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The Center for Financial, Legal & Tax Planning, Inc. |
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Advisories
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Personal Goodwill Introduction Personal goodwill is a relatively new concept in the
area of tax authority. It was given
life in a recent court case. In the
case, the owner of a C corporation desired to sell the business to another
person by means of an asset sale.
Facing the detriment of being taxed twice on all of the assets (once
at the corporate level) and once at the personal level), the owner and his
counsel invented the concept of personal goodwill. In a dispute with the IRS in court
concerning the concept of personal goodwill, the court reaffirmed personal
goodwill’s existence. Normally goodwill is attributable to
the company itself, but personal goodwill is different. Personal goodwill is goodwill attributable
to the owner and not the company. This
type of goodwill comes through personal relations, personal knowledge, and
other intangibles based on the owner of the business. Problems
with Ordinary Goodwill
When selling an S. Corporation,
partnership, sole proprietorship, or other pass through entity through an
asset or stock sale, ordinary goodwill does not present any problems. The sale of the goodwill gets taxed once at
the seller’s level as a capital asset.
The rate on the gain is presently 15%. However, when selling a C Corporation
through an asset sale, ordinary goodwill potentially creates a tremendous tax
burden that is not present during a stock sale. During the sale, ordinary goodwill is taxed
at the corporate level. Since C
corporations do not get the benefit of the lower capital gains tax rates, the
capital gain is taxed at the corporation’s ordinary rate. This rate can be as high as 39% at certain
income levels. Once ordinary goodwill
is taxed at the corporate level, it is given to the seller usually in the
form of a dividend distribution. When
given to the seller, it is taxed at the dividend rate of 15%. This means that of every $100 given to the
selling corporation as part of an asset sale, potentially $48 of it will be
paid to the federal government as taxes. In addition, we might have to deal
with state taxes. How
Personal Goodwill is Used
When a seller is in the position
described above, it is most advantageous to split personal goodwill off from
other goodwill. During the asset
allocation, assets are assigned values.
There will be value given to inventory, equipment and among other
things, goodwill. During this phase,
the seller must include a provision stating that some of the goodwill being
sold is personal goodwill. This amount
should be based on a reasonable and objective estimation of the two values
while keeping in mind more personal goodwill means fewer taxes, but also
raises the potential of the amount being lowered on an audit by the IRS. Conclusion
When appropriate, personal goodwill can provide
large tax savings to taxpayers. Being
a relatively new concept, it is important that the allocations to personal
goodwill be reasonable and objective as there is not much guidance through
cases at this point. Although personal
goodwill is not a well-established concept, valuations of companies and
assets are well established and can be used to value personal goodwill. The Center specializes in reducing tax
burdens upon disposition of assets and liquidations of companies through the
use of personal goodwill and other leading edge techniques. Call the professionals at the Center for
help with the sale of your business if you are concerned about taxes. (04-10) To receive the Advisory by e-mail,
please send your address to lacie@taxplanning.com |
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The Center for Financial, Legal and Tax Planning, Inc. |
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Satellite Office: Longboat Key, FL |
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(618) 997-3436 Fax: (618) 997-8370 © Copyright 2005. All rights reserved. |
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