Treatment of Goodwill Upon the Sale of a Business: Asset of the Owner v. Asset of the Company

In 1980, Larry E. Howard, D.D.S. incorporated his dental practice and entered into an employment agreement and covenant not to compete with the corporation. In 2002, Dr. Howard retired and negotiated the sale of his practice to a corporate buyer for approximately $613,000, most of which was allocated to intangible assets. Dr. Howard reported over $320,000 of the purchase price on his personal return as long-term capital gain from the sale of personal goodwill. The IRS rejected this claim and asserted that the goodwill was a corporate asset that was distributed as a dividend. The recharacterization resulted in a deficiency determination in excess of $60,000, plus penalties and interest. Dr. Howard thereafter paid the additional tax and sought a full refund. The federal district court found in favor of the IRS and determined that when an employee is covered by a covenant not to compete, any goodwill generated from the employee’s work is an asset of the employer and not personal goodwill. 

Author’s Note: While medical practices generally are not considered to have goodwill, a dental practice can be distinguished and may have goodwill.

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