I had spent three or four weeks in a hospital and what helped me through each night was a fox my mother purchased from the hospital gift shop.
Later that same year my mother took me to a department store and I saw the Holy Grail of animals — a stuffed seal. After much “discussion,” my mother approached the register to ask the price of the seal. It had no price tag or any other markings.
The lady at the register looked puzzled and eventually said a price. We paid it. My fox now had a sea-faring friend.
I must have been a brilliant kid. I named my fox “Red Fox.” He was red. He was a fox. I named the seal Peppy.
I did not want to divulge the seal’s name too easily. So I wrote the name on the seal in secret code. “P” was the number 16. “E” was the number 5. “Y” was the number 25.
This rivaled the Nazi Enigma Code.
There was one other thing I knew. Peppy was left in that store by some other kid. He was clearly a homemade animal.
He was lime green. His nose was multi-colored pieces of yarn protruding out and falling out. He was worn and dirty.
That purchase was tainted. Deep down I knew a department store cannot sell that which it does not own. It can try, but it still isn’t right.
I thought of Peppy many years later when reading a Tax Court case about a guy who helped distribute Häagen-Daz ice cream in supermarkets.
This guy owned a corporation. When Pillsbury bought Häagen-Daz it decided to pay the guy for his “seller’s rights” to exit the distribution relationship.
The guy reported the Pillsbury payment as income on his personal tax return. The check had been made out to him.
IRS said the payment really belonged to the corporation. This would create two levels of tax — one for the corporation and the second for the shareholder when distributed.
The guy was able to prove that he had built personal relationships that did not rely on his corporation. He had sold these personal relationships to Pillsbury.
The Tax Court opinion said, “a corporation cannot sell that which it does not own.” The corporation did not own the shareholder’s personal relationships. The IRS lost.
This case is long and complicated. It is often cited by advisers to inform sellers how to avoid two levels of tax when a corporation sells assets.
A buyer’s payments to purchase stock cannot be amortized. If the buyer splits the purchase between stock and the seller’s personal rights, the buyer gets a partial amortization deduction.
But no one can sell that which they do not own. Not a corporation. Not a department store. When I face this issue in tax practice, I feel that I can hear Peppy talking to me.
Because the seller’s rights case is long and complicated it is often not analyzed or explained properly. Some advisers make the issue as simple as, “Just say you bought/sold personal goodwill.”
It is often difficult to know who owns something. The rules of tax practice say that you must have “substantial authority” for your conclusions. This means 40% to 45% chance of success if challenged.
Peppy was not owned by that department store. I am 99% sure of that. That store lacked substantial authority for the sale it made.
None of us ever escapes our past. Peppy lives on as I study and apply tax cases dealing with personal goodwill sales.
Personal goodwill sales and purchases can save significant tax dollars. But you can’t just make up some story to try to claim a right to sell that which you do not own.
If you’re the kid who lost a green seal decades ago, I’m sorry. My penance will include careful analyses of tax authorities before I let someone claim they can sell that which they do not own.
To that kid, Peppy’s adopted life was a good one. And I’ll strive to ensure that claims to sell personal goodwill have substantial authority supporting ownership. That much I owe to Peppy.
Jim Hamill is the director of Tax Practice at Reynolds, Hix & Co. in Albuquerque. He can be reached at email@example.com.