                     118 T.C. No. 28



                UNITED STATES TAX COURT



WARREN L. BAKER, JR. AND DORRIS J. BAKER, Petitioners v.
      COMMISSIONER OF INTERNAL REVENUE, Respondent



Docket No. 599-00.                 Filed May 29, 2002.



     P (husband) entered into “agents agreements”
(agreement) with State Farm Insurance Cos. (State Farm)
wherein P agreed to write insurance policies
exclusively for State Farm. The agreement provided
that all property including information about policy
holders belonged to State Farm. P’s compensation was
based on a percentage of net premiums. The agreement
also contained detailed provisions for termination.
P was entitled to a termination payment based on the
percentage of policies that either (1) remained in
force after termination or (2) were in force for the 12
months preceding termination. P and State Farm did not
negotiate the terms of the agreement.

     P retired after approximately 34 years of
operating as an independent agent for State Farm.
Pursuant to the termination agreement P returned
account information, computers and the like to State
Farm and the successor agent. P received a payment of
$38,622 in 1997 from State Farm pursuant to the
termination agreement.
                               - 2 -

          Ps reported the payment on their 1997 Federal
     income tax return as a long-term capital gain. In a
     notice of deficiency issued to Ps, R disallowed capital
     gain treatment and determined that the payment was
     ordinary income. R did not impose self-employment tax
     on the income.

          Held: P did not own a capital asset or sell a
     capital asset to State Farm, nor did the termination
     payment P received from State Farm represent payment
     for transfer of a capital asset to State Farm or the
     successor agent. Held, further, that Ps are not
     entitled to capital gain treatment for the termination
     payment received from State Farm in 1997. Held,
     further, Ps must treat the payment received in 1997 as
     ordinary income.


     Thomas J. O’Rourke, for petitioners.

     Roger W. Bracken, for respondent.



                              OPINION


     DAWSON, Judge1:   This case was assigned to Chief Special

Trial Judge Peter J. Panuthos pursuant to the provisions of

section 7443A(b)(5) and Rules 180, 181, and 183.2   The Court


     1
        I wrote the Court’s majority opinion in Jackson v.
Commissioner, 108 T.C. 130 (1997), holding that termination
payments received by the insurance agent from State Farm were not
subject to self-employment tax under secs. 1401 and 1402, I.R.C.
I also joined Judge Parr’s concurring opinion indicating that
such payments could be treated as being in the nature of a buyout
of the agent’s business. After further consideration, I am now
persuaded by the opinion of Chief Special Trial Judge Panuthos
that this petitioner (agent) is not entitled to capital gain
treatment for the termination payment he received.
     2
        Section references are to the Internal Revenue Code in
effect for the year in issue. All Rule references are to the Tax
                                                   (continued...)
                                 - 3 -

agrees with and adopts the opinion of the Special Trial Judge,

which is set forth below.

                  OPINION OF THE SPECIAL TRIAL JUDGE

     PANUTHOS, Chief Special Trial Judge:     Respondent determined

a deficiency in petitioners’ Federal income tax of $2,519 for

1997.     All references to petitioner are to Warren L. Baker, Jr.

     After a concession by petitioners,3 the issue for decision

is whether the termination payment received by petitioner upon

retirement as an insurance agent of State Farm Insurance Cos. is

taxable as capital gain or ordinary income.

                              Background

     Some of the facts have been stipulated and are so found.

The stipulated facts and the related exhibits are incorporated

herein by this reference.    At the time of filing the petition,

petitioners resided in Fairview Heights, Illinois.

I.   Petitioner’s Agreement With State Farm

     a.     General

     Petitioner began his relationship with State Farm Insurance

Cos. (State Farm) on January 19, 1963.     State Farm consisted of

State Farm Mutual Automobile Insurance Co., State Farm Life



     2
      (...continued)
Court Rules of Practice and Procedure, unless otherwise
indicated.
     3
        Petitioners concede that they failed to report dividend
income of $919 from Magna Group, Inc.
                                 - 4 -

Insurance Co., State Farm Fire & Casualty Co., and State Farm

General Insurance Co.

