The sale of a C corporation's assets generally results in double taxation on the sale proceeds, first, at the corporate level, and then, upon distribution of proceeds to its shareholders, at the personal level. However, individual business owners of C corporations who can establish that their personal goodwill is integral to the business and is not an asset of the corporation have an opportunity to improve their tax position upon the sale of the corporation. Such owners may (i) avoid the double taxation on a portion of the sale proceeds by allocating a portion of the sales price to personal goodwill as an asset owned by the business owner, and not the corporation; and (ii) recognize long term capital gain (LTCG) on the portion of the sales price allocated to personal goodwill, instead of ordinary income which the business owner would recognize for payments related to other intangible assets (i.e. covenants not to compete).
To effectively invoke the benefits of allocating a portion of the purchase price to personal goodwill, the courts have established several factors that they consider when determining if personal goodwill exists and the allocation of value to personal goodwill. Just some of these factors include:
- The owner(s) of the selling business is integrally involved in the business operations
- The business is primarily built on the strength of the owner's personal relationships, reputation, skills, and know-how
- No employment agreement or non-competition agreement between the selling entity and the owner(s) exists (if in existence, it will be deemed to have transferred the asset of personal goodwill to the selling entity)
- The loss of the individual(s) would negatively impact the revenue and profitability of the business
When selling a closely held C corporation's assets, shareholders should work with their professional team to determine if the opportunity to sell their personal goodwill exists.