Recovery Group, Inc. v. Commissioner
652 F.3d 122
1st Cir.2011Background
- Recovery Group, an S corporation, redeemed 23% of its stock from a former shareholder, Edgerly, for $255,908.
- Edgerly signed a noncompetition and nonsolicitation covenant lasting July 31, 2002 to July 31, 2003.
- Recovery Group expensed the covenant by amortizing $400,000 over the covenant’s 12-month duration (2002–2003).
- IRS determined the covenant was an amortizable section 197 intangible, amortizable over 15 years beginning with the month of acquisition.
- Tax deficiencies issued to Recovery Group and shareholders arose from disallowed deductions for 2002–2003.
- Tax Court rejected Recovery Group’s view and held the covenant is a section 197 intangible applicable to stock acquisitions.
Issues
| Issue | Plaintiff's Argument | Defendant's Argument | Held |
|---|---|---|---|
| Does §197(d)(1)(E) apply to covenants in stock acquisitions? | Recovery Group: applies only to substantial portions, not all stock. | Commissioner: applies to covenants in acquisitions of any stock stake. | Yes; covenants in stock acquisitions are within §197(d)(1)(E). |
| What is the antecedent of 'thereof' in §197(d)(1)(E)? | Recovery Group: 'an interest in a trade or business' means the entire interest. | Commissioner: refers to a trade or business or substantial portion of it. | Ambiguous; court adopts the interpretation that covers stock interests. |
| Does the covenant constitute a 'section 197 intangible' for stock redemption? | Recovery Group: not a section 197 intangible if stock, not asset, is acquired. | Commissioner: covenant falls within section 197 intangible when acquired with stock. | Yes; covenant is an amortizable section 197 intangible. |
Key Cases Cited
- Frontier Chevrolet Co. v. Comm'r, 329 F.3d 1131 (9th Cir. 2003) (treats stock acquisition as indirect acquisition of an interest in a trade or business)
- Newark Morning Ledger Co. v. United States, 507 U.S. 546 (Supreme Court, 1993) (context for amortization of intangibles under § 197)
- Home Sav. Bank v. City of Des Moines, 205 U.S. 503 (Supreme Court, 1907) (goodwill as an element of stock value and going concern)
- Carcieri v. Salazar, 555 U.S. 379 (S. Ct. 2009) (interpretation of statutory text in context)