Covenant not to compete income ?

[Twin Turbo Z]

Taxpayers sold a 1065 business in 2022 and part of the monies was a "covenant not to compete". Total business purchase price (including non compete money) is on an installment sale for 5 years. The taxpayers current preparer says all of the "non compete" monies has to be claimed in 2022 ? Even though the non compete monies is being paid over 5 years ? I've searched and found nothing that says it has to be all claimed the year of the sale. Thats taxing monies they have not received yet. The current preparer is listing the "non compete" monies on form 4797 Pt II Ordinary Gains and Losses ? Any input is welcome.

[Snaggletooth]

I believe such a covenant is ultimately ordinary income. I think there is a form 8843 or something designed to be submitted by both the buyer and seller (independently) when a sale occurs. The issue for the buyer is to minimize goodwill, and the issue for the seller is to maximize capital gains. The 8843 defines the nature of income and expenses, but the two parties have different agendas and usually disagree.

[Maribeth]

The non-compete is ordinary income to the seller. It does not qualify for installment sale and it's usually a separate part of the sales contract. I would pull it out of the installment sale calculation, and report it as received during the 5 year period. Make sure that your Form 8594 agrees to the purchasers.

[Lion]

If it does not qualify for installment sale, do you report the whole ordinary income from the non-compete in the first year?

If so, does that reduce the amount that IS reported as an installment sale in the first year?

Can Turbo put some hypothetical round numbers to his question to help me follow the flow the first year and the next four years, please?

[Twin Turbo Z]

Unfortunately all I was given is a copy of the 2022 1065 & 1040 to look at. And a copy of the "Promissory Note" signed by the buyers. Pretty simple note. Lists equipment value (150k), inventory value (50k), goodwill value (150k), and non compete value (150k). That total was $500,000. And the 5 year payment structure of $100k plus 3% interest per year. Taxpayers questioned the preparer as to why all the $100k in "Non Compete" had to be claimed in year one ? The preparer is showing a $200k payment for 2022 when all that was received is $100k. Preparer told them it was the law ? These are friends (that are not clients) and I said I would ask around tax forums. We do not do many 1065's and those we do are pretty cut and dry. Never came across this scenario before with "Non Compete" monies. Seems strange the preparer is claiming it all the "non compete" when they only got a 1/5th.

We contacted the taxpayers and they are going to ask what IRS code the preparer relied on for the decision to claim it all. But from my reading the non compete should be spread over the life of the promissory note. Looked at sec 453(b)(2) which does not indicate the covenant is excluded from installment sale treatment. If claimed all in year one, then future payments reported will be less than actually received.