Covenant Not To Compete

[DONNA ASTON]

s corporation tax return. My client is the seller. Attorney gave me a copy of the purchase and sale agreement. Which states "purchase price" for assets and non-compete agreement is 300,000 of which 50,000 shall be allcoated to the covenant not to compete over 5 years with the balance allocated to customer lists and goodwill. I will prepare the s corp return but the personal return will be prepared by another accountant. The two accountants one being me do not agree on what tax return to report the covenant not to compete income (s corp or 1040) and in what year it is reported. Could anyone out there help.

[veritas]

Who is the seller

of the covenant?

Is it an installment sale?

[DONNA ASTON]

I was just pointing out my client is the seller not buyer. Yes it is an installment sale

[veritas]

Since your client,

a corporation is the seller the covenant should be reported first on form 6252 and then carried to form 4797 as ordinary income. Included in the corporate return.

Assuming the corporation is no longer necessary you have one year to liquidate from the sale in order to transfer the installment sale to the shareholder(s). Otherwise you would need to continue filing corporate returns until the installment sale is paid in full.

[DONNA ASTON]

thanks for the reply. A few other facts of the situation are they will not close company this yr recievables on the books. The buyer paid 60,000 (30,000 earnest money and 30,000 at end of year). The rest is paid over five years in annual installments no interest.
So the 240,000 includes the non compete. The example in the taxbooks shows the entire non-compete amount on 4797 with zero basis.

[veritas]

Given the numbers you

have provided 16.6667 of each dollar as it is received would be allocated towards the covenant over the life of the contract.

60,000 * 16.6667 =10,000 in the year of sale to be reported in the first year for the covenant.

oops

I just noticed no interest. You will need to compute a portion of the payments received using the applicable federal rate to be reported as interest income.

[DONNA ASTON]

no they negotiated no interest lucky buyer. Sorry I'm a little confused the $60,000 was the down payment the remaining including $50,000 non compete is 240,000.

[BOB W]

no they negotiated no interest lucky buyer. Sorry I'm a little confused the $60,000 was the down payment the remaining including $50,000 non compete is 240,000.

Regardless of what the contract says IRS REQUIRES the sale price to be reduced by an amount equal to the unstated interest. I don't think you can go below (appx) 5%. The interest must be included Separately on your clients 1120s>1040. The Buyer deducts it.

The remaining sale $s are allocated accordingly. All Gain from the recapture of depreciation gets reported in the year of sale and is not part of the installment sale.

[veritas]

Your biggest problem here

to start with is there is no stated interest. What I am reading from your posts are:

You have a 300,000 sale with a 30,000 down payment. This leaves a remaining contract of $270,000. You need to look at the rules on installment contracts with unstated interest. Some part of the 270,000 contract must be classified as interest income.

This contract if not signed should be revisited.

[DONNA ASTON]

this client sold no other assets. It was not purchased goodwill so there was no basis in it. I am confused as to what to report on 6252 and 4797 this year. The business will not liquidate this year.

[DONNA ASTON]

sorry for confusion the down payment is 60,000

[BOB W]

to start with is there is no stated interest. What I am reading from your posts are:

You have a 300,000 sale with a 30,000 down payment. This leaves a remaining contract of $270,000. You need to look at the rules on installment contracts with unstated interest. Some part of the 270,000 contract must be classified as interest income.

The Sale price is $300,000 not 270,000. The $300,000 get reduced by the imputed interest on the $270,000.

[DONNA ASTON]

yes your correct. Thank you I understand the interest must be calculated. I am on the computer and having problems with the 6252 it doesn't look correct.

[BOB W]

I was just making sure that Donna understood how to apply the interest and that $300,000 is NOT the sale price.

[veritas]

I'm

confused now. The sales price is $300,000. The contract balance is $240,000? Which means some part of 240,000 will be interest?