Allocation of goodwill to personal goodwill can alter individual tax liability on the sale of a company.  Personal goodwill should be valued by a third-party valuation firm.  It should be clearly identified in the purchase price agreements and agreed to by the acquirer.

Recent Tax Court decisions in Bross Trucking, Inc., T.C. Memo. 2014-107, and Estate of Adell, T.C. Memo. 2014-155 continue to show the Tax Court does differentiate between personal and corporate goodwill.  The personal goodwill concept is typically associated with the landmark case Martin Ice Cream Co., 110 T.C. 189 (1998).

In Martin Ice Cream, the United States Tax Court decided that the majority shareholder’s relationships with his clients were not owned by the corporation as the shareholder did not have either an employment agreement with the Company nor a covenant not to compete.  Therefore, the goodwill associated with this was not the asset of the Company but an asset of the shareholder himself.

Personal goodwill is dependent on the personal characteristics of the business owner.  Personal relationships, ability, personality, and reputation of a shareholder-employee key to the business’ success must be defined and supported.

Quantifying the proportion of personal versus business goodwill is often based on factors associated with the shareholder-employee such as these:

  • Age and health
  • Demonstrated earning power
  • Community reputation for judgment, skill and knowledge
  • Comparative industry success
  • Nature and duration of person’s role in creating company profits
  • Personal relationship with customers
  • Importance to developing new business
  • Personal involvement in solving client problems
  • Critical role in financial/operational decisions
  • Direct impact on profitability
  • Personal knowledge, experience, known-how and abilities

A vital test is whether the individual holds the right to sell the goodwill.  It must be the shareholder’s asset that was not previously transferred to the corporation. Evidence of such transfers include employment agreements and non-compete agreements.

Multiattribute Utility Model

The Multiattribute Utility Model (“MUM”) is a commonly-used tool to allocate goodwill between personal goodwill and enterprise goodwill.  It calls for the analyst to identify key attributes of goodwill and segregate them between personal and enterprise goodwill.  Attributes span industries.

To each attribute, a weight of importance (with 1 as the lowest and 5 the highest) is assigned.  Attributes include those above and are fine-tuned for each situation.  An attribute is weighted based on the importance of the attribute to the person and enterprise. The weights determine the allocation between personal and corporate goodwill.

As with any valuation, each allocation of weight must be supportable.  Our philosophy at JBV is if you can’t support it, don’t state it.

At JBV, we are here to assist you.