*158 Decision will be entered for petitioner.
Held, the amount of $ 50,000 which petitioner received from an accounting firm in 1944 was the purchase price paid for his accounting practice and is taxable as capital gain under section 117, Internal Revenue Code.
*1251 Respondent determined a deficiency of $ 26,628.62 in petitioner's income*159 tax for the calendar year 1944. The sole question for determination *1252 is whether the amount of $ 50,000 which petitioner received from an accounting firm in 1944 upon the transfer to it of his accounting practice is taxable as ordinary income or as capital gain. The petitioner contends that the $ 50,000 in question was payment for the sale of his good will and, therefore, that it is taxable as capital gain under the provisions of section 117, Internal Revenue Code. The Respondent, on the other hand, maintains that that amount was only an additional payment for his personal services and, consequently, should be taxed as ordinary income.
FINDINGS OF FACT.
Petitioner, a certified public accountant, is a resident of Kansas City, Missouri. His tax return for the year involved was filed with the collector of internal revenue for the sixth district of Missouri, at Kansas City.
Petitioner began his career as an accountant in 1916. He became a certified public accountant in 1920. In 1916 he was employed by Peat, Marwick, Mitchell & Co. (sometimes hereinafter referred to as Peat), a firm of accountants having offices in various cities throughout the Nation. In 1920 he left that*160 firm to start a practice of his own under the name of Richard S. Wyler & Co. That practice was begun with a nucleus of clients which formerly had been with Peat.
Between 1920 and 1944, petitioner developed a considerable accounting practice. Included among his clients were a number of lumber companies, retail stores, wholesale businesses, and manufacturing concerns. He had more lumber clients than any other. In 1944 the greatest part of his clients had been with him a number of years.
During most of the time between 1920 and 1944 petitioner conducted the business as an individual. From 1936 to 1940 another accountant had a partnership interest with him and from 1940 to 1944 another accountant was a junior partner in his firm. By February 7, 1944, petitioner had no partners, although he employed five accountants.
During the years 1940 through 1943, petitioner's firm billed its clients for fees and realized net income as follows:
| Year | Fees billed | Net income |
| 1940 | $ 42,439.54 | $ 18,886.96 |
| 1941 | 54,821.22 | 27,280.81 |
| 1942 | 70,519.44 | 33,481.62 |
| 1943 | 70,582.54 | 32,802.27 |
In November, 1943, petitioner had lunch with a friend, Miller Bailey. Bailey and petitioner were employed*161 on the same date in *1253 1916 by Peat. Bailey remained with Peat and by November, 1943, had become one of its partners, ranking fifth out of about 30 partners. He was a member of the firm's advisory committee.
During this luncheon petitioner complained of nervousness and ill health, stating that he felt it was due to the excess of work and the responsibility which he had in connection with his accounting practice. He said he wanted to take life easier. Bailey then suggested that petitioner sell his business to Peat and join that firm.
Subsequently, at a meeting held in Kansas City on January 24, 1944, by petitioner, Bailey, and James Hall, who was senior partner of Peat, a tentative agreement was reached in regard to petitioner's selling his accounting practice to Peat and his joining that firm.
In a memorandum dated January 25, 1944, Hall stated in part as follows with respect to the taking over of petitioner's practice and his proposed association with Peat:
Some few weeks ago, Mr. Bailey telephoned me in New York, advising me he had had some conversation with Mr. Richard S. Wyler, formerly a member of this staff and later in business for himself in Kansas City. I do *162 not know just what led up to the question, but the conversation turned on what would happen to Mr. Wyler's practice in the event he retired from active work or upon his demise. After some discussion, it was decided to ask me to sit in at a meeting and I came here for that purpose. The entire day yesterday was devoted to talking the matter over with Mr. Bailey and Mr. Wyler.
* * * *
The terms of consolidation have received careful consideration and I have discussed the following deal with Mr. Wyler.
(1) That we will sign an agreement for a period of three years, and he is just sentimental enough to wish that dated February 7, his sixtieth birthday. It is understood that if the practice be not securely tied into us during this three-year period, or if other circumstances make it advisable, we may extend the agreement. Mr. Wyler has an idea he would like at some later date to settle in the Pacific Northwest and, to occupy himself while there, he feels he may do a little consulting. I can see benefits to us by having an experienced lumber accountant associated with us in the Northwest, but this was left for consideration when the time comes. If Mr. Wyler is as good in the lumber *163 industry as we believe him to be, his association with one of our Pacific offices might be extremely valuable.