     Petitioner conducted his business as the Warren L. Baker

Insurance Agency (the agency).    He sold policies exclusively for

State Farm.    When he began his relationship with State Farm, he

was not assigned customers.    Instead, he developed a customer

base.   He selected the location of his office with State Farm’s

approval.    He also hired and paid employees.   He was responsible

for paying the expenses of an office such as rent, utilities,

telephones, and other equipment.    He was obligated to establish a

trust fund into which he deposited premiums collected on behalf

of State Farm.

     Petitioner entered into a series of contracts with State

Farm known as agent’s agreements.    The agent’s agreement at issue

was executed on March 1, 1977.    While the agreement contains

approximately 6 pages, there are numerous attachments including

schedules of payments, amendments, addenda, and memoranda that

total 61 pages.    The agreement was prepared by State Farm.

Petitioner did not have the ability to change the terms of the

agreement, but he had the option to refuse a new or revised

agreement.

     The preamble to the agreement reads, in part, as follows:

“The Companies believe that agents operating as independent

contractors are best able to provide the creative selling,
                                 - 5 -

professional counseling, and prompt and skillful service

essential to the creation and maintenance of successful multiple-

line companies and agencies.”

     Section I of the agreement, Mutual Conditions and Duties,

provides that petitioner was an independent contractor of State

Farm.    As a State Farm agent, petitioner agreed to write policies

exclusively for State Farm, its affiliates, and government and

industry groups.     Paragraph C, section I of the agreement states

that State Farm “will furnish you, without charge, manuals,

forms, records, and such other materials and supplies as we may

deem advisable to provide.     All such property furnished by us

shall remain the property of the Companies [State Farm].”

Further, State Farm considered any and all information regarding

policyholders to be its property, as follows:

        D.   Information regarding names, addresses, and
             ages of policyholders of the Companies; the
             description and location of insured property;
             and expiration or renewal dates of State Farm
             policies acquired or coming into your
             possession during the effective period of
             this Agreement, or any prior Agreement,
             except information and records of
             policyholders insured by the Companies
             pursuant to any governmental or insurance
             industry plan or facility, are trade secrets
             wholly owned by the Companies. All forms and
             other materials, whether furnished by State
             Farm or purchased by you, upon which this
             information is recorded shall be the sole and
             exclusive property of the Companies.

Essentially, any data relating to a policyholder recorded by an

agent on any paper was the property of State Farm.
                                - 6 -

     Petitioner’s compensation was based on a percentage of the

net premiums.   The compensation varied by the type of insurance,

such as automobile and homeowner’s.     Petitioner was also assigned

policies for which he received a smaller commission than those

policies he personally produced.    State Farm assigned existing

policies to petitioner because the policyholders moved to the

geographic location covered by his agency.    Similarly, when

policyholders covered by petitioner moved to a different

geographic location, the policies were assigned to another agent

in that geographic area.    Petitioner did not compensate other

agents for policies he assumed, and he did not receive payments

for policies assigned to other agents.

     The commissions payable for assigned policies are provided

for in the schedule of payments attached to the agreement in

relevant part as follows:

     an amount equal to 66-2/3 percent of the graded
     commission scale in Section I, provided, however, no
     commission shall be payable to you on any premium
     collections on business credited to your account from
     the account of an agent whose agreement with * * *
     [State Farm] has been terminated, or as a result of an
     agreement between an agent and * * * [State Farm]
     pursuant to the applicable paragraph of Section IV of *
     * * [an agreement], until a one-year period has elapsed
     following the date of such termination, except as
     provided for in paragraph IV-B-2 of this Schedule of
     Payments.

     b.   Termination

     Section III of the agreement addresses termination.    Either

party could terminate the agreement by written notice.    The
                                - 7 -

agreement also provided for termination upon the death of

petitioner.    Within 10 days after termination of the agreement,

“all property belonging to the Companies shall be returned or

made available for return to the Companies or their authorized

representative.”

     Petitioner was required to abide by a covenant not to

compete for a period of 12 months following termination.    The

covenant not to compete provides as follows:

      E.   For a period of one year following
           termination of this Agreement, you will not
           either personally or through any other
           person, agency, or organization (1) induce or
           advise any State Farm policyholder credited
           to your account at the date of termination to
           lapse, surrender, or cancel any State Farm
           insurance coverage or (2) solicit any such
           policyholder to purchase any insurance
           coverage competitive with the insurance
           coverages sold by the Companies.

