Questions: 1. What worked, and the lessons to be learned, from Martin Ice Cream,
ID: 350164 • Letter: Q
Question
Questions: 1. What worked, and the lessons to be learned, from Martin Ice Cream, 110 TC 189 (1998)
2. And what didn’t work, and the lessons to be learned, from Kennedy, TC Memo 2010-206. Supllemental information:
Regular (“C”) Corporations have the potential for two levels of tax. So, if a C corporations sells all of its assets and then liquidates, there will be a corporate tax and a shareholder tax imposed (see Chapter 19). Let’s assume that a shareholder of the C corporation has established important, and valuable, contacts in the community that help the business. This value may be an intangible asset such as goodwill. The shareholder might call this his or her “personal goodwill.” If the business is sold and the shareholder is paid directly for the value of his or her goodwill, then the 21% corporate tax is avoided on that payment. The corporation then has more money to distribute to the shareholder because no tax is paid on the gain from the goodwill (which will have no tax basis ot the corporation). If the shareholder receives 21 cents more for every dollar of goodwill allocated to his or her level, then the shareholder’s gain will be higher by 21 cents. The shareholder can pay no more than 23.8 cents for every dollar of shareholder gain. This means for every dollar of personal, rather than corporate, goodwill, a net savings of 16.002 cents is realized: Save 21 cents of corporate tax Cost 4.998 cents (23.8 cents of added 21 cents) of shareholder tax Net 16.002 cents per dollar If the goodwill value is $1 million, the savings are $160,002 This has led to an incentive for sellers to ask for contracts that allocate purchase price to the shareholder’s intangibles rather than to the corporation. One cannot simply say it belongs to the shareholder – the facts have to support that.
Explanation / Answer
Regular (“C”) Corporations have the potential for two levels of tax. So, if a C corporations sells all of its assets and then liquidates, there will be a corporate tax and a shareholder tax imposed (see Chapter 19). Let’s assume that a shareholder of the C corporation has established important, and valuable, contacts in the community that help the business. This value may be an intangible asset such as goodwill. The shareholder might call this his or her “personal goodwill.” If the business is sold and the shareholder is paid directly for the value of his or her goodwill, then the 21% corporate tax is avoided on that payment. For this owner has to establish that his personal goodwill helped company to increase sale.
Case 1: Martin Ice cream
Martin Ice cream or MIC is a wholesale ice cream distributor established in 1971 with Martin Strassberg as its sole shareholder. In 1979, Arnold martin’s father owned 51% of share in MIC. He developed close relationship with managers of supermarket store to sell ice creams. Due to this sale of ice cream increased. During coarse of time Both Martin & Arnold developed differences with each other and decided to slit. In order to facilitate this MIC created wholly owned subsidiary Strassberg Ice Cream with supermarket distribution as primary business. It then sold this subsidiary to Arnold for his stake in the company.
Shortly thereafter, Pillsbury Co. paid $300,000 to SIC for “records” and $1.2 million to Arnold personally for “seller’s rights.” The issue underlying the case was whether the assets purchased by Pillsbury were corporate assets owned by SIC or personal assets owned by Arnold.
The court ruled in favor of Arnold because sales of Ice cream was completely depended on personal relationship developed by Arnold with managers of supermarket store. Hence he can claim it was his goodwill which helped in development of business. This helped him to save Taxes.
Case 2: Kennedy case
Back ground: Kennedy established KCG international Inc in order to provide service of employee benefits consulting to clients. After its incorporation KCG provided service to client and received revenue for this. KCG had two full time employees Kennedy and Thomas Dolatowski. In 2000, Edward approached Kennedy for the sale of KCG company to Mark & Parker Inc. Kennedy sold the company to Edward.
The parties executed a final purchase-and-sale agreement that consisted of a goodwill agreement, consulting agreement, and asset purchase agreement. Under the agreements, Kennedy would work with M&P as a consultant, without salary, and continue to provide services to his former clients for the next five years, after which he planned to retire. Also, under the agreements, Kennedy and KCG would not compete with M&P for five years. M&P would make a lump-sum payment of $10,000 to KCG and annual payments to KCG and Kennedy for five years. The annual payment amounts would depend on revenue received from Kennedy’s former clients and were allocated 75% to Kennedy in exchange for the “personal goodwill” associated with his customer relationships, his know-how, and his promise not to compete or otherwise engage independently in employee benefits consulting.
In Kennedy, the key issue revolved around whether payments received were from proceeds from the sale of personal goodwill and therefore taxable as capital gain, or payments for services and therefore taxed as ordinary income.
First, the IRS argued that KCG, not Kennedy, owned the customer list and without the customer list, Kennedy could not transfer goodwill.
The IRS also contended that even if Kennedy was the owner of personal goodwill, this asset should not be considered a saleable asset. Any personal goodwill would be based upon the value of Kennedy’s relationships with his customers, which the IRS maintains would have no value unless Kennedy continued to perform services to the clients.
The court agreed that KCG owned the customer list and not Kennedy hence he could not sale. The court also agreed that as long as Kennedy served his customer they would be loyal to him and if he stops there would be no customer. Hence there was no good will to transfer.
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