* * * *
(3) The question of what partnership interest to give Mr. Wyler received careful consideration by Mr. Bailey and myself, and our conclusion was that of a "D" partnership with a 1% interest. We felt this would be best under the circumstances, with the understanding that the 1% would be guaranteed to Mr. Wyler at $ 10,000.00 per annum (each year and not cumulative).
If 1% is more than $ 10,000.00, Mr. Wyler receives the excess. At first, Mr. Wyler rather felt he would like to come in on the main agreement but when its complexities and extended life were explained to him, he realized the benefits to him and his Estate of being on a shorter period agreement.
(4) The major question was what to pay for the practice. This was discussed at length, first by Mr. Bailey and myself, and then with Mr. Wyler. The problem here is the tax one. Obviously, any payment for a practice of *1254 this size under an agency or commission arrangement, would almost certainly be subject to attack by the Treasury Department. If the agency were accepted as an expense, Mr. Wyler would*164 pay income tax and when it is borne in mind that he has a substantial private income, over that from his practice, we realize such a deal would not be acceptable to him. As a matter of fact, he made it very clear he would not be interested in any such arrangement. Apart from that consideration, there is a question in my mind no matter how the agreement is written, an agency of this description is not a taxable deduction. The fact remains we are purchasing Good Will. While we have charged minor expenses of this nature, and so far they have not been questioned by the Treasury Department, I would not expect the department to pass an item of major amount. After reviewing the entire matter I made an offer of $ 50,000.00 for the practice, with the proviso that should the business turned over during the period of the agreement, i. e., three years, be less than $ 180,000.00, Mr. Wyler would rebate proportionately the price of $ 50,000.00. If the business we receive in the next three years is $ 150,000.00, Mr. Wyler will rebate 1/6 of the amount of the $ 50,000.00, the amount of this rebate being applied in reduction of the profit assigned to Mr. Wyler in the third year. The $ 50,000.00*165 will be placed to Mr. Wyler's credit on deposit at 6% interest with permission to withdraw at his convenience.
* * * *
I recommend the deal. I would have preferred paying for the practice on a percentage of business acquired, treating the transaction as a capital one but I could not make it in that way. As it is, I believe the transaction is a good one for us and I should like to have a note from you either concurring or disagreeing. As I have promised Mr. Wyler an answer on the 31st of the month, you might be good enough to deal with the matter promptly by return mail, or by wire if necessary.
The other partners of Peat approved the transaction set forth in Hall's memorandum. Petitioner then consulted with his clients and they approved his becoming associated with Peat. A formal contract between petitioner and Peat was executed on February 7, 1944. The terms of that agreement are incorporated herein by this reference.
The agreement provides in part as follows:
1. Second Party [petitioner] shall become a partner of First Party [Peat, Marwick, Mitchell & Co.] and shall be assigned to service as one of the partners in the office maintained by First Party in Kansas City, Missouri, *166 or at such other points as may be agreed upon by the parties.
2. This partnership agreement shall go into effect at the beginning of business on February 7, 1944, and terminate at the close of business on June 30, 1947, unless sooner terminated in accordance with its terms.
* * * *
5. First Party shall have supreme control of any office or business in charge of Second Party, and Second Party shall defer to First Party's instructions in all matters affecting the same. All appointments, business and correspondence shall be in the name and on behalf of First Party. Subject, however, to conformance to the general policies prescribed by First Party, and regardless of any other provision of this contract, Second Party shall have the direction of the business of clients who just prior to the making of this agreement were clients of Second Party or of Richard S. Wyler & Co. and of clients that may subsequently be obtained for First Party by Second Party and of business relations with such clients, in order that the goodwill of the business heretofore conducted *1255 by Second Party may be retained and may accrue to and for the benefit of First Party.
6. Second Party shall have no interest*167 whatever in the capital, goodwill, firm name or other assets of Peat, Marwick, Mitchell & Co., and no voice in the management, direction or control of the said partnership or its business (other than in the office located at Kansas City, Missouri).