     Pursuant to section IV of the agreement, petitioner

qualified for a termination payment if he met certain

requirements.    First, he must work for 2 or more continuous years

as an agent.    Second, within 10 days of termination, he must

return or make available for return all property belonging to

State Farm.

     The amount of the termination payment payable is different

for each of the State Farm companies.    With two of the State Farm

companies, the amount of the termination payment is based on a

percentage of policies that either remained in force after
                              - 8 -

termination of the agreement or those that had been in force for

the 12 months preceding termination.4   The formulas for the

amount of termination payment are as follows:

     State Farm Mutual Automobile Insurance Company * * *
     the lesser of (1) or (2)-

     (1) twenty percent (20%) of the service compensation on
     “personally produced” policies, you earned under the
     Schedule of Payments for Other than Health Insurance
     Policies in the twelve (12) preceding months, or twenty
     percent (20%) of the service compensation on
     “personally produced” policies credited to your
     account, as of the date of termination, which remain in
     force in the same state, during the first twelve (12)
     months following the date of termination; whichever is
     greater, or

     (2) thirty percent (30%) of the service compensation on
     “personally produced” policies credited to your account
     as of the date of termination, which remain in force in
     the same state during the first twelve (12) months
     following the date of termination.

     State Farm Fire and Casualty Company and State Farm
     General Insurance Company * * * the lesser of (1) or
     (2)-

     (1) twenty percent (20%) of the commissions you were
     paid on “personally produced” policies for those lines
     of insurance * * * of the applicable Schedule of
     Payments, in the twelve (12) preceding months, or
     twenty percent (20%) of the commissions on “personally
     produced” renewal premiums you would have been paid
     under the applicable Schedule of Payments, if this
     Agreement had not been terminated, in the twelve (12)
     months following the date of termination on “personally
     produced” policies which remain in the same state, for
     those lines of insurance designated above and credited


     4
         It is not clear from the record whether the termination
payment that petitioner received was calculated based upon
policies that remained in force after termination or instead had
been in force for the 12 months preceding termination. These
facts have no bearing on our decision.
                              - 9 -

     to your account as of the date of termination;
     whichever is greater, or

     (2) thirty percent (30%) of the commissions on
     “personally produced” renewal premiums you would have
     been paid under the applicable Schedule of Payments, if
     this Agreement had not been terminated, in the twelve
     (12) months following the date of termination on those
     “personally produced” policies designated in (1) and
     credited to your account as of the date of termination.

     State Farm Life Insurance Company-

     An amount equal to the same compensation for the second
     and subsequent policy years as would have been due and
     payable to you for the first five years following the
     date of termination on all State Farm life policies
     personally written by you or assigned to you by the
     Company for compensation, under the terms of the
     applicable Schedule of Payments attached hereto, if
     this Agreement had not been terminated.

     State Farm and petitioner did not negotiate the amount or

conditions of the termination payment.    State Farm agreed to pay

petitioner a termination payment over either a 2- or 5-year

period.

     Section V of the agreement provides for an extended

termination payment if petitioner worked for State Farm for at

least 20 years, of which 10 years were consecutive.    The extended

termination payment would begin 61 months after termination and

continue until petitioner’s death.    The extended termination

payment is also based on policies personally produced by

petitioner during his last 12 months as an agent for State Farm.

     State Farm paid commissions for new business personally

written by the agent as a percentage of the first policy year
                                - 10 -

premium due according to the percentage established in table I of

the “Schedule of Payments Referred to in State Farm Agent’s

Agreement” (schedule of payments) attached to the agreement.      For

many of the policies, commissions would be paid during the first,

second, third, fourth, and fifth policy year, depending upon the

type of policy and its length.    Section VI of the schedule of

payments provides as follows:

      Upon termination of this Agreement by death or
      otherwise any unpaid compensation provided for under
      this Schedule of Payments then due and payable shall be
      paid as soon as ascertainable, and there shall be no
      further liability on the part of the Company under the
      terms of this Schedule of Payments.

