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B. The Danielson Rule
In Commissioner v. Danielson, 378 F.2d 771, 773 (3d Cir.
1967), Thrift Investment Corporation (Thrift) offered to buy all
the common stock owned by individual stockholders, including
Danielson, for $374 per share. In the agreement of sale, Thrift
allocated $152 per share to a covenant not to compete and $222
per share to the contract for the sale of stock. Id. On each
payment check, Thrift printed a notation that the payment
represented a payment for both the stock and the covenant not to
compete. Id. On their tax returns, Danielson and the other
stockholders reported the payments received as income from the
sale of a capital asset. Id. The Court of Appeals for the Third
Circuit held:
a taxpayer who enters into a transaction of this type
to sell his shares and executes a covenant not to
compete for a consideration specifically allocated to
the covenant may not, absent a showing of fraud, undue
influence and the like on the part of the other party,
challenge the allocation for tax purposes. We so
conclude even though the evidence, as here, would
support finding that the explicit allocation had no
independent basis in fact or arguable relationship with
business reality. * * *
Id. at 777 (emphasis added). The Danielson rule, as adopted by
the Third Circuit, is:
a party can challenge the tax consequences of his
agreement as construed by the Commissioner only by
adducing proof which in an action between the parties
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