Non-Compete Allocation: Seller Tax and Buyer Amortization
By AE Tax Advisors ยท Published 2026-06-25
Updated November 8, 2026.
A payment for a covenant not to compete can have a different tax result from goodwill, consulting services or a stock sale. Identify who receives the payment, what it buys and the transaction structure before negotiating the allocation.
Separate the agreement's economic components
A seller's restrictive covenant, transition services, employment compensation and sale proceeds should not be grouped together merely because one contract covers them. The tax treatment follows substance and applicable rules. Legal counsel must evaluate enforceability and the actual protection delivered to the buyer.
The seller's comparison is not always ordinary versus capital gain
Covenant payments generally produce ordinary income to the recipient. Goodwill does not universally receive a fixed capital-gain rate: self-created and acquired goodwill, Section 197 recapture, holding period and entity structure can change the result.
Model the actual seller's basis and history. A C corporation asset sale followed by a distribution differs from an individual's stock sale. Do not multiply a proposed allocation by one presumed rate difference and call that guaranteed savings.
The buyer reviews Section 197
A qualifying covenant acquired in connection with a trade or business generally is amortized under Section 197 over 15 years, even if its legal restriction lasts fewer years. Qualifying acquired goodwill often follows that period too, but eligibility, related parties and the transaction still need review.
The amortization period does not justify an arbitrary covenant value. Support the allocation using the transaction facts and valuation evidence.
Apply the correct reporting framework
An applicable asset acquisition can require buyer and seller reporting on Form 8594 using the residual method. An ordinary stock transaction should not automatically be assigned that same form merely because it includes a covenant. Review each payment and the legal owner.
Where an allocation agreement applies, both parties should provide the final version and later adjustments to their preparers. Agreement between the parties does not make unsupported values defensible.
Prepare the pre-signing workpaper
- Seller, buyer and legal ownership of the assets or shares.
- Covenant terms, service obligations and payment schedule.
- Valuation support and proposed allocation.
- Seller basis, amortization and gain-character history.
- Buyer deduction timing and required forms.
Use the asset-allocation guide and request a pre-signing tax review.
Frequently Asked Questions
Is every goodwill allocation taxed at 20%?
No. Asset history, recapture, entity and owner tax treatment can change the result.
Does a three-year covenant mean three-year tax amortization?
Not generally for a qualifying Section 197 covenant; the statutory amortization period is 15 years.
Does every covenant require Form 8594?
No. The asset-acquisition reporting rules must apply; other deal structures require separate analysis.
Sources and update notes
Source references and the changes described in this guide were checked November 8, 2026. Published by AE Tax Advisors; see our editorial policy. Examples are illustrative and require review of your records before filing.