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38 MoldMaking Technology —— FEBRUARY 2018 THE BOTTOM Molding Personal Goodwill By Adam J. Herman, CPA/ABV/CFF, CVA, ASA, CFE and Michael J. Devereux II, CPA, CMP The issue of who owns goodwill (an individual or a company) has important tax and economic consequences. Personal good- will can make a big difference when determining the value of a mold shop that is for sale. Personal goodwill represents intan- gible economic characteristics and the related intangible asset value that is attributable to an individual's reputation, specific skills and knowledge, personal relationships, judgment, exper- tise, experience, personality, past success and management style. An employee or shareholder of a corporation can own good- will separately from the corporation if customers value the owner or employee (rather than the corporation) as the center of their commercial relationship. This is commonplace for mid- size and small mold shops. Personal goodwill characteristics are generally considered inseparable from the individual. This is not the case for company goodwill, which represents those intangible economic characteristics and the related intangible asset value that is attributable to the business entity. Company goodwill examples include the company's name, reputation, research efforts, location, facility, phone number, customer list and trained and assembled workforce. Tax Impact One major reason to value the level of personal goodwill in a business is because of the double taxation involved in the sale of assets that C Corporations hold. In the sale of a C Corporation's assets, all gains are taxed at the corporate tax rate, which has a top rate of 35 percent. Soon the rate will be 21 percent, under the tax reform bill. The C Corporation must then distribute the proceeds of the sale to the shareholder. The proceeds are then taxed again at the shareholder level, typically at the capital gains tax rate of 23.8 percent (which is the qualified dividend rate of 20 percent plus the 3.8 percent Medicare surtax). However, if personal goodwill can be carved out of the sale and attributed to the business owner, and not as an asset of the corporation, the gain allocable to the personal goodwill from the sale is only taxed once, as personal assets of the shareholder are taxed at the capital gains rate of 23.8 percent. Economic Impact When the C Corporation has more than one owner, the eco- nomic impact of the sale can be affected if a portion of the pur- chase price is allocable to personal goodwill, and that personal goodwill is not proportionate with the ownership interests. For example, Adam and Mike each own 50 percent of XYZ Mold Builders, which is taxed as a C Corporation in the sale of all of the assets for $4 million. In allocating the purchase, the valuator determined that $3 million is allocable to the business' assets, $750,000 to Adam's goodwill and $250,000 to Mike's goodwill. In this example, Adam will recognize greater proceeds from the sale, since more of the purchase price was allocated to the per- sonal goodwill that he owned. Available Guidance The most frequently cited personal goodwill case is Martin Ice Cream, Petitioner v. Commissioner of Internal Revenue, Respondent, the 1998 court decision that gives authority to the separate treatment of personal and business goodwill. Arnold Strassberg, an ice cream industry veteran, and his son Martin jointly owned a wholesale ice cream company. The two disagreed about how the business should be run, so they divided the company in two. Arnold decided to sell his side of the business to Häagen- Dazs for $1.5 million. Relative to the taxes associated with the sale, Martin Ice Cream contended that the majority of the value was actually the personal goodwill Arnold had built over a long industry career. As personal goodwill, the gains would be taxed at Arnold Strassberg's capital gains rate. The IRS contended that the sale proceeds should be attributed to Martin Ice Cream and taxed at the corporate rate. The tax court ruled against the IRS, agreeing that these intan- gible assets were the property of the shareholder. So, the value of those assets was not included in the value of the corporate sale. The Martin Ice Cream case underscores the opportunities available for significant tax savings in a business sale. Carefully evaluating corporate and personal assets can help shop owners avoid a major tax burden. Final Factor In the sale of a business, personal goodwill itself cannot be transferred. However, the rights to one's goodwill can be transferred. If an individual signs a non-compete or any other employment agreement, his or her personal goodwill may actu- ally be considered an asset of the company. Therefore, verify that the key individual(s) did not sign a non-compete or any other employment agreement before trying to allocate personal goodwill. CONTRIBUTOR Adam J. Herman, CPA/ABV/CFF, CVA, ASA, CFE, is a partner and chief visionary officer for Mueller Prost LC who regularly advises manufacturers in the exit of their businesses. Michael J. Devereux II, CPA, CMP is a partner and director of Manufacturing, Distribution and Plastics Industry Services at Mueller Prost LC. FOR MORE INFORMATION Mueller Prost / 314-862-2070 mdevereux@muellerprost.com / muellerprost.com