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(1982), affd. 54 AFTR 2d 84-5139, 84-2 USTC par. 9885 (10th Cir.
1984); sec. 1.167(a)-3, Income Tax Regs. However, the fact that
a taxpayer has allocated a specific amount to a covenant not to
compete is not controlling for tax purposes. Lemery v.
Commissioner, 52 T.C. 367, 375 (1969), affd. per curiam 451 F.2d
173 (9th Cir. 1971). We may look beyond the formal dealings of
the parties to see if the form reflects the substance of those
dealings. Annabelle Candy Co. v. Commissioner, 314 F.2d 1, 5
(9th Cir. 1962), affg. T.C. Memo. 1961-170; Buckley v.
Commissioner, T.C. Memo. 1994-470. In order for the form in
which the parties have cast their transaction to be respected for
tax purposes, the covenant not to compete must have some
independent basis in fact or some arguable relationship with
business reality such that a reasonable person, genuinely
concerned with his or her economic future, might bargain for such
an agreement. Schulz v. Commissioner, 294 F.2d 52, 55 (9th Cir.
1961), affg. 34 T.C. 235 (1960). This test is commonly referred
to as the "economic reality" test. See Patterson v.
Commissioner, 810 F.2d 562, 571 (6th Cir. 1987), affg. T.C. Memo.
1985-53.
The Court of Appeals for the Fifth Circuit has held that
determining whether a covenant has economic reality is a
threshold inquiry. Balthrope v. Commissioner, 356 F.2d 28, 31
(5th Cir. 1966), affg. T.C. Memo. 1964-31. The essential
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