FILED
NOT FOR PUBLICATION AUG 29 2011
MOLLY C. DWYER, CLERK
UNITED STATES COURT OF APPEALS U.S. COURT OF APPEALS
FOR THE NINTH CIRCUIT
LARRY E. HOWARD, et al., No. 10-35768
Plaintiffs - Appellants, D. C. 2:08-cv-00365-RMP
v. MEMORANDUM*
UNITED STATES OF AMERICA,
Defendant - Appellee.
Appeal from the United States District Court
for Eastern Washington, Spokane
Rosanna Malouf Peterson, Chief District Judge, Presiding
Argued and Submitted July 13, 2011
Seattle, Washington
Before: CLIFTON and N.R. SMITH, Circuit Judges, and KORMAN, Senior
District Judge.**
Dr. Larry E. Howard and Joan M. Howard (jointly, the “Taxpayers”) appeal the
district court’s grant of summary judgment in favor of the United States on their claim
*
This disposition is not appropriate for publication and is not precedent except
as provided by 9th Cir. R. 36-3.
**
The Honorable Edward R. Korman, Senior District Judge for the U.S. District
Court for Eastern New York, Brooklyn, sitting by designation.
for a refund of a tax deficiency and interest payment. The Taxpayers maintain that the
goodwill proceeds from the sale of Dr. Howard’s dental practice were personal assets
subject to federal income taxation as long-term capital gain. The government
contends that the goodwill proceeds belonged to Dr. Howard’s professional service
corporation (the “Howard Corporation”), which the Internal Revenue Service properly
recharacterized as a dividend payment. We have jurisdiction under 28 U.S.C. § 1291,
and we review the district court’s grant of summary judgment de novo. Bagdadi v.
Nazar, 84 F.3d 1194, 1197 (9th Cir. 1996).
Goodwill “is the sum total of those imponderable qualities which attract the
custom of a business,—what brings patronage to the business.” Grace Brothers v.
Comm’r, 173 F.2d 170, 175–76 (9th Cir. 1949). For purposes of federal income
taxation, the goodwill of a professional practice may attach to both the professional
as well as the practice. See, e.g., Schilbach v. Comm’r, 62 T.C.M. (CCH) 1201(1991).
Where the success of the venture depends entirely upon the personal relationships of
the practitioner, the practice does not generally accumulate goodwill. See Martin Ice
Cream Co. v. Comm’r, 110 T.C. 189 at 207–08 (1998). The professional may,
however, transfer his or her goodwill to the practice by entering into an employment
contract or covenant not to compete with the business. See, e.g., Norwalk v. Comm’r,
76 T.C.M. (CCH) 208, *7 (1998) (finding that there is no corporate goodwill where
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“the business of a corporation is dependent upon its key employees, unless they enter
into a covenant not to compete with the corporation or other agreement whereby their
personal relationships with clients become property of the corporation”) (emphasis
added); Martin Ice Cream Co., 110 T.C. at 207–08 (finding that “personal
relationships . . . are not corporate assets when the employee has no employment
contract [or covenant not to compete] with the corporation”) (emphasis added);
Macdonald v. Comm’r, 3 T.C. 720, 727 (1944) (finding “no authority which holds that
an individual’s personal ability is part of the assets of a corporation . . . where . . . the
corporation does not have a right by contract or otherwise to the future services of that
individual”) (emphasis added). In determining whether goodwill has been transferred
to a professional practice, we are especially mindful that “each case depends upon
particular facts. And in arriving at a particular conclusion . . . we . . . take into
consideration all the circumstances . . . [of] the case and draw from them such
legitimate inferences as the occasion warrants.” Grace Brothers v. Comm’r, 173 F.2d
170, 176 (9th Cir. 1949).
In the instant case, Dr. Howard worked for the Howard Corporation pursuant
to an employment contract by which he agreed “to practice dentistry solely as an
employee of the [Howard] Corporation and . . . [to] devote his entire professional time
to the affairs of the [Howard] Corporation.” Under this agreement, the Howard
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Corporation retained “complete control and authority with respect to the acceptance
or refusal of any client” and “all files . . . and other records concerning clients of the
[Howard] Corporation . . . belong[ed] to . . . the [Howard] Corporation.” In addition
to the employment contract, Dr. Howard agreed not to “engage . . . in any
business . . . competitive to that of the [Howard Corporation,]” as “long as [Dr.
