Use of Personal Goodwill

USE OF PERSONAL GOODWILL

Internal Revenue Code Sec. 351

Section 351 of the Internal Revenue Code (IRC) deals with the tax treatment of transfers of property to a corporation by its shareholders in exchange for stock.

One of the lesser-known assets or “property” is personal goodwill. The determination of value for one’s personal goodwill must be supported by a thorough valuation of the business. Then, the resulting goodwill is separated into business goodwill and personal goodwill.

1. Tax-Deferred Treatment: One of the key provisions of IRC Section 351 is that it allows for tax-deferred treatment of certain transactions involving the transfer of property to a corporation. This means that shareholders can transfer assets such as cash, securities, or other property (e.g. personal goodwill) to a corporation in exchange for stock without triggering immediate tax consequences.
2. Non-Recognition of Gain or Loss: Under Section 351, shareholders generally do not recognize any gain or loss on the transfer of property to the corporation. Instead, they receive stock in the corporation equal to the fair market value of the property transferred. This helps to facilitate the formation of new corporations and allows for the consolidation of existing businesses without immediate tax liabilities.
3. Exceptions and Limitations: While Section 351 provides for tax-deferred treatment in many cases, there are certain exceptions and limitations. For example, if the transfer of property is part of a transaction that is essentially a sale or exchange rather than a contribution to capital, then gain or loss may need to be recognized. Additionally, certain types of property, such as inventory or accounts receivable, may not qualify for tax-deferred treatment under Section 351.
4. Control Requirement: One important aspect of Section 351 is the requirement that the transferors must be in control of the corporation immediately after the transfer. Control generally means that the transferors collectively own at least 80% of the total combined voting power of all classes of stock immediately after the transfer. This requirement helps to ensure that Section 351 is used for legitimate business purposes rather than tax avoidance.
5. Anti-Abuse Provisions: The IRS has the authority to challenge transactions that it believes are abusive or do not meet the requirements of Section 351.