The sale of the business – either an asset purchase or a share purchase – is usually a capital event, giving rise to capital income to the seller. In the case of a closely held business, the purchase agreement often includes a covenant not to compete.
Even if executed in connection with complete sale of a business, a covenant not to compete is taxable as ordinary income under the “substitute for ordinary income doctrine.” This is true regardless of whether the covenant to compete is executed as a separate document, or whether it is included in the purchase agreement. The explanation for this treatment was explained by one court as follows: “Compensation paid for refraining from labor [is] taxable income no less than compensation for services to be performed.” Thus, the percentage of the purchase price allocable to the covenant not to compete is taxed as ordinary income in the year received. When the purchase agreement includes a covenant not to compete, the seller should allocate what portion of the purchase price is attributable to the covenant in the purchase agreement. The IRS will generally respect such allocations unless they are “not appropriate.” Failure to do so will leave the allocation up to the IRS who may attribute a higher value to the covenant. From the buyer’s perspective, a covenant not to compete is a “Section 197 Intangible” which allows the buyer to amortize the amount paid over a 15 year period. This treatment is only allowable in the case of an asset sale. The deduction is not available in the case of a sale of stock or partnership interests. Further, the 15 year amortization period must be used, even if (as will ordinarily be the case), the non-compete period is less than 15 years.
8 Comments
8/23/2015 06:09:39 am
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12/1/2015 07:14:24 am
Thus, the percentage of the purchase price allocable to the covenant not to compete is taxed as ordinary income in the year received.
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2/28/2016 08:02:34 pm
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9/24/2016 04:04:58 pm
There is a lot of things to look at when managing a business.
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12/14/2017 03:18:18 am
اليك الان افضل الخدمات من شركة سوقني التي تعتبر افضل شركة تسويق الكتروني تعمل مع مجموعه متخصصة من الفنيين والمصممين في اعمال تصميم مواقع وباقل التكاليف التي تعمل بها الشركة وتتميز عن غيرها من الشركات .
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9/28/2019 03:28:54 am
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9/28/2019 03:38:44 am
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blogHi. I'm Stephen Flynn. Attorney and founder of the Law Offices of Stephen M. Flynn. This is my blog. Enjoy! Archives
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