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Noncompete Agreements - In General
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How are noncompetition agreements taxed? Related Topics:
Payments you receive for a noncompetition agreement are taxable as ordinary income. The entity making the agreement that s/he will not compete will receive the money, or if involved in a bulk sale owe tax on the apportioned amount attributed to the non-competition agreement. Contracts completed before 1993 had the opportunity to spread the amount over a 60 months period. In 1993 the 15 year rule was required for writing off the cost of the agreement. The recipient must pay all the tax in the year the money is received. In Burien Nissan, Inc., et al. (T.C. Memo. 2001-116) the taxpayer had to include such amounts in income. He tried to assign the proceeds to the corporation and transform the payments into a return of capital. The Court didn't buy it. These are agreements reached between a buyer and a seller preventing the seller from reestablishing a business that will compete with the buyer. These can be between individuals as well as corporations. They usually specify a legal life and value. When tax rates for ordinary income and capital gains are nearly the same, the buyer and seller do not have opposing interest and an arms-length transaction is in doubt. The non-compete agreement merely becomes a convenient way for the buyer to quickly amortize purchase price. Therefore, the buyer must provide documentation to support the value of the covenant. The value must account for both the probability of the seller competing as well as the effectiveness of the competition. The projection period for valuing the covenant should not extend beyond the legal life of the covenant.
Solutions are dependent upon facts & circumstances, law and the objectives. These elements vary from one time to another, from one circumstance to another and from person or entity to another
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