      During the operation of the agency and pursuant to the

agreement, petitioner operated a trust fund.    When petitioner

terminated his relationship with State Farm, the trust account

was closed and audited by State Farm.

II.   Petitioner’s Retirement

      Petitioner retired and terminated his relationship with

State Farm on February 28, 1997.    At that time, he held

approximately 4,000 existing policies generated from 1,800

households.   Approximately 90 percent of the policies were

assigned to one successor agent.    The successor agent received

reduced compensation (that is, a lower percentage) for the

assigned policies.

      Petitioner returned State Farm’s property, such as policy

and policyholder descriptions, which he gathered in master
                                  - 11 -

folders that he purchased, claim draft books, rate books, agent’s

service texts, and a computer.       He maintained much of the

information regarding the policies and policyholders on the

computer.       He fully complied with the provision in the agreement

for return of property to State Farm.

       The successor agent hired the two employees previously

employed by petitioner and assumed petitioner’s telephone number.

The successor agent also worked with petitioner on occasion prior

to petitioner’s retirement to meet policyholders and to ask

questions.       The successor agent opened an office in the vicinity

of petitioner’s office.       When the termination was completed,

petitioner had returned all of the assets used in the agency to

State Farm and the successor agent.

III.       Tax Return and Notice of Deficiency

       Petitioners timely filed their 1997 Federal income tax

return.       They reported the income of $38,622 from the termination

payment which petitioner received in 1997 as long-term capital

gain on Schedule D, Capital Gains and Losses.       Petitioners

attached a two-page statement to Schedule D on which the

termination payment was described as an annuity payable over 5

years.5      The annuity was described as a sale of assets to State




       5
        Timing of the recognition of income is not at issue. The
record does not indicate how State Farm treated the termination
payment on its return.
                                - 12 -

Farm that included “personally produced policies and other

intangible assets”.

      Petitioners attached Form 8594, Asset Acquisition Statement

Under Section 1060, to their tax return.     On Form 8594,

petitioners indicated the fair market value for the Class IV

asset as $164,140.6   Petitioners answered “yes” to the following

question on line 6 of Form 8594:     “did the buyer also purchase *

* * a covenant not to compete?”     Petitioners did not assign a

value for the covenant not to compete.

     In a notice of deficiency, respondent determined that the

termination payment from State Farm was ordinary income and did

not qualify for capital gain treatment.

                              Discussion

I.   Positions of the Parties

      Respondent argues that petitioner did not sell any property

to State Farm because all of the property was owned by State Farm

and reverted to State Farm when petitioner terminated his

relationship with State Farm.     Respondent contends that the

agreement does not evidence a sale because the contract does not

list a seller or purchaser.     Respondent also argues that

petitioners failed to establish that the termination payment

represents proceeds from the sale of a business, business assets,


      6
        A taxpayer may treat goodwill acquired before Feb. 14,
1997, as a Class IV asset. Sec. 1.1060-1T(a)(2)(ii), Temporary
Income Tax Regs., 62 Fed. Reg. 2272 (Jan. 16, 1997).
                              - 13 -

or goodwill.   Respondent also suggests that the termination

payment is in the nature of income from self-employment, but

hedges that position in arguing that the payment is “similar to

an annuity” and a “retirement benefit”.   We note that respondent

did not determine that petitioners were liable for self-

employment tax with respect to the termination payment.

     Petitioners argue that the termination payment was for the

sale or buyout of a business resulting in capital gain.    They

assert that petitioner developed a customer base and the

termination payment was designed to protect the existing customer

base for the successor agent as well as compensate petitioner for

the goodwill and going business concern he developed.

Petitioners rely on the concurring opinion in Jackson v.

Commissioner, 108 T.C. 130, 141 (1997), which characterizes a

termination payment similar to the one at issue as a buyout of

the taxpayer’s business.

     The Coalition of Exclusive Agent Associations, Inc. (CEAA),

filed with leave of the Court an amicus brief pursuant to

conditions specified in the Court’s order.   The CEAA’s argument

is similar to the arguments made by petitioners:    State Farm

purchased the goodwill generated by petitioner; therefore,

petitioner is entitled to capital gain treatment.
                              - 14 -

II.   Evidentiary Issue

      We first deal with an evidentiary issue presented at trial.

