Litigation & Dispute Resolution

April 16, 2018

Observations of New Tax Reform Law on Personal Goodwill in Family Law Cases

Most professionals have seen countless reports of the 2017 Tax Cuts & Jobs Act (TCJA) on national news and been bombarded with requests to discuss the impact and various changes in the new law.  For the family law community, obvious takeaways are the change in the deductibility, or lack thereof, in alimony payments after 2018, elimination of personal exemptions, and expanded use of 529 plans to include secondary and lower-level education expenses.  Can a provision in the TCJA actually provide some insight into the presence of personal goodwill?

Personal Goodwill Under Tennessee Law

Under Tennessee case law, personal goodwill is not a divisible marital asset.  As discussed in the seminal case Koch, the Court reiterates the findings and definition of personal goodwill provided by the Wisconsin Court of Appeals in HolbrookHolbrook describes personal goodwill as follows:

“The concept of professional goodwill evanesces when one attempts to distinguish it from future earning capacity. Although a professional business's good reputation, which is essentially what its goodwill consists of, is certainly a thing of value, we do not believe that it bestows on those who have an ownership interest in the business, an actual, separate property interest. The reputation of a law firm or some other professional business is valuable to its individual owners to the extent that it assures continued substantial earnings in the future. It cannot be separately sold or pledged by the individual owners. The goodwill or reputation of such a business accrues to the benefit of the owners only through increased salary.”

Section 199A of the TCJA and Personal Goodwill

So, what does personal goodwill have to do with the TCJA?  Upon closer examination of the provision for a Section 199A deduction, some individual’s trusts and estates could be eligible for a 20% deduction on certain pass-through income.  However, there are special limitations that apply to “specified service businesses.”  According to the TCJA, “specified service businesses” are defined as follows:

A specified service trade or business means any trade or business involving the performance of services in the fields of health, law, accounting, actuarial sciences, performing arts, consulting, athletics, financial services, brokerage services, or any trade or business where the principal asset of such trade or business is the reputation or skill of one or more of its employees or owners, or which involves the performance of services that consist of investing and investment management trading, or dealing in securities, partnership interests, or commodities.

Sound familiar?  Both the Holbrook and “Specified Service Businesses” definitions have some common elements including reputation and skill of the employee.  Under the TCJA, can tax returns now be used to assist attorneys and business appraisers to determine if the presence of personal goodwill exists?  In other words, if an individual fails to qualify for a Section 199A deduction because of the “specified service businesses” limitation, does that illustrate that personal goodwill is present?

We think the Section 199A provision and a person’s deductibility or exclusion of this deduction can provide another data point for attorneys and appraisers in determining whether personal goodwill is present.  As with any thorough analysis of personal vs. enterprise goodwill, other important factors to consider are:

  1. Size of business and number of owners/practitioners
  2. Presence/lack of covenants not to compete
  3. Dependence on owner(s) for selling feature with Company’s products
  4. Presence/lack of ancillary income

Conclusion

The 2017 Tax Cuts & Jobs Act may assist attorneys and appraisers in determining if personal goodwill is present via the Section 199A deduction.

As we’ve pointed out, this deduction/exclusion is just one of several data points that should be considered. It should also be noted, that determining whether personal goodwill is present or not is only the first step to an analysis. If personal goodwill is present, the second step is to determine or assign value to the personal goodwill. In other words, a company’s value could be comprised of both enterprise and personal goodwill. A qualified business appraiser is necessary to make this determination and to provide an allocation of the goodwill.

Originally published in Mercer Capital's Tennessee Family Law Newsletter, First Quarter 2018

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