Selling Personal Goodwill - A Strategy that Works for Buyer and Seller

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When structuring the sale of assets of a C corporation, what is a good strategy for the buyer from a tax standpoint is generally bad for the owners of the corporation  and vice versa.  There are some exceptions however.  One strategy that helps the corporation’s owners without hurting the buyer is allocating part of the total purchase price to be paid by buyer to the personal goodwill of the corporation’s owners.   This strategy does not increase the overall purchase price, does not reduce the amount of purchase price allocated to depreciable assets, does not lengthen the depreciation recovery period and does not otherwise eliminate or slow down the buyer’s depreciation cost recovery process.  Yet by allocating part of the total purchase price to be paid by buyer to the personal goodwill of the corporation’s owners, the aggregate tax paid by the corporation and its owners is significantly reduced, and the net proceeds the owners actually receive is significantly increased.

To use this personal goodwill strategy, it is necessary to separate the personal goodwill (reputation, expertise and relationships) of the seller’s owners from the goodwill of the corporation itself.  For example, if the assets of a “C” corporation are being sold for $20 million and the tangible assets are worth $12 million, the remaining $8 million would normally be classified as goodwill. If that goodwill is allocated solely to the intangible assets of the corporation, the goodwill will be taxed at the corporate tax rate (about 34%), and then taxed again (20%) when the proceeds are distributed to the corporation’s owners.  If, on the other hand, part of the goodwill (say $4 million) is attributable to the owners of the corporation, then this $4 million would be paid directly to the owners and would be taxed only once as long-term capital gain (20%).  The federal income tax savings alone in this example would be over $1 million.  As a side benefit, this allocation process would works to keep this $4 million of purchase price out of reach of the corporation’s creditors.  And all this  would occur without penalizing the buyer or affecting the buyer’s tax treatment of the purchased assets.

Determining the existence and amount of goodwill that can be somewhat complicated.  The evidence that personal goodwill of the owners exists can be found in the type of advertising the corporation does to promote its business, why repeat customers come back, where business referrals come from, how corporation profits are allocated among the owners, whether business revenue and income is attributable to one or more producers and whether non-compete agreements are in place with the owners.

If the focus of advertising is on the reputation, experience and skills of the owners, including use of the owners name and pictures (as opposed to use of only the corporation name and logo), personal goodwill exists.  If customers come back time and again and ask to see one or more of the owners personally, personal goodwill exists.  If other business professionals refer work to the corporation based on the reputation, experience and skills of one or more owners then personal goodwill exists.  If revenue and income of the corporation are allocated among the owners based on revenue or income production, personal goodwill exists.  If the corporation’s business is primarily based on the work of one or more owners, and the income stream would be disrupted if one or more of the owners left, personal goodwill exists.   And maybe the most important factor, if the owners have not executed enforceable non-compete agreements, personal goodwill exists.

Allocating part of the purchase price to personal goodwill can save owners of a corporation significant taxes and increase the amount of after tax net proceeds the owners receive.  If we can help you structure a sale of your business, please call one of our tax and business attorneys at 937-223-1130 or Jsenney@pselaw.com.

AND ONE MORE THING.   We are holding a seminar on various legal issues on Wednesday October 16th from 8 am (registration) 8:30 am to 10 am seminar at the   Dayton Country Club. Breakfast will be served.  Issues that will be covered during the seminar include: (1) Current procedures for common Immigration Issues; (2) Asset Protection and Succession Planning; (3) desirable/necessary LLC operating agreement provisions; and Document Retention and Data Preservation requirements.  Space is limited.  Register Now!