Petitioners proffered a list of questions and answers dated

February 14, 1991, which was marked for identification as Exhibit

12-P.   The questions were prepared by a representative of

respondent, and the answers were provided by a representative of

State Farm.   Respondent objected to the admission of the document

and asked for an opportunity to authenticate the document.    The

Court admitted the document, although it was not admitted for the

truth of the assertions contained therein.    In a supplemental

stipulation of facts the parties agreed that the State Farm

representative who provided the answers to Exhibit 12-P, if

called as a witness, would testify as set forth in a declaration

attached to the supplemental stipulation as Exhibit 13-R.    In the

declaration the representative states that he provided the

answers contained in Exhibit 12-P and further explains the

answers set forth in Exhibit 12-P.     Petitioners, however, object

to the admission of Exhibit 13-R on the ground that State Farm’s

“view” of certain matters is not relevant.    In this regard, the

objection appears inconsistent with petitioners’ proffer of

Exhibit 12-P, which expresses the “view” or opinion of the same

individual.

      Considering Exhibits 12-P and 13-R together, we are

satisfied that our initial ruling was correct and that Exhibit
                                - 15 -

12-P should not be admitted for the truth of the contents because

it contains hearsay.     To be consistent with our treatment of

Exhibit 12-P, we admit Exhibit 13-R for the limited purpose of

supplementing Exhibit 12-P but not for the truth of the

assertions made therein.     Fed. R. Evid. 401, 701, 801.

III.   Burden of Proof

       Generally the taxpayer bears the burden of proof.    Rule

142(a)(1).    Section 7491, which is effective with respect to

court proceedings arising in connection with examinations by the

Commissioner commencing after July 22, 1998, the date of its

enactment by section 3001(a) of the Internal Revenue Service

Restructuring and Reform Act of 1998, Pub. L. 105-206, 112 Stat.

726, does not apply to place the burden of proof on respondent.

Petitioners have neither alleged that section 7491 is applicable

nor established that they complied with the requirements of

section 7491(a)(2)(A) and (B) to substantiate items, maintain

required records, and fully cooperate with respondent’s

reasonable requests.

IV.    Sale or Exchange of a Capital Asset

       We must decide the proper characterization of the

termination payment made by State Farm to petitioner.       We first

consider whether petitioner owned a capital asset and whether

petitioner sold or exchanged a capital asset for Federal income

tax purposes.    We also consider whether petitioner sold a
                                - 16 -

business to which goodwill attached.     If petitioner did not sell

or exchange a capital asset, then the termination payment is

taxable as ordinary income.

     Long-term capital gain is defined as gain from the sale or

exchange of a capital asset held for more than 1 year.     Sec.

1222(3).     A “capital asset” means property held by the taxpayer

(whether or not connected with his trade or business) that is not

covered by one of five specifically enumerated exclusions.       Sec.

1221.

     In Schelble v. Commissioner, T.C. Memo. 1996-269, affd. 130

F.3d 1388 (10th Cir. 1997), we considered whether the taxpayer

received gain from the sale or exchange of a capital asset.

Pursuant to the terms of the agreement with the insurance company

for which he was an agent, the taxpayer was required to return

all records, manuals, materials, advertising, and supplies or

other property of the company.     Id.   We concluded that there was

no evidence of “vendible business assets”, and the record did not

support a finding of a sale of assets of a business.

        The Court of Appeals in Schelble v. Commissioner, 130 F.3d

at 1394, held that there was “no evidence in the record of

vendible assets to support the sale of Mr. Schelble’s insurance

business”.     It observed the following:

        By transferring policy records to * * * [the insurance
        company] pursuant to the Agreement, * * * [the
        taxpayer] maintains he transferred insurance business
                                - 17 -

      goodwill developed by him. * * * [The taxpayer] has
      failed, however, to show a sale of assets occurred.

Id.

