February 20, 2020
Goodwill Hunting and the Mary Kay Sales Director.
Turning ordinary income into capital gains is a holy grail of tax planning. Where ordinary income can be taxed at rates as high as 37%, the federal capital gains rate caps out at 23.8%.
One innovative way to generate capital gains is through the use of "personal goodwill." The idea is to value and allocate income to business relationships and customer goodwill developed by the individual taxpayer. The tactic originated to move income on business asset sales out of C corporations to avoid corporate level tax. The Martin Ice Cream case is the textbook example, involving the man who brought Häagen-Dazs to America.
A Mary Kay consultant who rose high in the organization attempted to use the personal goodwill idea to turn payments from the organization into capital gains, instead of deferred compensation taxable as ordinary income. Tax Court Judge Gerber explains:
Petitioners argue that, in effect, Taxpayer sold the goodwill of her trade or business to Mary Kay. The argument derives from some of the preamble text in various agreement documents concerning the FSP program. The following text is in the preamble to the July 1, 1991, Mary Kay FSP agreement: “[E]ach National Sales Director desires to participate in this program in exchange for the offer by Mary Kay Cosmetics, Inc. to acquire at retirement the valuable goodwill and all other rights associated with the business, including future goodwill generated by her continued support and loyalty to Mary Kay Cosmetics, Inc.”
The Tax Court was unconvinced. It didn't help that the same issue had been litigated unsuccessfully by another Mary Kay sales director, but Judge Gerber elaborates:
The facts here belie petitioners' sale argument. There was no agreement between Mary Kay and Ms. Dunlap with respect to any sale of a business or goodwill. Other than the reference to goodwill in the preamble to some documents, there is no evidence in the record that would support a sale of a business interest. The payments under the FSP are calculated on the basis of sales and commissions and are being paid at a rate of 60% of a high average tiered sales activity. Lastly, Ms. Dunlap had no rights or legal relationship with the consultants and sales directors in her tiered Mary Kay activity. Accordingly, her goodwill argument does not change the outcome of this case.
Personal goodwill failed here, but it can succeed with the right facts. The personal goodwill needs to be a separate and identified part of the sale. It needs to be clear that the goodwill belonged to the individual - for example, non-compete arrangements in place before the sale are bad facts for this. A good valuation, preferably from an outside appraiser, can make the difference.
Cite: T.C. Summ. Op. 2020-10
White House Adds Corporate AMT, SALT Cap to 2.0 Wish List - Jonathan Curry, Tax Notes ($). "The proposals, first reported February 19 by The Washington Post, are the latest in a series of vague proposals that may end up in the White House’s plan for a second round of middle-income tax cuts that it plans to release ahead of the November elections. White House economic advisers are considering the proposals but have made no decisions, according to the Post."
Better to fix problems with the existing tax. Minimum taxes give pols an easy way out while making life harder for taxpayers.
Latest IRS Compliance Push Targets High-Income Nonfilers - William Hoffman, Tax Notes ($):
The IRS initiative will focus on individuals with incomes exceeding $100,000 a year who haven’t filed tax returns in 2018 or previous years, according to a February 19 release. Many of the IRS visits will be unannounced, though the revenue officer assigned may opt to send an appointment letter, [IRS Small Business/Self-Employment Division director of field collection operations] Kea said. However, the IRS will have contacted these individuals multiple times, sometimes over a period of years, in an effort to collect, [IRS SB/SE director of collection operations]Mamo said. The visits “should not come as a surprise . . . to the taxpayer,” Kea added.
The Case of the Missing K-1 - Russ Fox, Taxable Talk:
"John and Mary Smith came by my office yesterday. “We normally get to you in June,” Mrs. Smith told me, “but this year we have everything so we’d like to file today.” Well, they had almost everything.
Unfortunately, there was one K-1 from a partnership that they didn’t have.
Give the K-1s time to arrive. It's always better to extend for a tardy K-1 than to amend for one that comes after you file.
5 Tax Filing Tips for 2020 - Kelly Phillips Erb, Forbes. "4: Safeguard Your Financial Data."
Wisconsin Considers Standard Deduction Increase, TPP Tax Reduction - Katherine Loughead, Tax Policy Blog. "Assembly Bill 910 and companion bill Senate Bill 821 would reduce individual income taxes for low- and middle-income taxpayers by increasing the standard deduction. In addition, this legislation would chip away at some of Wisconsin’s remaining tangible personal property (TPP) taxes by removing machinery, tools, and patterns assessed as the personal property of manufacturers from Wisconsin’s property tax base."
Did TCJA’s Corporate Rate Cuts Work As Promised? No Signs Yet. - Steven M. Rosenthal, TaxVox.
Owners of popular Iowa State Fair concessions arrested for tax evasion, fraudulent practices - Alex Schuman, KCCI. Sales tax Problems for Diamond Jack's. "The documents do not include the exact number owed, but it does exceed $10,000 for each count. The alleged fraudulent business practices started in 2016 and went until 2019. The counts of sales tax evasion include 2017, 2018 and 2019."
This is a roundup of tax news and opinion. Any opinions expressed or implied are those of the author and not necessarily those of Eide Bailly. Opinions found in linked items are those of the authors of the linked item, not of your bloggers or of Eide Bailly. “$” means link may be behind a paywall. Items here do not constitute tax advice.