CPA Charles j. Reichert write for the journal of accountancy says, that the tax court in James p. and Joan E. Kennedy v. Commissioner, TC memo 2010 206, decided that in some has cases a sale of business assets ordinary rather than capital gain income (emphasis added) generates:
The Tax Court held that payments is a taxable person from the sale of his consulting business, he as long-term capital gain instead should be taxed from his goodwill as ordinary income reported. It instead of the purchase contract, which reserved amounts to the taxpayer as business or goodwill and to its wholly-owned company for future consulting services and its client list were not based on economic realities but rather were determined to minimize taxes.
If a taxpayer sells a business in what its or your personal relations with customers/clients are important to the purchasing entity and after the sale of busy is that the entity arises the question of the taxpayer received payments for taxpayers future services or the taxpayer's business or goodwill. For goodwill performance capital income during payments received for services result in ordinary income amounts received. The existence of the business or goodwill is a question of fact that determines on a case by case basis. See Butler v. Commissioner, 46 TC 280.
Was James p. the sole shareholder of his benefits consulting business, KCG International Inc., in addition to the one being made his two full-time employees. In the year 2000 offered Mack & Parker Inc. (M & P) to buy the consulting business and as a consultant to join Kennedy M & P. M & p Kennedy offered a percentage of the annual revenue from KCG clients over the next five years. Later in the year 2000 the parties executed a definitive purchase and sale agreement, the a goodwill agreement Consulting was agreement and an asset purchase agreement.
Due to the agreement Kennedy work would, services without salary for M & P continues to former customers for the next five years, after which he planned to retire. Also, Kennedy would be by virtue of the agreements and KCG compete with M & P for five years. M & p would a flat fee amounting to $10,000 KCG and annual payments to KCG and Kennedy for five years. Annual payments would depend on revenue from Kennedy's former clients receive and were assigned 75% Kennedy in exchange for the "personal goodwill" associated with its customer relations, know-how and his promise not to compete or otherwise independently engage consulting in employee benefits be. The remaining 25% Agreement KCG was assigned to its client list and Noncompete. After 18 months of work under this arrangement Kennedy felt, undercompensated and negotiated a salary in addition to the payments
In accordance with the contract of sale Kennedy received $176,100 and $32,758 M & P in 2001 and 2002 respectively and lots as long-term goodwill to the joint capital gain from the sale of the business or returns he and his wife filed reported. Kennedy had capital losses that have offset to do gain nothing from the 2002 and all but win $2,442 of 2001.
The IRS recharacterized the capital gains in two years as ordinary income and rated defects and accuracy-related penalties amounting to $87,989 against Kennedy and his wife on their joint returns. The Kennedys petitioning the tax court for relief.
The Kennedys argued that the tax court in Martin ice co. v. Commissioner, 110 keeps TC 189, controlled and payments to Kennedy on goodwill were he owned. Martin, the Court considers, receive payments from sole partner of a company for its supermarket relations and distribution rights were owned by him, the company is missing any agreement that transfer these rights to the company. The Court declared however, his participation in Martin Kennedy, were not applied because Martin the Court only decided whether the payments to the company were taxable persons and not handled, was whether the payments for the rights were ordinary income or capital gain for the shareholder.
In this case the Court found that the payments that were received for goodwill as worked for M & P for five years from Kennedy got little compensation for his services for 18 months and agreed not to compete with M and p in the five years. The Court stated that it don't need to payments for Kennedy's services as well as for his promise to compete because both ordinary income were not distinguish those. In addition, the Court considers the payments were subjected to self-employment tax. However, the Court granted the penalties, the establishment of the Kennedys had provided accurate and complete information to their long-term CPA tax preparer and rely on his professional advice.
This is an interesting, and I think correctly, which further clarified the need for small business owners control lawyers have experienced judgment or CPA negotiate accompanying their companies.
Kennedy agreed to work for the new owners for another five years without a paycheck and was actually for 18 months that it is reasonable to accept that part of otherwise purchase price really compensation for his services to.
Maybe I am Monday morning quarterbacking, but my guess is that structured business in a way that could have had both met economic realities and resulted in capital gains rather than ordinary income treatment for Kennedy.