7. As an essential consideration of this agreement, Second Party shall bring with him to the offices of First Party all of the working papers, files and records of the clients of Second Party and Richard S. Wyler & Co., or those who were such clients just prior to the dissolution of Richard S. Wyler & Co. and the making of this agreement, and, so far as he is able to do so, shall hold and continue to serve such clients as a partner of First Party, and deliver to First Party all accounting, auditing and other similar business of said clients. Second Party shall exert his best efforts to hold said clients as clients of First Party, and to hold their said business for the benefit of First Party. All services rendered to such clients shall be for the account and benefit of First Party and First Party shall bill, collect and receive from such clients, all sums chargeable for all services so rendered.
8. All accounts receivable of Second Party*168 and Richard S. Wyler & Co. outstanding at the date of this agreement shall be retained by Second Party. All fees accruing for services rendered by both parties to this agreement shall be prorated on the basis of time and service rendered (services rendered by Richard S. Wyler & Co. being for this purpose treated as having been rendered by Second Party). Second Party shall discharge all claims and liabilities arising out of the operation of the former firm of Richard S. Wyler & Co., and no responsibility shall fall upon the First Party to defend any suits or claims, or discharge any obligations, arising out of such operations.
9. Second Party shall convey, transfer and deliver to First Party, at the present location thereof, the furniture, fixtures, books and supplies owned and used by Second Party and Richard S. Wyler & Co. in their accounting and auditing practice just prior to the dissolution of Richard S. Wyler & Co. and the making of this agreement. First Party shall pay to Second Party an amount equal to the reasonable value of said furniture, fixtures, books and supplies, which value shall, if possible, be determined by an impartial appraiser agreed upon by the parties.
10. *169 Second Party states that his said firm of Richard S. Wyler & Co. had clients who produced gross fees in the approximate amounts of Forty-four Thousand Dollars ($ 44,000.00) for the calendar year 1940, Fifty-four Thousand Dollars ($ 54,000.00) for 1941, Sixty-six Thousand Dollars ($ 66,000.00) for 1942, and slightly in excess of Seventy Thousand Dollars ($ 70,000.00) for 1943. In consideration of the transfer of good will by Second Party to First Party provided for herein, First Party will pay to Second Party the sum of Fifty Thousand Dollars ($ 50,000.00) in cash upon the signing of this agreement. Second Party may leave the said sum, or any part thereof, on deposit with First Party, and any balance on this deposit account shall carry interest at six per cent (6%) per annum, compounded quarterly.
11. The fixed compensation or salary to be paid by First Party to Second Party during the term of this agreement shall be the sum of Ten Thousand Dollars ($ 10,000.00) per year, payable in equal monthly installments on the last day of each month.
12. In addition to said fixed compensation, First Party shall pay to Second Party, for and during the term of this agreement, amounts computed*170 as follows:
For each yearly accounting period (as hereinafter defined) the sum of Ten *1256 Thousand Dollars ($ 10,000.00) or a sum equal to one per centum (1%) of the profits of First Party for said period, whichever is greater. The "yearly accounting periods" herein referred to are the periods of one year each ending at the close of business on June 30, of the years 1945, 1946, and 1947 respectively. For the period beginning at the beginning of business February 7, 1944, and ending at the close of business June 30, 1944, First Party shall pay to Second Party the sum of Three Thousand Nine Hundred Sixty-one and 75/100ths Dollars ($ 3,961.75) or a sum equal to One Hundred Forty-five Three Hundred Sixty-sixths (145/366) of one per centum (1%) of the profits of First Party for the year ending June 30, 1944, whichever is greater.
Such profits of First Party shall be ascertained after charging all expenses, including the salaries of all partners, including Second Party, and such expenses of operation as have been customary heretofore. A statement of such profits will be prepared by First Party and delivered to Second Party within a reasonable time after June 30, 1944, and after*171 the end of each yearly accounting period thereafter. The additional compensation due Second Party under this subdivision "12" shall be payable on the last day of October of each year.
The decision of First Party on all matters, including the preparation of its accounts and the determination of its net profits, shall be final and binding on Second Party and not subject to review.
Second Party shall be entitled to charge to First Party all proper expenses incurred by him on behalf of the business of First Party.
