Personal Goodwill, An Even Better Type of Goodwill

Goodwill is an intangible asset that adds a premium value to a company based upon good customer relations, good employee relations and the like. Personal Goodwill by extension, is simply goodwill that applies to an owner or possibly a key employee of a business.

To begin with, the phrase “personal goodwill” does not appear anywhere in the Internal Revenue Code. Instead, a landmark case gave rise to the concept of personal goodwill for federal tax purposes. A subsequent Tax Court Memo affirmed its existence.

In the Martin Ice Cream Case (110 TC 189, (1998)), Arnold Strasberg was the co-owner of a company known as Martin Ice Cream Company. During his tenure with the company, he became a distributor of ice cream from Haagen-Dazs to multiple grocery stores under a non-written, “handshake” agreement. In the mid-1980’s, Pillsbury acquired Haagen-Dazs. Rather than allowing Arnold to continue in the distributorship, middle–man position, Pillsbury acquired Arnold’s company, the Martin Ice Cream Company. Forty-six percent of the purchase price was allocated to Arnold’s seller’s rights or what is now known as “Personal Goodwill”. When the case went to court, the Tax Court held that personal relationships of a shareholder-employee are not corporate assets when the employee has no employment contract with the company. This landmark tax case gave rise to personal goodwill.

Additionally, Norwalk (TCM 1998-279, 1998 – four months after the Martin Ice Cream case decision) found that the personal relationships of a group of accountants were the property of the individual owners and not the corporation itself. Thus affirming the existence of personal goodwill.

Comment: This concept is important when dealing with sales, mergers, or acquisitions of small and mid-sized corporations. During the 60’s and 70’s thousands of corporations were formed as subchapter C corporations. Many of these became wildly successful, being built into multi-million dollar enterprises and many owners of these are now nearing or exceeding retirement age.

Subchapter C corporations have one built in issue, their income is taxed at the corporate level. This potentially creates problems while newer, “flow-through” entities do not possess this issue. When a C corporation is sold, part of the goodwill running with the company does not escape the gravity of the corporation. It is therefore taxed at the entity and shareholder level. Personal goodwill on the other hand, runs and sells from the individual owner to the buyer, thus avoiding the issue of double taxation. If you are considering selling your company, whether it be a flow through company such as S Corporations, Limited Liability Companies, etcetera, be sure to examine your tax options (such as a personal goodwill agreement among other options) before the letter of intent is signed. Gaining the optimum tax position can save you a fortune!