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Is there personal goodwill on an S Corp sale

June 10, 2022
Is there personal goodwill on an S Corp sale
          I’ve been asked if the sale of the assets of a C Corporation could be considered sale of Personal Goodwill and not double taxed as would the sale of Alarm Contracts and tangible assets.  A Seller’s CPA may claim that the assets being sold are “Personal Goodwill” and, as such, the Seller is selling the Buyer a personal asset and not an asset of the Company.   As Ken and I have mentioned many times the biggest issue with operating as a C Corporation is that in an asset sale any gains are taxed once at the corporate level (the C Corp has sold the assets), and then again when the cash (what’s left of it) is distributed to the shareholders.  Since S Corporations are not generally taxable entities in the eyes of the IRS the sale of an S Corporation’s assets is generally only taxed to the shareholders in proportion to their ownership percentages. 
          Many Sellers, when confronted with double taxation in the sale of the assets of a C Corporation, attempt to reclassify the asset sale as a sale of Personal Goodwill.  The IRS defines Personal Goodwill as an asset that is owned by an individual, not the business itself. It is generated from the personal expertise or business relationships of an individual employee or shareholder (IRS Code Section 1.197-2(b)(1).  Although classifying part of the sales price as Personal Goodwill is effective as a tool to avoid taxation at the Corporate Level seems to be a great alternative to double taxation it ignores a fact of life in the Alarm Industry. 
          We have participated in over 500 transactions in the past 25 years, and in every single one the principal asset being sold was the monitoring agreements and their associated RMR.  Not only are the monitoring agreements named as an asset in the Purchase Agreement, there are also provisions in the Asset Purchase Agreement to adjust the price for non-qualifying RMR due to issues with contracts, customer payment status, cancellations, and other factors.  If the price is being determined by the RMR (which is an asset of the Company) it is hard to argue that the asset being purchased is an asset owned by an individual.  There is even case law, Martin Ice Cream Company v. Commissioner, in which the Tax Court affirmed the IRS position that Personal Goodwill was an asset held by an individual.
          I have spent hours on the phone with CPA’s who believe that there is Goodwill, and even Personal Goodwill, in the sale of an alarm company.  They don’t understand the alarm industry and don’t understand that monitoring agreements have value.  It is somewhat amusing that these are the same guys who advised their clients not to elect to be S Corporations.  I have performed hundreds of valuations and the only one that contained Goodwill of any kind was when I valued Sonitrol subsequent to its purchase from Tyco.  Yes, the Sonitrol name had value, but it was an asset of the Company, not any stockholder or individual.  Many CPA’s claim that the IRS is not likely to challenge their position.  I call this playing the “audit lottery.”  I don’t play the lottery and I certainly encourage my clients not to as well. 
Mitch Reitman
817-698-9999 XT 101
Reitman Consulting Group
Fort Worth, TX 76133
          “Good chance” you won’t get audited is a poor and very risky basis for legal or accounting advice.  In fact, you might be better off getting your advice from a Craps Dealer, they know the odds. 
          If you are still operating as a C Corp take a hard look and find out why.  Your tax advisor, accountant or tax-attorney, should have a very clear and convincing argument to support the C Corp decision.  I also think you need to be careful using the LLC entity because not all states treat the LLCs the same as corporations, including S Corps.  I prefer the S Corp and I think so does Mitch.
          There may be other ways to minimize tax consequences on an alarm deal; ideas best conceived by Mitch.

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Ken Kirschenbaum,Esq
Kirschenbaum & Kirschenbaum PC
Attorneys at Law
200 Garden City Plaza
Garden City, NY 11530
516 747 6700 x 301