If the gross fees billed or accrued by First Party during the period from February 7, 1944, to June 30, 1947, inclusive, on business of former clients of Second Party or Richard S. Wyler & Co. and other clients brought to First Party by Second Party shall be less than Two Hundred Thousand Dollars ($ 200,000.00), then the additional compensation for the yearly accounting period ending June 30, 1947, which would otherwise accrue to Second Party under this Subdivision "12" shall be reduced. The amount of such reduction shall be determined by First ascertaining an amount equal to one fourth of the difference between $ 200,000.00 and the aggregate of said fees exclusive of billable*172 expenses. If the amount so ascertained is equal to or greater than such additional compensation otherwise accruing, such additional compensation shall be reduced to zero. Otherwise it shall be reduced by the amount so ascertained.
* * * *
14. The Second Party shall not, for a period of three years after the termination of this agreement, either individually, or in conjunction with associates, or as an employee of another person, firm or company of accountants, directly or indirectly solicit or do any accounting or auditing work of or for any of the clients of First Party within the states of Missouri, Kansas or Oklahoma, for whom First Party has done business during the term of this agreement, or with whom First Party was in negotiation to do business on the date of termination of this agreement. Second Party shall not, without the express consent of First Party, negotiate for or accept a position of any kind with any of the clients of First Party during the term of this agreement or within one month after the termination thereof.
15. This is an agreement for personal service and its benefits shall not be pleadgeable [sic] or assignable in any way by Second Party.
16. This written*173 document embodies the entire agreement between the parties hereto, and there are no other understandings, agreements or representations, express or implied.
17. This agreement shall be considered as made in Kansas City, Missouri, and is to be construed in accordance with the laws of the state of Missouri.
*1257 By the above contract petitioner sold his accounting business or good will to Peat for $ 50,000. Included in that sale were all of petitioner's working papers pertaining to his clients which are mentioned in paragraph 7 of the contract.
The working papers referred to in the above contract contained important information concerning petitioner's clients which he had gathered together over a period of years. Such information was helpful in auditing petitioner's clients books. They included excerpts from documents and contracts and detailed information with respect to mortgages and break-downs of capital assets, showing dates of purchase and cost of each item. Petitioner's working papers were sheets 9 1/2" x 14." Those papers were bound, tied by a string, and contained in about 350 volumes.
Paragraph 15 of the above contract was intended by the parties thereto to relate*174 to that part of the contract which pertained to the services to be performed by petitioner and had no relation to the sale of his accounting practice. The compensation which he was to receive for such services is that provided in paragraphs 11 and 12 of the above mentioned contract. A similar provision is inserted in all of Peat's contracts of employment of managers, supervisors, and special partners. It was intended that the consideration for petitioner's agreeing to paragraph 14 would be the compensation that was to be paid to him for his services as provided in paragraphs 11 and 12.
Simultaneously with the execution of the contract on February 7, 1944, Peat delivered to petitioner its check for $ 50,000. Petitioner immediately deposited the check in his bank account in the Commerce Trust Co. and then redeposited the $ 50,000 with Peat in order that he might get the 6 per cent interest thereon as provided in the above contract.
Shortly after February 7, 1944, Peat took over all of petitioner's supplies and working papers, his practice, and all of his staff and continued in the same building the business which petitioner had formerly carried on, until more office space was made*175 ready in the building where Peat maintained its office. At that time all of the property formerly owned in connection with petitioner's business was moved into Peat's offices. For several years the name of Richard S. Wyler & Co. was maintained on Peat's office door in the building where its offices were located and his name has been kept in the telephone book under Peat's regular telephone number.
On March 1, 1944, Peat gave petitioner a check for $ 3,945.72, representing the purchase price of petitioner's supplies, equipment, and library, in compliance with the provisions of paragraph 9 of the contract between petitioner and Peat hereinabove set out.
*1258 On November 1, 1945, petitioner became ill and at his request his compensation (both salary and percentage of partnership profits) was reduced by 50 per cent until June 30, 1946, when the original contract was restored.
