The buyer wants to allocate fifteen percent of the purchase price to personal non-compete agreements and transition consulting fees rather than enterprise goodwill, which would convert millions of dollars of our sale proceeds from long-term capital gains into ordinary income. How do we negotiate purchase price allocation under Section 1060 to defend our net proceeds?

Question

Tyler Smith · Accepted Answer

In an asset purchase or a stock sale treated under Section 338 or 1060, the buyer and seller must file Form 8594 with the IRS, reporting an identical allocation of the purchase price. Buyers want to allocate significant value to restrictive covenants, non-competes, and consulting arrangements because they can amortize or deduct those expenses over shorter periods, shielding their taxable income immediately. For you as the seller, that allocation transforms proceeds from favorable long-term capital gains rates into ordinary income, costing you fifteen to twenty percent in extra taxes.

To defend your net proceeds, deploy these specific negotiation strategies:

- Mandate enterprise goodwill allocation. Argue that company value rests in institutional customer relationships, documented operational processes, and internal talent, not in personal founder attributes. Insist that Class VII enterprise goodwill receive the bulk of premium value above tangible assets.
- Apply the independent economic reality test. The IRS and courts scrutinize non-compete allocations that bear no realistic economic relationship to the underlying risk. If the buyer is already retaining the leadership team and customer contracts are legally secured, an oversized non-compete allocation is an audit vulnerability for both parties.
- Require a tax gross-up for consulting consideration. If the buyer requires genuine ongoing advisory services, limit the formal consulting compensation to fair market value for the actual hours required. For any allocation that pushes ordinary income above market consulting rates, require the buyer to gross up the cash consideration to neutralize your tax hit.

Lock the agreed purchase price allocation directly into the primary purchase agreement as an attached schedule before signing, rather than deferring the calculation to post-closing accountants.