Entering into an Employment Contract or Non-Compete Agreement with Yourself Can Have Adverse Tax Consequences

by Unfair Competition & Trade Secrets Counsel on September 14, 2011

tax dollars.JPGBy Eric C. Bellafronto and Jose Macias

In an unpublished decision regarding taxation of the “goodwill” upon the sale of a company, the Ninth Circuit recently ruled that while professional personal relationships are generally not corporate assets, such relationships can become corporate assets if the employee has an employment contract or covenant not to compete with the corporation, which would render the value of the “goodwill” a corporate dividend instead of a personal asset. 

In Howard v. United States [pdf], a dentist sold a dental practice.  He maintained that the goodwill proceeds from the sale of the practice were personal assets subject to federal income taxation as long-term capital gain.  The government, on the other hand, argued that the goodwill proceeds belonged to the appellants’ professional service corporation and therefore, the International Revenue Service properly re-characterized the proceeds as a dividend payment. 

The court sided with the IRS.  It found significant that the dentist worked for his professional dental corporation pursuant to an express employment contract by which he agreed “to practice dentistry solely as an employee of the Corporation and . . . devote his entire professional time to the affairs of the Corporation.”  Under this agreement, the corporation retained “complete control and authority” with respect to all clients, files and records, and the appellant also agreed not to compete with the corporation for a set number of years.  The court reasoned that although the relationships that the dentist developed with his patients may be accurately described as personal, the economic value of those relationships did not belong to him because he had conveyed control of the goodwill to the corporation through the employment contract and non-competition agreement.  The dentist could not save the goodwill from taxation as a corporate asset by re-defining it as a personal asset in the purchase agreement or by arguing that the employment contract and non-compete agreement terminated upon the closing of the purchase.  

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Curtailing Competition From Defecting Salespersons: Can Competition Be Restricted?

by Unfair Competition & Trade Secrets Counsel on April 12, 2011

woman on laptop.JPGBy Alison S. Hightower 

It’s a recurrent nightmare for many companies—that gung-ho salesperson you hired, trained, and developed, now that she’s profitable, has established customer relationships, and knows your trade secrets—bolts to work for a competitor or to open her own competitive business, using your customer list and proprietary information.  

How do you protect your business from this frustration?  No doubt you try by requiring your employees to sign a restrictive covenant and non-competition agreement.  But increasingly courts are reluctant to enforce such agreements, elevating (no pun intended, as you’ll see below) the allegedly devastating effects on the salesperson’s ability to make a living over the business’ rights to enforce its contracts. 

A case in point arose in Maryland, where a court struggled to balance the rights of a company to protect itself from the unsavory tactics of a former salesperson whose veracity was so questionable that the court outright rejected as wholly implausible his contention that his signature on the non-compete agreement was forged.  

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