For full time services for the period February 7, 1944, through October 31, 1945, half time for the period November 1, 1945, through June 30, 1946, and full time from July 1, 1946, to June 30, 1947, petitioner received from Peat, as compensation for his services, salaries and shares in the partnership profits*176 as follows:
| Share of | |||
| Salary | profit | Total | |
| 2/7/44 to 6/30/44 | $ 4,000.00 | $ 5,193.50 | $ 9,193.50 |
| Year ended 6/30/45 | 10,000.00 | 12,471.19 | 22,471.19 |
| Year ended 6/30/46 | 6,666.66 | 9,972.19 | 16,638.85 |
| Year ended 6/30/47 | 11,666.67 | 15,599.10 | 27,265.77 |
| Total | 75,569.31 |
By the acquisition of petitioner's business, Peat's business was increased about one-third. 1
Peat has purchased other accounting businesses, and other accounting firms have also purchased accounting practices.
In the partnership return of income filed by Richard S. Wyler & Co. for the calendar year 1944, petitioner reported in the schedule of "Long-Term Capital Gains and Losses -- Assets held for More*177 than Six Months" the $ 50,000 received from Peat on February 7, 1944, as having been derived from the sale of "Good Will of Practice." In his personal income tax return filed for the calendar year 1944 he reported the $ 50,000 under the heading "Property Other Than Capital Assets" and included it in his "Summary of Capital Gains and Losses." He computed and paid the tax as authorized in section 117 (b) and (c) of the Internal Revenue Code. Peat likewise treated the $ 50,000 as a capital item.
In the statement attached to the notice of deficiency, respondent stated as follows with respect to the amount in question:
(a) It is held that $ 50,000.00 of the amount received by you in 1944 in connection with an agreement executed February 7, 1944 between yourself and Peat, Marwick, Mitchell and Co. represents ordinary income, taxable in full. Since the foregoing amount was reported by you as a long-term capital gain, taxable to the extent of 50%, or $ 25,000.00, your taxable net income is hereby increased by $ 25,000.00.
*1259 OPINION.
The respondent contends that the $ 50,000 involved was not payment for the sale of petitioner's good will, but, instead, was payment for personal services*178 which petitioner performed for Peat under the terms of the agreement dated February 7, 1944. Respondent supports his position by calling particular attention to paragraph 15 of that contract, which provides that "this is an agreement for personal service * * *." He states that such language "should prevail as a clear statement of what was intended by the parties to be covered by the agreement." Nowhere, he argues, does the agreement regard "good will" as an asset apart from future earnings for personal services. He says further:
* * * The contract, in fact, directs that petitioner keep his good will. His contingent compensation is scaled in proportion to his success in so doing. Peat, Marwick, Mitchell and Company's ultimate acquiring of a right to serve petitioner's clients, which apparently is the "good will" argued for, is expressly tied into the services to be performed under the contract. * * *
The respondent also claims that, even assuming a sale of good will was intended under the contract, nevertheless, "* * * the law is well settled that a professional man accrues no good will as a salable property apart from his person," relying principally upon E. C. O'Rear, 28 B. T. A. 698;*179 affd., 80 Fed. (2d) 473.
The petitioner maintains that the $ 50,000 involved was paid by Peat to him in consideration of the transfer and sale to that firm of his accounting practice, or his good will, and that the resulting profit from that sale was capital gain and taxable as such under the provisions of section 117, Internal Revenue Code. He urges that the history of the negotiations resulting in the contract of February 7, 1944, the circumstances surrounding its execution, and the contract itself show definitely that Peat paid $ 50,000 for petitioner's practice. That payment, he contends, had no relation to his personal services performed for Peat, pointing out that he was paid a separate amount for them.
The first question which we must decide is whether good will under any circumstances may be sold by a person engaged in a profession. And this, in turn, raises the more basic question, what is good will? The parties use the terms petitioner's "good will" and "accounting practice" synonymously. There is no apparent dispute between the parties as to the meaning of the term "good will." In any event, the courts include as a leading element of good*180 will the probability that the customers of the old establishment will continue their patronage. Burke v. Canfield, 121 Fed. (2d) 877; Rodney B. Horton, 13 T. C. 143; appeal dismissed, Jan. 24, 1950. See also 38 C. J. S., sec. 1, p. 949, and *1260 cases cited. So we here, for the purposes of this case, shall treat the terms "good will" and "accounting practice" as being the same.
