In a recent Tax Court case (Bross Trucking, Inc. v. Commissioner, T.C., No. 7710-11, T.C. Memo. 2014-107, June 5, 2014), the question of whether goodwill and related intangible assets were corporate or personal in nature was the primary issue at hand. The IRS contended that Bross Trucking, Inc. (“Bross”) made a taxable distribution of intangible assets to Chester Bross (“Chester” - the owner of Bross) on February 1, 2004, and that Chester made a taxable gift of the appreciated intangible assets to his three sons, who organized a new trucking company, LWK Trucking Co. The IRS assessed Bross Trucking with a corporate income tax liability of nearly 1 million dollars and Chester individually with a gift tax liability of over 1 million dollars.
The primary issue before the Court was whether Bross truly owned any intangible assets of value that it could in fact distribute. Citing Martin Ice Cream Co. V. Commissioner, 110 T.C. 189, 209 (1998), the Court stated that a business can “distribute only corporate assets and cannot distribute assets it does not own. Specifically, a corporation cannot distribute intangible assets that are individually owned by its shareholders.”
In determining whether Bross owned any goodwill or other intangible assets, the Court examined the following facts:
Chester had close personal relationships with Bross’ primary customers.
Chester had no non-compete agreement that would prohibit him from competing with the company if he disassociated with it.
The value of Bross’ licenses was not significant given that it was relatively easy for new market participants to obtain trucking authority and comply with other regulations in Missouri.
Bross had recently been under investigation by the DOT and the Missouri Division of Motor Carrier and Railroad Safety. Bross received significant negative publicity from the audits, and the continued heightened regulatory scrutiny posed the risk that Bross would be put out of business; this risk caused Bross’ customers to reevaluate whether to trust Bross with their business.
Given the recent regulatory investigations, the value of the Bross trade name was not significant and was in fact negative. Contemporaneous proof of this was that Chester’s sons’ newly formed company - LWK Trucking – hid the Bross name on all of its trucks with magnetic covers.
Bross had no significant unique supplier relationships that allowed the company to generate superior returns. The Court noted that the fact that the relationships with suppliers of fuel and parts largely resided with Chester himself.
Bross relied on independent contractors to perform hauling services. Given this fact and the fact that only 50% of LWK Trucking’s employees were former Bross employees after the transfer, the evidence pointed to the fact that LWK Trucking assembled a work force independent of Bross. LWK’s work force consisted of new key employees–some of whom allowed LWK to extend new service offerings that were distinct from those that Bross offered.
In summary, the Court concluded that Bross had no trade name value, no value to its licenses, no unique supplier relationships, and no valuable assembled workforce that was transferred. The Court ruled that “Bross’ established revenue stream, its developed customer base, and the transparency of continuing operations were all spawned from Chester’s work in the road construction industry.” Based thereon, and the fact that Chester did not have a non-compete or employment agreement with the company, the Court held that Bross wasn’t liable for a tax on the distribution of its goodwill to Chester, its sole shareholder, and that Chester wasn’t liable for a gift tax related to the subsequent transfer of assets to his sons because the company, didn’t have any goodwill or other intangible assets to transfer.
When analysts and tax practitioners hear the term personal goodwill, they often think of insurance agencies, medical practices, small CPA firms, and other similar personal service companies. The decision in this case shows that whether the subject company distributes ice cream (i.e., Martin Ice Cream matter) or is a hauler of construction-related materials and equipment for road construction projects (i.e., Bross Trucking), the issue of whether goodwill is a corporate or personal asset is very case specific to the facts at hand.
This issue also commonly arises in situations when a C-Corporation and the personal goodwill of its owner are collectively sold in an asset sale to a third-party buyer. There is a tax advantage to the seller in such situations if the facts support an allocation of a portion of the total purchase price to personal goodwill as opposed to corporate goodwill (by avoiding the double layer of taxation of C-Corporations). Understanding what assets of the subject company truly drive the revenue and cash flows that it generates is the key to answering the question of whether goodwill is a corporate or personal asset.