to compete has a separate value or is
part of the overall corporate goodwill. fn 13

A valuation analyst valuing a business or business interest should approach these issues as a question of
fact. Arriving at an estimate of value in each case should be determined based on all relevant facts and
circumstances.

Proper valuation in an estate and gift tax context is not the only issue facing a valuation analyst and his
or her client (taxpayer). There are also possible income tax consequences to consider. If the business
was sold, then the character of the income (capital gain versus ordinary income to the seller) must be
considered, as well as whether the buyer can claim an amortization deduction when part of the stock
purchase price is allocated to a covenant not to compete.

In the Larry E. Howard case, the court decided that capital gains treatment occurs when the buyer pur-
chases the goodwill directly from the shareholder. However, if the goodwill belongs to the corporation,
then monies paid to the shareholder could be considered a constructive distribution. In this case, the
transaction would be treated as a sale by the corporation and a distribution to the shareholder. fn 14

In the Estate of Adell case, fn 15 the Tax Court ruled that (absent a covenant not to compete or other
agreement), if the key employee quit, the company could not exclusively use the customer relationships
that the employee cultivated. As a result, the goodwill was an asset of the employee and not of the com-
pany. In addition, due to the employee’s personal goodwill, the court agreed with an economic charge
high enough to compensate the employee for the value of the customer relationships he developed. This
charge resulted in reducing the value of the subject company even farther.

The issue of personal goodwill was first addressed in Revenue Ruling 57-480, 1957-2 CB 47 and clari-
fied by Revenue Ruling 60-301, 1960-2. The IRS concluded that personal goodwill did not attach to the
corporation where the business is dependent solely upon the professional skill or other personal charac-
teristics of the owner. In contrast, the IRS went on to say that goodwill was transferable where the suc-
cess is not dependent solely upon the personal characteristics of the owner even though such sale does
not involve a valid assignment of the exclusive use of the firm name.

fn 13 Covenants not to compete are contracts that, in general, prevent an individual from competing with a business for a specified pe-
riod of time within a designated geographic area.

fn 14 Larry E. Howard v United States of America, CA9 108 AFTR2d.

fn 15
Estate of Adell v. Commissioner, T.C. memo. 2014-155 (August 4, 2014)

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