There is conflict among the courts as to whether or not vendible good will can exist in a professional business. It has been held that salable good will can exist only in commercial or trade enterprises. In 24 Am. Jur. § 11, p. 808, however, it is stated:
* * * The better doctrine, however, appears to be that good will also exists in a professional practice or in a business which is founded upon personal skill or reputation. Where a person acquires a reputation for skill and learning in a particular profession, as, for instance, in that of a lawyer, a physician, or an editor, he often creates an intangible but valuable property by winning the confidence of his patrons and securing immunity from successful competition for their business, *181 and it would seem to be well settled that this is a species of good will which may be the subject of transfer. The courts have not infrequently adjudicated rights relating to good will in such cases with seemingly no question as to the reality of the existence of this property right. * * *
See also cases cited in 24 Am. Jur. § 11, pp. 808, 809.
In Rodney B. Horton, supra, we held that good will was a part of the assets transferred in a sale by a certified public accountant of his business. We do not believe that that case is distinguishable from the one here and we agree with petitioner that under the circumstances of this case he possessed vendible good will.
Having decided, then, that here there was vendible good will for sale, we must next decide whether petitioner in fact sold it, or whether the $ 50,000 was a payment for his personal services, as respondent urges.
We have found as a fact that the $ 50,000 involved was paid as the purchase price for petitioner's practice, or his good will. We base our finding upon the testimony presented at the hearing and the terms of the various documents in evidence, including the contract. Miller Bailey, *182 the senior partner of Peat, who was in on all negotiations leading to the contract of February 7, 1944, testified as follows concerning that payment:
Q. So you met his terms of the $ 50,000 to get him on a 3-year contract?
A. It wasn't his terms. It was our terms. We offered him $ 50,000.
Q. To get him on a 3-year contract?
A. No, not to get him on a 3-year contract; to get his practice, to get his good will.
Petitioner testified as follows:A. The $ 50,000 was in consideration of the transfer of my practice, my business, to Peat, Marwick, Mitchell and Company.
Q. The transfer to the right to these earnings that would result thereafter to Peat, Marwick, Mitchell and Company?
A. I presume the transfer of earnings which they might get from the properties that they bought.
*1261 In the memorandum dated January 25, 1944, which the senior partner of Peat wrote to the other partners there appears the statement that "The major question was what to pay for the practice. That was discussed at length first by Mr. Bailey and myself and then with Mr. Wyler. * * *"
As shown from the portions of this memorandum contained in our findings, Hall recommended that *183 $ 50,000 should be paid for such practice.
Paragraph 10 of the contract between petitioner and Peat contained the provision that "in consideration of the transfer of good will by Second Party to First Party provided for herein, First Party will pay to Second Party the sum of Fifty Thousand Dollars ( $ 50,000) in cash upon the signing of this agreement * * *." We think, in view of the above, that the following language from Rodney B. Horton, supra, is appropriate here:
* * * The purchaser certainly thought it was buying good will and agreed to pay for it. We agree that good will was a part of the assets transferred, and that payment was made for it. Good will is a capital asset and any gains resulting from the sale thereof are capital gains. * * *
Respondent cites in support of his argument that good will was not sold by petitioner E. O. O'Rear, supra. The Court in that case held that the agreements there were not contracts for the sale of good will. That case, therefore, is not controlling, for the terms of the contract involved and the circumstances surrounding its execution clearly indicate that there was a sale of*184 good will by petitioner to Peat. The other cases cited by respondent are also distinguishable.
This case differs from that part of the Horton case holding payment made for an agreement not to compete was ordinary income, by reason of our conclusion of fact here that, notwithstanding the contract provision that petitioner would not compete, the entire sum paid was for petitioner's good will.
In view of the fact that petitioner does not contend that he had any cost basis for the good will (see Rodney B. Horton, supra), $ 50,000 is taxable to petitioner for his taxable year 1944 as capital gain under section 117, Internal Revenue Code.
It follows that respondent erred in his determination.
Decision will be entered for petitioner.
Footnotes
1. We assume this is only one-third of Peat's business in the Kansas City Office. Bailey's testimony in this regard was as follows:
"Q. Mr. Bailey, to what extent did the business that you procured, that you acquired from Mr. Wyler, increase your business that you already had?
"A. To the best of my recollection, about a third."↩