The value of goodwill becomes a contentious issue when a marital estate includes a closely held business. In this case, goodwill is an intangible asset that can have substantial value. But, depending on case facts, state law, and legal precedent, it may or may not be considered a marital asset. Valuing business goodwill during divorce is something a business valuation professional can help you navigate, as the issue can become very complex very fast.
What’s Goodwill?
According to the International Valuation Glossary — Business Valuation, “Goodwill can arise as a result of name, reputation, customer loyalty, location, products, and similar factors not separately identified.” A business can have two types of goodwill.
The first type is business (or entity) goodwill. This belongs strictly to the entity itself. Business goodwill may arise from many sources, including the company’s name, phone number, location, and special attributes, such as special menu items or recipes at a restaurant.
The second type is personal (or professional) goodwill. This type of goodwill is directly attributable to an individual’s characteristics or attributes. It includes not only the owner’s skills, knowledge, and reputation, but also their contacts and relationships.
Is Goodwill A Marital Asset?
In a divorce settlement, only assets that are part of the marital estate are divided between the spouses. The treatment of goodwill varies significantly across jurisdictions.
More than half the states specifically exclude personal goodwill from the marital estate (but still include business goodwill) if the business owner’s earnings are used to determine maintenance payments. Other states make no distinction between personal and business goodwill. In these states, all goodwill is either included in or excluded from the marital estate. When there’s limited legal precedent in a court’s jurisdiction, the court might consider other sources of case law.
In jurisdictions that exclude goodwill — entirely or just the business portion — when dividing the marital estate between the spouses, it’s essential to hire a business valuation professional. A valuator can estimate the value of goodwill and, if needed, allocate it between business and personal goodwill.
Is Goodwill Attributable To The Business Or The Individual Owner?
Personal goodwill is typically associated with medical and other professional practices, such as law, accounting, and architectural firms. The success (or failure) of these ventures often depends on the skills and reputation of the individual practitioners. But a professional practice may also possess some business goodwill — for example, if it has strong name recognition and an established workforce.
However, personal goodwill isn’t limited to professional practices. Other types of businesses — such as retailers, contractors, and manufacturers — may also possess elements of personal goodwill.
This issue was addressed in Huffman v. Commissioner (T.C. Memo. 2024-12). In this recent case, the U.S. Tax Court looked at the purchase price allocation for the sale of an aerospace manufacturer. Although the company had decades of operating history and significant hard tangible assets, the court concluded that a substantial portion of its goodwill was attributable to the CEO’s personal relationships with customers and key employees rather than to the corporation itself.
Because personal goodwill isn’t considered a business asset for federal income tax purposes, the value allocated to it generally isn’t subject to entity-level tax. Instead, personal goodwill is taxable to the shareholder at favorable capital gains rates.
While Huffman isn’t a divorce case, it may still be instructive in determining the value of personal goodwill for tangible-asset-intensive businesses, especially in jurisdictions with limited legal precedent. The relevant inquiry is whether economic value is attributable to the individual owner or the business.
Valuation Expertise Is Essential
Proper treatment of goodwill can significantly affect the value of a marital estate. A clear understanding of relevant legal precedent and the theory underlying goodwill allocations can help divorcing spouses achieve equity. We can provide a comprehensive business valuation that addresses valuing business goodwill during divorce. Contact us for help determining what’s appropriate for your situation.
