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OPINION
Issue 1. Fair Market Value of the Covenant Not To Compete
Entered Into by Mr. Langdon and Bravo
The amounts of any tax deficiencies of the parties herein
turn on the value of the covenant not to compete. That is so
because, as to BDC, the amount properly allocated to intangibles
(in excess of basis) is taxable as capital gain. When it is
distributed to the shareholder (Mr. Langdon), it is treated as a
nondeductible dividend and taxed again to him. See secs.
61(a)(7), 11, 301(c)(1).
On the other hand, the amount allocated to the covenant will
be taxed to the shareholder as ordinary income, but such amount
will escape tax at the corporate level. Thus, it is only taxed
once, not twice. The same applies to the consulting agreement.
In other words, the consulting agreement and covenant, even
though part of a total package, are treated as separate
agreements between the buyer and shareholder, and the selling
company is not taxed thereon.
The buyer's interests are not adverse. It can ratably
deduct the cost of the covenant not to compete over the life of
the covenant-–in this case 5 years. See sec. 1.167(a)-3, Income
Tax Regs. So once again, the more that is allocated to the
covenant, the greater the tax benefit to all parties.7
7Bravo, the buyer, was not before the Court.
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