Covenants not to compete.For legitimate business purposes and occasionally to modify the taxation of a business sale, taxpayers--over time--have used covenants not to compete. Under current law, these covenants may be covered by IRC (Internet Relay Chat) Computer conferencing on the Internet. There are hundreds of IRC channels on numerous subjects that are hosted on IRC servers around the world. After joining a channel, your messages are broadcast to everyone listening to that channel. section 197. Recently the Tax Court considered the application of section 197 to a stock redemption including a covenant not to compete covenant not to compete n. a common provision in a contract for sale of a business in which the seller agrees not to compete in the same business for a period of years or in the geographic area. This covenant is usually allocated (given) a value in the sales price. .
Frontier Chevrolet sells and services new and used cars. Roundtree Automotive Group buys and operates auto dealerships. In 1987 Roundtree purchased all of Frontier's stock. Dennis Menholt, an employee/manager of Frontier, was permitted to buy Frontier stock. As of August 1, 1994, Roundtree owned 75% and Menholt 25%. On that date Frontier redeemed re·deem
tr.v. re·deemed, re·deem·ing, re·deems
1. To recover ownership of by paying a specified sum.
2. To pay off (a promissory note, for example).
3. all of the remaining stock Roundtree owned for $3.5 million. At the time of the redemption, Roundtree and Frank Stinson, who worked for Roundtree, signed a covenant not to compete. The agreement required Frontier to pay Stinson $22,000 a month for 60 months. Initially, Frontier treated the covenant as a section 197 asset and amortized it over 15 years. In 1999, however, it filed a refund claim, arguing the covenant should be amortized over the 60-month life of the contract. The IRS An abbreviation for the Internal Revenue Service, a federal agency charged with the responsibility of administering and enforcing internal revenue laws. denied the claim and Frontier sued.
Result. For the IRS. Section 197 provides for the amortization of intangible assets Intangible Asset
An asset that is not physical in nature.
Examples are things like copyrights, patents, intellectual property, and goodwill. These are the opposite of tangible assets. over a 15-year period. Included in the covered intangibles is a covenant not to compete that a taxpayer enters into in connection with the direct or indirect acquisition of a trade or business.
Frontier argued the transaction was not covered not covered Health care adjective Referring to a procedure, test or other health service to which a policy holder or insurance beneficiary is not entitled under the terms of the policy or payment system–eg, Medicare. Cf Covered. by section 197 because it was a stock redemption--not a purchase from an outsider--and it was not a business acquisition because the corporation engaged in the same activities after the redemption as before.
The Tax Court rejected Frontier's arguments. The definition of acquisition is gaining control. Since this transaction included the purchase (redemption) of 75% of the corporation's stock, it involved acquisition of control. (Treasury regulations section 1.197-2(b)(9), effective after the date of this transaction, says an acquisition can take the form of a purchase of assets, stock or the redemption of stock or a partnership interest.)
The court rejected the second part of the taxpayer's argument because the legislative history of section 197 does not indicate it was intended to apply only to new business acquisitions. Therefore, this transaction was an acquisition of a trade or business, and the covenant not to compete was a section 197 asset. The amortization, thus, should be over 15 years rather than over the life of the payments.
In the future, taxpayers should remember this expansive definition of acquisition of a business when agreeing to a covenant not to compete.
* Frontier Chevrolet Co. v. Commissioner, 116 TC no. 23.
Prepared by Edward J. Schnee, CPA (Computer Press Association, Landing, NJ) An earlier membership organization founded in 1983 that promoted excellence in computer journalism. Its annual awards honored outstanding examples in print, broadcast and electronic media. The CPA disbanded in 2000. , PhD, Joe Lane Professor of Accounting and director, MTA (1) (Message Transfer Agent or Mail Transfer Agent) The store and forward part of a messaging system. See messaging system.
(2) See M Technology Association.
1. (messaging) MTA - Message Transfer Agent. program, Culverhouse School of Accountancy, University of Alabama The University of Alabama (also known as Alabama, UA or colloquially as 'Bama) is a public coeducational university located in Tuscaloosa, Alabama, USA. Founded in 1831, UA is the flagship campus of the University of Alabama System. , Tuscaloosa.