Personal Goodwill in a C Corporation Sale and the 16 Points It Saves.

A machine shop owner in his early sixties signs a letter of intent. The buyer wants assets, not stock, and $4,000,000 of the price is goodwill: the customer list, the reputation, the twenty years of knowing which purchasing manager actually returns a call. His corporation has been a C corporation since 1994. On that $4,000,000 the tax is either $1,592,080 or $952,000, and what decides it is a two-page employment agreement his attorney drafted in 1994 that nobody has read since.

A C corporation asset sale is taxed at the corporate level first. The rate is a flat 21% under §11(b), and it applies to goodwill the same as it applies to a lathe. Getting what is left to the shareholder takes a distribution, and in a complete liquidation that is an exchange for the stock under §331, taxed at long-term capital gains rates plus the 3.8% net investment income tax. Stack the two on a zero-basis asset and the effective rate is 39.8%.

The obvious fix is to sell stock instead, and buyers say no. A stock purchase gives them carryover basis and nothing to amortize. An asset purchase lets them write the intangibles off straight-line over 15 years under §197. On a $4,000,000 goodwill number that deduction is $266,667 a year, and nobody gives that up to be nice.

Personal goodwill is not in the Code. It comes from Martin Ice Cream Co. v. Commissioner, 110 T.C. 189, decided in 1998. Arnold Strassberg had built the supermarket relationships that put Häagen-Dazs on freezer shelves, and when the business was sold the IRS said the corporation had sold its own intangibles. The Tax Court disagreed. Strassberg had no employment agreement with the corporation and no covenant not to compete running to it, so the corporation had no claim on his relationships and could not have sold what it did not own.

Bross Trucking, Inc. v. Commissioner, T.C. Memo. 2014-107 put the test in one sentence: an employer has not received personal goodwill from an employee where the employer has no right, by contract or otherwise, to the future services of that employee. Chester Bross had never signed an employment contract or a noncompete with his own trucking company, and the court held that virtually all of the goodwill was his and not the corporation's.

So the question is not whether you are the reason customers call. It is whether you already promised that to your corporation in writing.

Those 16 points are the whole argument, and they cost the buyer nothing. Goodwill bought from you and goodwill bought from your corporation are both §197 intangibles amortized over the same 15 years, so the buyer's deduction is identical either way. That is the version of this conversation to have at the negotiating table.

Howard v. United States, 448 F. App'x 752, decided by the Ninth Circuit on August 29, 2011, is the case to read before you get optimistic. A Spokane dentist incorporated his practice in 1980, and his own incorporation papers included an employment agreement barring him from competing with the corporation for three years after leaving. When he sold in 2002, the asset purchase agreement allocated $549,900 to his personal goodwill and $16,000 to a covenant not to compete with the buyer. The court held the goodwill belonged to the corporation, because the 1980 agreement had already handed it both his services and his forbearance. What the sale documents called it did not matter.

Kennedy v. Commissioner, T.C. Memo. 2010-206 is the second failure mode. Kennedy sold his benefits consulting business, and late in the negotiation the parties agreed to call 75% of the price goodwill and 25% consulting. He then worked full time for the buyer for 18 months without being paid anything close to what that work was worth. The court called the split a tax-motivated afterthought and treated the whole payment as ordinary compensation. Ordinary income runs to 37%, so he landed within striking distance of the 39.8% he was trying to avoid.

• –Cancel any employment agreement or noncompete between you and your own corporation, and do it long before a letter of intent exists. Terminating one the month before closing looks exactly like what it is.
• –Sign two contracts. The corporation sells its assets in one. You sell your goodwill in a separate agreement, in your own name, and the buyer pays you directly.
• –Get an appraisal that names what is yours: the customer relationships you originated, the referral sources, the technical reputation. A percentage picked at the closing table is what sank Kennedy.
• –Price the covenant not to compete you give the buyer on its own and keep it modest. Money for a covenant is ordinary income to you at up to 37% and a §197 intangible to the buyer, so it costs you 13 points against goodwill and buys the buyer nothing extra.

The two contracts have to tell one story. The corporation and the buyer report the asset sale on Form 8594 under the allocation rules of §1060, and you report your goodwill on Form 8949 and Schedule D as long-term capital gain. Allocations that contradict each other are the first thing an examiner finds.

The doctrine is settled. The number is not. In Huffman v. Commissioner, T.C. Memo. 2024-12, the IRS first valued the shareholder's personal goodwill at zero, its own expert then put it at $3,900,000, and the Tax Court found the $21,800,000 the taxpayers had allocated was overstated. Plan on arguing about how much of the goodwill is yours, not about whether the asset exists.

An S corporation has no entity-level tax, so most of the 16 points disappear. Two situations keep it live. If you converted from C to S and you are inside the five-year recognition period in §1374, built-in gain on corporate goodwill is taxed at 21% at the entity level and personal goodwill is not. And if the sale is a year or two out, the structure itself is still on the table, which is where an F reorganization comes in, and where selling to an ESOP is worth pricing as an alternative.