      In Foxe v. Commissioner, 53 T.C. 21, 26 (1969), we

considered whether payments made to an insurance agent were made

pursuant to the sale or exchange of a capital asset to his former

insurance company upon the cancellation of his employment

contract.   The taxpayer claimed that in the course of his

business he built up “something of value, an organization” that

the insurance company acquired.    Id.    Moreover, his personal

contacts with customers, which were important to the insurance

company, were “something of real value”.       Id.

      We concluded that even if the taxpayer had “built up an

organization of value, it was not his to sell since * * * [the

insurance company] under the contract owned all the property

comprising such organization.    As to the customer contacts

* * *.   They were not his to sell.”     Id.   It was held that the

taxpayer did not sell or exchange a capital asset, and the

payments were taxable as ordinary income.

      Section 1001(c) provides that gain is recognized upon the

sale or exchange of property.    “The word ‘sale’ means ‘a transfer

of property for a fixed price in money or its equivalent’”.

Schelble v. Commissioner, supra at 1394 (quoting Iowa v.

McFarland, 110 U.S. 471, 478 (1885)); see also Commissioner v.

Brown, 380 U.S. 563, 570 (1965).    “Exchange” means an exchange of
                               - 18 -

property for another property that is materially different either

in kind or in extent.   Sec. 1.1001-1, Income Tax Regs.

     The key to deciding whether there has been a sale for

Federal income tax purposes is whether the benefits and burdens

of ownership have passed.    Highland Farms, Inc. v. Commissioner,

106 T.C. 237 (1996); Grodt & McKay Realty, Inc. v. Commissioner,

77 T.C. 1221, 1237 (1981).   Among the many factors we may

consider in deciding whether there has been a sale are the

following:   Whether legal title passes; how the parties treat the

transaction; whether an equity was acquired in the property;

whether the contract creates a present obligation on the seller

to execute and deliver a deed and a present obligation on the

purchaser to make payments; whether the right of possession is

vested in the purchaser; which party pays the property taxes;

which party bears the risk of loss or damage to the property; and

which party receives the profits from the operation and sale of

the property.   Levy v. Commissioner, 91 T.C. 838, 860 (1988);

Grodt & McKay v. Commissioner, supra at 1237-1238.

     Cases addressing whether there has been a sale or exchange

of a capital asset often combine the issue of whether the

taxpayer owned a capital asset with the issue of whether the

taxpayer sold the asset.    For example, in Erickson v.

Commissioner, T.C. Memo. 1992-585, affd. 1 F.3d 1231 (1st Cir.

1993), we concluded that there was no sale of the taxpayer’s
                               - 19 -

assets to his former insurance company because there was nothing

in the facts showing that there was a sale of “vendible tangible

assets” of a business.   In Erickson, the Court stated:

           [The taxpayers] maintain that * * * certain
      indicia of a sale exist. They assert that employees
      who formerly worked for * * * [the taxpayer] went over
      to Union Mutual and that all records, supplies, and
      equipment were turned over to Union Mutual. * * *
      however, the individuals who had worked with * * * [the
      taxpayer] had always been salaried employees of Union
      Mutual. * * * And by his own admission, * * * [the
      taxpayer] had owned very little in the way of supplies
      and equipment * * *

Id.

      Respondent cites Jackson v. Commissioner, 108 T.C. 130

(1997), Milligan v. Commissioner, T.C. Memo. 1992-655, revd. 38

F.3d 1094 (9th Cir. 1994), and similar cases for the proposition

that the taxpayer did not sell or exchange the assets in his

business.   These cases bear a factual resemblance to the case at

hand in that the taxpayer, a former insurance agent, received a

termination payment after the termination of his agreement with

the insurance company.   But these cases focus on whether the

taxpayer was subject to self-employment tax under sections 1401

and 1402.

      The holdings by the Court of Appeals in Milligan and by this

Court in Jackson do not require a conclusion that the termination

payment paid to petitioner represents proceeds from the sale or

exchange of a capital asset.   Both Jackson and Milligan left open

the question of whether termination payments constitute the sale
                              - 20 -

or exchange of capital assets subject to capital gain treatment

or whether they should be treated as ordinary income (other than

income subject to self-employment tax).

V.   The Controlling Facts of This Case

     We now apply the above discussion to the facts before us in

this case.   Upon his retirement, petitioner returned all assets

used in the daily course of business, including a computer, books

and records, and customer lists to State Farm pursuant to the

agreement.   Thus, much like the taxpayers in Foxe v.

