Deal	Typical Tax Ramifications
Stock	Seller pays favorable federal capital gains tax rate of 15% on amount purchase price exceeds stock basis.
	Seller pays only 1 level of taxation -  at the personal tax level no corporate level tax.
	Buyer does not receive basis step-up in the assets purchased no tax deduction on amount purchase price exceeds tax basis in assets.
	Buyer takes subject to any known liabilities and unknown liabilities of the corporation existing at purchase date.
Asset	Seller pays 2 levels of taxation.
	Corporate level tax (federal and state) can be as high as 40% on the amount the purchase price exceeds tax basis of corporate assets.
	Personal income tax on amount of after-corporate tax proceeds remaining exceeds stock basis in corporation at favorable capital gain tax rates of 15% federal.
	Buyer receives step-up in assets purchased in the amount the purchase price exceeds tax basis in assets purchased - buyer receives future tax deductions in this amount.
	Buyer does not take subject to corporate liabilities that exist they do not assume within corporate transaction agreement.

 

In a typical transaction, whether a stock or asset deal, the buyer is purchasing tangible and intangible assets.  Tangible assets include accounts receivable, inventory, prepaid expenses, and hard assets such as machinery & equipment.  Intangible assets include customer lists, workforce in place, research & development in process, formulas, covenant not to compete agreements, corporate goodwill as well as personal/professional goodwill. 

Goodwill is defined as the amount of purchase price that exceeds the basis of the assets purchased.  When purchasing assets goodwill is typically written off over 15 years for tax purposes.   When purchasing corporate stock corporate goodwill is not written off. 

A seller pays corporate and personal tax related to corporate goodwill with an asset purchase.  A seller only pays personal income tax related to goodwill with a stock purchase.

Personal or professional goodwill is the portion of the value of the business that is based upon the reputation, integrity and relationships the owner(s) have that are of value.  The more involved and/or integral the owner(s) are in retaining key customers the better the argument for higher personal/professional goodwill amounts.

Advantages

Personal/professional goodwill is not a corporate asset.  Personal/professional goodwill is a personal asset belonging to the person to whom the goodwill relates to.  Therefore, the sale of personal or professional goodwill is the sale of a personal asset. 

As a personal asset, the sale of personal/professional goodwill is not subject to corporate level income tax when sold.  The amount allocated to personal/professional goodwill is subject to personal level capital gain tax and has a basis of zero ($0) - therefore the purchase price is subject to personal capital gain taxes.

In addition, the buyer of the personal/professional goodwill asset is purchasing an asset that can be written-off over the 15 year tax life assigned to intangible assets under IRC section 197, assuming the intangible asset has a finite life. 

Example

Assume a $1M purchase price of a business with assets holding a tax basis of $500K and having a stock basis of $100K.  The stock sale has a $900K capital gain and assuming a combined federal/state tax rate of 20% results in $180K of tax. The buyer has no tax deductions relating to the purchase price of the business.  The seller nets $720K in after-tax sale proceeds.

An asset sale has a corporate gain of $500K and assuming a 40% federal/state tax rate results in $200K of corporate level tax.  On liquidation of the corporate stock, the seller receives $800K and has the stock basis of $100K realizing a capital gain of $700K.  Using the 20% effective federal/state capital gain tax rate the seller pays an additional $140K in personal income tax.  The seller nets $660K of after-tax proceeds.  The buyer receives an asset step-up of $500K - an approximate future tax benefit of $200K.

Using the same example assume $300K was allocable to professional goodwill.  The asset deal proceeds would be $700K with a basis of $500K resulting in a corporate gain of $200K and $80K of corporate level tax.  The personal gain on the liquidation of corporate stock is $520K resulting in $104K in capital gain tax.  In addition, the professional goodwill of $300K results in $60K of capital gain tax.  Total personal income tax is $164K.  Seller's after-tax proceeds are $756K.

A stock deal would result in a personal capital gain of $600K and a capital gain tax of $120K.  In addition, the personal gain on the sale of the personal/professional goodwill is $300K and results in a capital gain tax of $60K.  Total seller tax liability is $180K and the seller has net after-tax proceeds of $820K.

From a buyer's perspective, the professional goodwill is written off over 15 years as an asset purchased from the buyer.  This is advantageous in a stock purchase because corporate goodwill amounts are not tax deductible.  Therefore, the purchaser receives a tax deduction over a 15 year period equal to approximately 40% of the $300K professional goodwill purchase price or $120K.

Summary

Utilizing professional/personal goodwill is often a good way to bridge the gap between a buyer's and seller's tax desires in corporate transactions.  Seller's like the tax favored capital gain tax rates and the elimination of double taxation when dealing with c corporations.  When dealing with s corporation asset sales the use of personal/professional goodwill can often reduce the built-in gains tax liability as well.

From a buyer's perspective the personal/professional goodwill is an asset that can be written off over a 15 year period that is tax favorable than corporate goodwill that is not amortizable with a stock purchase. 

Care has to be performed when utilizing this technique in how much of a total transaction price can be allocated to the personal goodwill.  Typically a valuation professional can be engaged to value the amount of personal or professional goodwill that exists and this can be used should an IRS examination into the transaction occur. 

In addition, the use of covenant not to compete agreements should be considered as the IRS has taken the position that personal goodwill cannot exist without an enforceable covenant not to compete agreement.  The Tax Court case Martin's Ice Cream Company (110 TCM 189, 1998).

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