The buyer wants to reallocate ten percent of the purchase price into a post-closing consulting agreement and non-compete payments to write off the expense. How does this reclassification affect our net tax proceeds and post-close liability?

Question

Tyler Smith · Accepted Answer

Buyers frequently attempt to reallocate a portion of the enterprise purchase price into post-closing consulting agreements and personal non-compete covenants because it creates an immediate tax advantage for them. Payments for consulting are expensed as ordinary business costs, and non-compete covenants are amortized quickly, allowing the acquirer to shield taxable operating income after closing.

For the seller, this reclassification can destroy significant net proceeds. The sale of equity or goodwill in a standard stock or asset transaction is typically taxed at favorable long-term capital gains rates. In contrast, consulting fees and non-compete payments are treated by the IRS as ordinary income, which can push your federal and state tax burden significantly higher, while also subjecting the consulting payments to self-employment taxes.

Beyond the tax hit, an extended consulting agreement creates operational liability. The buyer can tie consulting payments to specific deliverables, attendance, or transition milestones, effectively converting guaranteed cash into an operational performance dispute. If the buyer claims you failed to assist them adequately or breached ambiguous terms, they may withhold consulting checks.

If the buyer insists on a consulting carve-out, demand an exact dollar-for-dollar tax gross-up so your net after-tax proceeds equal what you would have received under capital gains treatment. Require that the consulting agreement be non-contingent, paid on a fixed schedule regardless of services requested, and insulated from general indemnity claims.