When you sell s corp goodwill asset do you pay capital gains and ordinary income tax on the sale

[LauraVF · Accepted solution]

IT DEPENDS.

If the goodwill asset is considered personal goodwill from one of the shareholders, the shareholder recognizes capital gain on the sale of the asset. For instance, if a shareholder sells a business in which his or her personal relationships with clients/customers are important to the purchaser, the personal relationships are considered personal goodwill and will be taxed as capital gain to the shareholder.

If the shareholder sells the personal goodwill to the s-corporation and in return gets paid in the future for services provided to the s-corporation as a result of the goodwill, then those earnings will be ordinary income to the shareholder. For example, if the only shareholder in an s-corporation sells the personal goodwill listed above and agrees to be a shareholder/owner at the business acquiring the goodwill, the income earned by the selling shareholder at the new business will be taxed as ordinary income to the selling shareholder. 

Lastly, if the business created the goodwill, such as a license, a customer list, brand name, etc, the asset will be considered a capital asset and will be subject to capital gains tax to the s-corporation. The asset will have zero basis if it is self-created.

Please read the following article found in the Tax Adviser Journal.
https://www.thetaxadviser.com/issues/2014/may/payne-may2014.html 

[auhnalev]

"if the business created the goodwill, such as a license, a customer list, brand name, etc, the asset will be considered a capital asset and will be subject to capital gains tax to the s-corporation. The asset will have zero basis if it is self-created"

The term “goodwill” refers to that intangible asset that comes into play only when a company is planning to acquire another company and is willing to pay a price that is significantly higher than the fair market value of the net assets of the company. In short, the goodwill can be seen as the difference between the purchase price and the fair market value of a company’s identifiable assets and liabilities.

The calculation of the goodwill equation is done by adding the consideration paid, the fair value of non-controlling interests, and the fair value of previous equity interests and then deducting the fair value of net assets of the company.

The goodwill calculation method is represented as,

Goodwill Formula = Consideration paid + Fair value of non-controlling interests + Fair value of equity previous interests – Fair value of net assets recognized.

Can you elaborate why the self created goodwill will have a zero basis?