When businesses are sold in an asset sale transaction, often the purchase price is greater than the book value of the assets. That spread is often referred to as goodwill and is entered by the purchaser on its books as an amortizable asset. Most people likely regard goodwill as an asset of the company. But the courts and the IRS recognize in certain circumstances and subject to scrutiny that there is a second type of goodwill—that being the personal goodwill of a shareholder. This is a possibility that should be explored by sellers in C corporation asset sale transactions. In the C corporation scenario, an asset purchase transaction should be reviewed to see if there is a legitimate basis for attributing part of the purchase price to the personal goodwill of a shareholder. If this can be done and is supportable, there can be an income tax advantage by lessening the consequences of the two-level tax scenario—an income tax at the corporate level upon the sale of the assets and another tax at the shareholder level upon liquidation of the company.

The courts and IRS want to make sure that any attribution of a part of goodwill to personal goodwill is supportable. That generally means that the personal goodwill is identifiable, has a determinable value and is owned by the individual and not the company.

As far as being identifiable, I can think of no better example in the metro Phoenix area than Tex Earnhardt. He has been in the auto business since 1951 and I believe is still at it. I started living in the Phoenix area in 1968, and I could not even begin to count the number of newspaper and TV ads I’ve seen over the years with Tex wearing his western clothes with a big cowboy hat and sitting on or alongside a big bull. If he decided to go into a different line of business, I would venture that his persona would attract a great many customers.

As far as determinable value, a business appraiser should be engaged to do an appraisal of the personal goodwill value. Speculating among the parties without verifiable support would not likely cut it with the IRS or a court.

In determining whether the personal goodwill is owned by the shareholder, it is important to determine if the shareholder is subject to any non-compete provisions either in an employment agreement or a non-competition agreement entered into with the seller prior to the sale. If such agreement or agreements exist, that would undercut any claim by the shareholder that he or she owns the personal goodwill. The ownership position would be bolstered by having a separate agreement between the shareholder and the buyer for the sale of the shareholder’s personal goodwill. Obviously, this should not be an agreement first discussed far into the negotiation process or even after the closing.

Personal goodwill will not be available in most situations, but it deserves a thorough review in asset sale transactions involving a C corporation.

Michael Margrave

Disclaimer: This blog is for information purposes only. Legal advice is provided only through a formal, written attorney/client agreement.

Personal Goodwill - A Saleable Business Asset? 1

(Courtesy of Dale Earnhardt)