If personal goodwill is not a property right of the enterprise, its value is not includable in the assets of the business. Thus, it is separable from business goodwill.
What is personal goodwill? It is that portion of total goodwill that is directly attributable to key employee's functions in the business. Critical to this separation from business goodwill is the ability of the evaluator to articulate specific examples that identify and quantify how the key employee is responsible for producing business profitability. These examples can explain how a portion of the profits are solely attributable to him or her. It is more than merely showing that any competent, qualified employee could perform in the same position. The analysis must be specific to the key employee.
C Corporation Sale of Assets followed by Liquidation of Corporation
The importance of separating personal from corporate goodwill is especially apparent in a C corporation sale of assets. The first level of tax occurs at the corporate level when the assets are sold for cash and the sales proceeds, after tax, are distributed to shareholders in exchange for their shares. Once the proceeds are distributed, the shareholders also incur a tax on their gain measured by the difference between the distributed proceeds and the tax basis in their stock. The importance of placing value on personal goodwill ("p.g.") as an asset sold is to remove this amount from the sales proceeds paid to the corporation and instead have that sum paid to the shareholder-key employee directly.
By doing so, the p.g. sales proceeds received by the shareholder is not taxed at the corporate level.
Factors
Quantifying the proportion of personal versus business goodwill is based on these factors for the individuals:
- Age and health
- Demonstrated earning power
- Community reputation for judgment, skill and knowledge
- Comparative industry success
- Nature and duration of person's role in creating company profits