A tax newsletter stated, When a business is sold, part of the sales price may be allocated

A tax newsletter stated, “When a business is sold, part of the sales price may be allocated to tangible assets and part to a ‘covenant not to compete.’ How this allocation is made can have important tax consequences to both the buyer and seller.”

A large law firm, organized as a professional services corporation, purchased a successful local firm for $100,000. The purchase included both tangible assets, which have an average remaining useful life of 10 years, and a 3-year covenant not to compete. Suppose the buyer has legally supportable latitude concerning how to allocate this amount, as follows:

1. For income tax purposes, which allocation would the buyer favor? Why?
2. For shareholder reporting purposes, which allocation would the buyer favor?Why?

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Allocation One Allocation Two $48,000 52,000 $100,000 $ 72,000 Covenant Tangible assets Total for two assets 28,000 $100,000