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business to a charitable remainder unitrust, resulted in taxable
income to petitioners by reason of a covenant not to compete
executed at the time of the sale.
Petitioners contend that because ownership of the business
had been irrevocably transferred to the trust, because they were
not parties to the purchase agreement between the trust and the
buyers, and because the trust received the entire proceeds of the
sale, the covenant not to compete contained in such agreement can
have no tax consequences for them. Petitioners further assert
that the separate document entitled “COVENANT NOT TO COMPETE” was
signed by them only as an accommodation and cannot result in
taxable income because it is without true economic value,
unsupported by consideration, and unenforceable under California
covenant law.
Conversely, respondent argues that the portion of the
purchase price attributable to a covenant not to compete is
taxable to petitioners. Respondent contends that because
petitioners executed a personal covenant in conjunction with the
sale of the Little Rascals business and because they, not the
trust, posed the only real threat of competition, they cannot
escape tax on the income apportioned to such a covenant by
anticipatorily assigning that income to the trust. Respondent
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Last modified: May 25, 2011