A recent Tax Court decision highlights the possibility that personal goodwill is an item of property having economic value that may be inadvertently transferred from the senior generation to a younger generation. Much attention has been paid to the U.S. Tax Court holding in Bross Trucking, Inc. v. Commissioner, T.C., No 7710-11, T.C. Memo 2014-107, June 5, 2014), that the trucking company didn’t distribute intangible assets in the form of goodwill to its owner and, thus, wasn’t liable for tax associated with a distribution of corporate goodwill. For estate planning professionals, however, this memorandum opinion reaffirms the court’s position that personal goodwill may be personal property separate from the business goodwill, which, depending on the action and relationship of the parties, may be transferred to family members resulting in transfer tax consequences.
IRS Assesses Gift Taxes on Goodwill
Chester Bross formed Bross Construction in 1972 to engage in a number of construction projects. Chester continued to organize companies to provide services and equipment to the numerous construction projects undertaken by Bross Construction. Chester was responsible for arranging and seeing to the completion of the projects, developed personal relationships in the road construction industry and was responsible for maintaining those relationships on behalf of the family business.
In 1982, Chester formed a solely owned trucking company known as Bross Trucking. In the late 1980s, Bross Trucking was investigated by a number of government agencies overseeing the trucking business. Fearing his trucking business would be forced to shut down, Chester and his three sons met with an attorney to discuss the best way to ensure the Bross family business had a suitable trucking provider.
Chester’s sons, who weren’t previously involved in Bross Trucking, formed a new trucking business in 2003 known as LWK Trucking. LWK Trucking provided a broad range of services to Bross Trucking. According to the Internal Revenue Service, Bross Trucking distributed intangible assets, principally in the form of goodwill, to Chester, and Chester made a gift of that goodwill to his three sons, who then used the intangible asset in their new trucking company. The IRS assessed gift taxes and penalties on Chester and his wife of almost $1.7 million for the 2004 tax year.
Corporate Versus Personal Goodwill
The Tax Court found that there was no significant corporate goodwill to be distributed to Chester. In fact, the court referred to the business at issue as the “antithesis of goodwill” due to its regulatory infractions, impending suspension and negative attention brought to the corporate name. Any goodwill of the company resulted from Chester’s personal relationships and work in the construction industry. The lack of employment contract between Chester and Bross Trucking indicated to the court that Bross Trucking didn’t expect to receive personal goodwill from Chester. Accordingly, Chester personal goodwill remained a personal asset separate from the corporation.
To determine whether Chester made a taxable gift of his personal goodwill to his sons, the court found no evidence that the sons’ trucking company, LWK Trucking, used any of Chester’s personal relationships. The record supported the finding that LWK Trucking’s employees created their own goodwill.
The Bross Trucking case demonstrates the court’s willingness to find personal goodwill as an item of property that may be transferred, rather than simply finding that personal goodwill is future earning potential of the person who creates it, which can’t be transferred. If personal goodwill is property, it’s entirely possible, based on the facts and circumstances, that a client may inadvertently transfer that goodwill to the next generation resulting in transfer tax consequences. For example, will there be a taxable transfer if a client is an attorney who introduces his granddaughter, also an attorney, to an existing client relationship, and that client engages the client’s granddaughter to do legal work. If a client’s goodwill is property transferred to his granddaughter, what’s the value of the goodwill transferred, and will the transfer be subject to the generation-skipping transfer tax?
The Bross Trucking case had unique facts to eliminate any corporate goodwill and allow the court to find the personal goodwill wasn’t in fact transferred to the next generation. If the son’s new trucking business relied on the father’s personal relationships to be successful, it’s very possible the court might have come to a different conclusion on the gift tax liability question.