Non-compete conveys personal goodwill to professional corporation, 9th Circuit confirms

BVWireIssue #109-1
October 5, 2011

When a dentist incorporated his solo practice back in 1980, he also signed a non-compete, effectively agreeing not to compete against his own corporation (of which he was sole shareholder, officer, and professional employee). More than 30 years later, when he sold the practice to another dentist, he allocated nearly $550,000 of the purchase price to his personal goodwill and then reported the sale on his federal income taxes as long-term capital gain income. After the IRS re-characterized the goodwill as a corporate asset and treated the proceeds as a dividend, the taxpayer sued for a refund in district court, which found for the IRS--and the taxpayer appealed.

Held: the U.S. Court of Appeals for the Ninth Circuit found that under the facts of the case, the dentist effectively transferred his personal goodwill to the corporation through the original non-compete. For federal tax purposes, his professional goodwill became a corporate asset and its sale proceeds constituted a dividend to the taxpayer. Look for the complete digest of Howard v. United States, 2011 WL 3796723 (C.A.9 (Wash.))(Aug. 29, 2011), in a future Business Valuation Update; the 9th Circuit’s opinion will be posted soon at BVLaw, where you can also find the federal district court’s opinion.

For a current, comprehensive guide to valuing dental practices—including sample reports: check out BVR’s Guide to Valuing Dental Practices, edited by Stanley Pollock, who is both a dentist and a business appraiser. The new guide contains two sample appraisals of dental practices and chapters on valuing orthodontic practices as well as professional goodwill.

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