Howard] h[eld] any stock [in the Howard Corporation]” and for a period of three years
thereafter. Under these circumstances, while the relationships that Dr. Howard
developed with his patients may be accurately described as personal, the economic
value of those relationships did not belong to him, because he had conveyed control
of them to the Howard Corporation.
Pursuant to the underlying purchase agreement, the buyer obtained the goodwill
of the dental practice. The purchase agreement provides that “[t]he personal goodwill
of the [p]ractice . . . [was] established by Dr. Howard . . . [and] is based on the
relationship between Dr. Howard and the patients.” To preserve the value of the
goodwill, Dr. Howard entered into a restrictive covenant with the buyer, (the
“Covenant Not to Compete”). In accordance with the Covenant Not to Compete, both
Dr. Howard and the Howard Corporation agreed “not to practice dentistry . . . within
a radius of ten . . . miles from the [practice] . . . until three . . . years from the date [Dr.
Howard and the Howard Corporation] discontinue[] . . . dentistry [at the practice.]”
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Along with the Covenant Not to Compete, the Howard Corporation executed a
provider agreement with Bryan K. Finn, DDS, PS, the buyer’s professional service
corporation.
The Taxpayers make two arguments based on the language of the purchase
agreement. First, they rely on the declaration that the goodwill “represents a personal,
non-corporate asset that is being conveyed individually by Dr. Howard . . . .” The
argument that this clause is dispositive of the issue whether the goodwill belonged to
the Howard Corporation or to Dr. Howard is without merit. By now it is well settled
that “the incidence of taxation depends upon the substance, not the form of [a]
transaction.” Comm’r v. Hansen, 360 U.S. 446, 463 (1959). As a result, we “look[]
to the objective economic realities of a transaction rather than to the particular form
the parties employed.” Frank Lyon Co. v. United States, 435 U.S. 561, 573 (1978).
Self-serving language in a purchase agreement is not a substitute for a careful analysis
of the realities of the transaction.
Second, the Taxpayers contend that the purchase agreement impliedly
terminated both the employment contract and the non-competition agreement, thereby
transferring the accumulated goodwill of the practice back to Dr. Howard. This
argument appears to be inconsistent with the agreement entered into between the
Howard Corporation and the buyer by which the Howard Corporation arranged for Dr.
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Howard to provide “dental treatment on the patients of [the buyer.]” Dr. Howard was
compensated for the services he rendered to the buyer by the Howard
Corporation—an arrangement that lasted for approximately three years and during
which the Howard Corporation paid all of Dr. Howard’s operating expenses.
Nevertheless, even if we accept the premise that the purchase agreement terminated
both the employment contract and the non-competition agreement, such a release
would constitute a dividend payment, the value of which would be equivalent to the
price paid for the goodwill of the dental practice. See 26 U.S.C. § 316(a) (a
“dividend” is “any distribution of property made by a corporation to its
shareholders”); 26 U.S.C. § 301(b)(1) (“the amount of any distribution shall be the
amount of money received, plus the fair market value of . . . property received”); 26
U.S.C. § 301(c)(1) (“that portion of [a] distribution which is a dividend . . . shall be
included in gross income”).
Finally, the Taxpayers concede that Dr. Howard chose to conduct his business
as a C corporation to take advantage of tax benefits that accrued to him over the years.
As one of the members of the panel aptly observed at oral argument, “so having then
made himself available to the advantages of using the corporation, and having entered
into the agreements that he did with the corporation, then why should we try then to
allow him . . . out of what he got himself into.” Audio Recording of Oral Argument,
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Howard v. United States, No. 10-35768 (9th Cir. July 13, 2011). Dr. Howard has
offered no compelling reason why he should be let out of the corporate structure he
chose for his dental practice.
The judgment of the district court is AFFIRMED.
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