Is the transfer of goodwill to the next generation a taxable gift?
A recent case involving the transfer of goodwill from a father to his sons asked just that question. The IRS wanted more than $2.7 million inincome tax, gift tax deficiency and penalties.
The IRS’s willingness to litigate the Bross Trucking case opens the door to the possibility that the agency may find a future case with a better set of facts.
These facts might allow it to convince a court that a corporation should recognize gain on the distribution of goodwill, the shareholder should recognize dividend income on the receipt of the goodwill, and the transfer of the goodwill to the next generation is a taxable gift.
In the case of Bross Trucking, Inc. v. Commissioner, TC Memo 2014-107, June 5, 2014, three brothers formed a corporation to conduct a trucking operation after their father’s wholly owned corporation ceased operations.
Chester Bross, the father, owned 100 percent of Bross Trucking, Inc. The corporation provided trucking services, and 90 to 95 percent of its customers were companies owned by members of the Bross family.
Bross did not have an employment contract with Bross Trucking, and he never signed a noncompete agreement. The company leased its trucks from CB Equipment, another Bross family-owned entity.
After Bross Trucking came under investigation by federal and state regulatory agencies for safety issues, Bross decided to cease trucking operations. Bross Trucking remained in existence as a viable entity, complete with insurance and its original trucking authority. The corporation had cash assets and over $250,000 of other assets, including accounts receivable, which it continued to collect.
Bross’s three sons, who were not previously involved with Bross Trucking, started their own trucking business – LWK Trucking. About 50 percent of LWK’s employees were former employees of Bross Trucking. LWK executed a lease with CB Equipment allowing LWK to use equipment that had previously been leased to Bross Trucking.
LWK provided a broader range of services than Bross Trucking, including doing truck repairs and providing GPS devices. LWK obtained its own licenses, regulatory authorizations, suppliers and customers. In other words, nothing was transferred from Bross Trucking to LWK Trucking.
The Tax Court ruled that there was no taxable transfer of goodwill from the father’s corporation to his sons. The IRS assessed tax and penalties based on the following:
1. Bross Trucking distributed appreciated intangible assets to its sole shareholder, Chester Bross, and
2. Bross made gifts of those assets to his sons.
The IRS said that the intangible assets included:
- An established revenue stream
- A developed customer base
- Transparency of the continuing operations between the entities
- An established work force, including independent contractors
- Continuing supplier relationships
Although the IRS did not call the intangible assets “goodwill,” the Tax Court did.
The court ruled that Bross Trucking’s goodwill was primarily owned by Bross personally, and the company did not transfer any corporate goodwill to Bross. Thus, there was no taxable distribution to Bross and no gift from Bross to his sons.
The court reasoned as follows:
- The court concluded that the sole attribute of goodwill displayed by Bross Trucking was an in-place work force, and it was therefore the only attribute that the corporation could have distributed to Bross.
- Nearly all the goodwill used by Bross Trucking was Bross’s personal asset. A company does not have any corporate goodwill when all of the goodwill is attributable solely to the personal ability of an employee.
- Bross never transferred his personal goodwill to Bross Trucking.
- No intangible assets were transferred from Bross Trucking to LWK.
- Bross Trucking did not distribute any cash assets and retained all the necessary licenses and insurance to continue business.
Further, Bross remained associated with Bross Trucking and was not involved in operating or owning LWK Trucking. He was free to compete against LWK Trucking and use every cultivated relationship to do so.