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Closely Held Company Did Not Transfer Goodwill to Owner.
(Parker Tax Publishing June 27, 2014)

A solely owned trucking company did not distribute intangible assets (in the form of goodwill) to its owner and, thus, there was no subsequent gift of such assets by the owner to his sons, who had organized a new trucking company. Bross Trucking, Inc. v. Comm'r, T.C. Memo. 2014-107 (6/5/14).

In 1972, Chester Bross organized Bross Construction to engage in various road construction projects. As Chester's road construction projects grew, he organized several other companies, including CB Equipment and CB Asphalt, to provide services and equipment to the construction projects. In 1982, Chester organized, and was the sole owner of, Bross Trucking. He did not have an employment contract with Bross Trucking, nor did he sign a noncompete agreement. None of Chester's three sons ever worked for Bross Trucking. Bross Trucking's principal customers were Bross Construction, CB Asphalt, and Mark Twain Redi-Mix, Inc. Mark Twain Redi-Mix was owned by Chester's wife, Mary, and two of the Bross sons.

As a result of certain publicized regulatory problems with government agencies which oversee trucking businesses, Chester was afraid that his trucking business might be shut down. In July 2003, Chester and his three sons met with an attorney to discuss the best way to ensure that the Bross family businesses had a suitable trucking provider. To meet their goals, the attorney recommended that the Bross sons start a new trucking business. The Bross sons agreed and organized a new company called LWK Trucking. They created a different type of trucking company that provided more services than Bross Trucking. Chester Bross was not involved in managing LWK Trucking. LWK Trucking hired several of the employees that had worked for Bross Trucking. In 2004, about 50 percent of LWK Trucking's employees had worked for Bross Trucking.

On August 22, 2001, Chester and Mary Bross, and their three sons organized Bross Holding Group. Initially the Bross family owned Bross Holding Group in the following percentages: Chester, 37.5 percent; Mary, 25 percent; and each of the three Bross sons, 12.5 percent. Shortly after organization, Bross Holding Group acquired sole ownership of Bross Construction and CB Equipment. Later it acquired CB Asphalt. Chester never conveyed Bross Trucking to Bross Holding Group. In 2006, Chester and Mary gave portions of Bross Holding Group to their three sons and reported the gifts and paid gift tax for the 2006 tax year. They did not report any gifts for tax year 2004, the year LWK Trucking began to do business.

The IRS assessed a corporate income tax deficiency of almost $900,000 on Bross Trucking as well as an accuracy related penalty of approximately $177,000 for the 2004 tax year. The IRS also assessed gift taxes and penalties on Chester and Mary of almost $1.7 million for the 2004 tax year.

According to the IRS, Bross Trucking distributed intangible assets to Chester on February 1, 2004, and Chester then made a gift of the appreciated intangibles, principally goodwill, to his three sons, who used the intangibles in their new trucking company. The IRS said that Chester and Mary should have filed a gift tax return and paid gift tax for tax year 2004. The Tax Court was asked to decide whether Bross Trucking, Inc. distributed appreciated intangible assets to Chester on February 1, 2004, under Code Sec. 311(b) and whether Chester gave any distributed intangible assets to his three sons in 2004.

The Tax Court held that Bross Trucking did not distribute assets to Chester in 2004 and, accordingly, Chester did not give his sons the alleged distributed assets. Thus, neither Chester nor Mary was required to report and pay gift taxes for 2004.

According to the Tax Court, the only reasonable interpretation of the IRS's position was that Bross Trucking transferred goodwill to Chester which he then transferred to his sons. Citing Martin Ice Cream Co. v. Comm'r, 110 T.C. 189 (1998), the Tax Court noted that a business can distribute only corporate assets and cannot distribute assets that it does not own. Specifically, a corporation cannot distribute intangible assets that are individually owned by its shareholders. While Bross Trucking might have had corporate goodwill at some point, most of it was lost by the time of the alleged transfer because of negative attention resulting from state investigations and scrutiny. According to the Tax Court, the only attribute of goodwill that Bross Trucking may have corporately owned and transferred to Chester was a workforce in place. While the IRS argued that "most" of the Bross Trucking employees became LWK Trucking employees, the court said the evidence showed that only about 50 percent of LWK Trucking's employees formerly worked at Bross Trucking. The Tax Court was unconvinced that most of Bross Trucking's workforce in place was transferred when only 50 percent of the current employees were previously Bross Trucking employees. Instead, it appeared to the court that LWK Trucking assembled a workforce independent of Bross Trucking. This was demonstrated, the court said, by the new key employees and services offered by LWK Trucking and that the former Bross employees could have been recruited away.

The court found that the remaining attributes assigned to Bross Trucking's goodwill all stemmed from Chester's personal relationships. Bross Trucking's established revenue stream, its developed customer base, and the transparency of the continuing operations were all spawned from Chester's work in the road construction industry, the court said. Further, the lack of an employment contract between Chester and Bross Trucking showed the court that Bross Trucking did not expect to - and did not - receive personal goodwill from Chester. Accordingly, Chester's personal goodwill remained a personal asset separate from Bross Trucking's assets.

The court found no indication that LWK Trucking used any relationship that Chester personally forged. The Bross sons, the court observed, were in a similarly close capacity to Bross Trucking's customers to develop relationships apart from Chester's relationships. Cultivating and profiting from independently created relationships are not the same as receiving transferred goodwill. While it was true that LWK Trucking's and Bross Trucking's customers were similar, the court said that did not mean that Bross Trucking transferred goodwill; instead the record showed that LWK Trucking's employees created their own goodwill.

The Bross Trucking case demonstrates that courts are moving in support of personal goodwill as an item of property that can be sold or transferred. However, this is not the only existing view. There have been differing court decisions across the country and in U.S. Tax Court on whether professional personal goodwill is truly property or rather it is future earning potential of the person who creates it, which cannot be transferred. The reasons for this view include: considering that the goodwill depends on the presence of a particular person in the business and thus, that is not marketable; that goodwill is only associated with the company or company name and so not transferable; it has no or only nominal resale value; and personal goodwill is simply not transferable as established through precedent. See Bateman v. United States, 490 F.2d 549 (9th Cir. 1973); Hall v. Commissioner, 19 T.C. 445, 460 (1952); Coates v. Commissioner, 7 T.C. 125, 134 (1946); Clukey v. Clukey, No. 391,871, 1998 Conn. Super. LEXIS 2260. (Conn. Super. Ct. Aug. 12, 1998); Taylor v. Taylor, 386 N.W.2d 851 (Neb. 1986); Powell v. Powell, 648 P.2d 218, 223-24 (Kan. 1982); Holbrook v. Holbrook, 309 N.W.2d 343 (Wis. Ct. App. 1981) Nail v. Nail, 486 S.W.2d 761, 764 (Tex. 1972).

Thus, in this case, the Tax Court cites and follows the key cases backing the property theory of personal goodwill, finding that Chester has personal professional goodwill separate from the business goodwill of Bross Trucking, but Bross did not actually transfer that goodwill. The case further moves the personal goodwill as property concept because the court discusses and identifies the other intangible assets subsumed within goodwill, items that can be sold or transferred which have tax consequences.

For a discussion of the taxation of the sale of goodwill, see Parker Tax ¶117,135. (Staff Editor Parker Tax Publishing)

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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