Client received payment for non-compete clause - what form to use? Put on Line 21 for other income?

[itonewbie · Accepted solution]

You'll need to look at the underlying agreement to determine the nature and character of the payment.  Often times, non-compete is part of a severance package and generally constitutes wages reportable on W-2.  Once you have more information after reviewing the agreement, please feel free to come back if you have further questions.

[itonewbie]

"I've read the agreement, and basically the Sole Proprietor (a Veterinarian) received 10K to agree not to compete within 30 miles of town. I understand this is ordinary income but not subject to SE tax. Anything better than Line 21?"

@Greta On what basis are you making a determination that it is ordinary income but not subject to SE tax?  Even if that is the case, you still need to determine the character(s) of the income for proper reporting.  It would be unusual for veterinarian to engage in his/her professional practice as a sole practitioner rather than as a body corporate, in which case, you will need to examine not only the sales agreement that is between what might be a personal service corporation and the buyer but also the employment agreement of the veterinarian as well as any termination agreement he may have received as a result of or in conjunction with the sale.  More info is needed for this.

[Edit: Included a minor thought on character of income]

[itonewbie]

It is possible that the payment for non-compete would constitute business goodwill and be treated as dividends in the hands of your client.  But again, this is just one possibility and you should have a more comprehensive review as mentioned earlier.

[Marc-TaxMan]

I bet there was a lawyer representing the Seller in the deal.  I would get written direction from lawyer regarding taxability of NCC.  That means I do not have to even see the Agreement, or get blamed later if IRS disagrees

[itonewbie]

Unfortunately, I haven't yet come across an attorney who structures deals that would commit to identifying the tax treatment.  They would always refer the parties to consult their own tax advisers - unless, of course, it's a tax attorney we are talking about.  Hopefully, Greta would have better luck than me.

On a different note, reviewing the agreement to determine the appropriate tax treatment would definitely be billable work.

[Greta]

I've read the agreement, and basically the Sole Proprietor (a Veterinarian) received 10K to agree not to compete within 30 miles of town. I understand this is ordinary income but not subject to SE tax. Anything better than Line 21?

[Greta]

Or should it go on 4797 Part II... but how would I enter it there?