Commissioner, supra, and Schelble v. Commissioner, 130 F.3d 1388

(10th Cir. 1997), petitioner did not own these assets and,

therefore, could not have sold them to State Farm.

     Petitioner argues that the successor agent assumed his

telephone number and hired the two employees of the agency, and

that petitioner taught the successor agent about the agency and

introduced him to policyholders, all of which support the

argument that he sold the agency to State Farm.

     The successor agent obtained the right to use the telephone

number utilized by petitioner’s agency.   Petitioner did not

argue, and we do not conclude, that the telephone number was a

capital asset in the hands of petitioner.   Additionally, there

are no facts in the record that indicate that petitioner received

any portion of the termination payment as payment for the

successor agent’s use of the telephone number.
                               - 21 -

     There are no facts in the record that indicate that there

was an employment contract between petitioner and the employees

who worked for the agency or that the successor agent was

required to hire the employees.   Petitioner did not argue, and we

do not conclude, that the employees constitute capital assets in

the hands of petitioner.   There is nothing in the record that

indicates that petitioner received any portion of the termination

payment as payment for the successor agent’s hiring of the

employees.   The fact that the successor agent hired petitioner’s

former employees does not support petitioner’s argument that he

sold his agency.

     Petitioner may have taught the successor agent about the

agency and introduced him to policyholders when the successor

agent visited petitioner’s office, but there are no facts in the

record that indicate that petitioner received the termination

payment as payment for teaching the successor agent about the

agency and introducing him to policyholders.

     We conclude that petitioner did not own a capital asset that

he could sell to State Farm.   He did not receive the termination

payment as payment for any asset.   Accordingly, the termination

payment does not represent gain from the sale or exchange of a

capital asset.
                               - 22 -

      Petitioner also argues that State Farm purchased goodwill.

To qualify as the sale of goodwill, the taxpayer must demonstrate

that he sold “‘the business or a part of it, to which the

goodwill attaches’”.   Schelble v. Commissioner, 130 F.3d at 1394

(quoting Elliott v. United States, 431 F.2d 1149, 1154 (10th Cir.

1970)).   Goodwill is “the expectancy of continued patronage, for

whatever reason.”   Boe v. Commissioner, 307 F.2d 339, 343 (9th

Cir. 1962), affg. 35 T.C. 720 (1961); see also VGS Corp. v.

Commissioner, 68 T.C. 563, 590 (1977).

      Nevertheless, because petitioner, for the reasons already

explained, did not own and sell capital assets in his agency to

State Farm, we conclude that petitioner did not sell goodwill.

VI.   Nature of Ordinary Income

      Respondent does not clearly explain his position as to the

nature of the termination payment other than to argue that it is

not taxable as capital gain.   In the notice of deficiency,

respondent determined that the termination payment was ordinary

income.   In his brief, respondent primarily argues that

petitioners did not satisfy their burden of proof to establish

that the termination payment was proceeds of a sale and thus

subject to capital gain treatment.

      Having concluded above that the termination payment was not

received for the sale or exchange of a capital asset and is not

entitled to treatment as a capital gain, we conclude that the
                                  - 23 -

termination payment is taxable as ordinary income.       Ordinary

income treatment is accorded to a variety of payments.       See,

e.g., Hort v. Commissioner, 313 U.S. 28 (1941) (income received

upon cancellation of lease derived from relinquishment of right

to future rental payments in return for a present substitute

payment and possession of premises); Elliott v. United States,

supra (payment for termination of insurance agency contract was

ordinary income); Foxe v. Commissioner, 53 T.C. at 25 (payment to

insurance agent upon cancellation of employment contract was

ordinary income); General Ins. Agency, Inc. v. Commissioner, T.C.

Memo. 1967-143 (payment for agreement not to compete was ordinary

income), affd. 401 F.2d 324 (4th Cir. 1968).

VII.    Covenant Not To Compete

       An amount received for an agreement not to compete is

generally taxable as ordinary income.       Banc One Corp. v.

Commissioner, 84 T.C. 476, 490 (1985), affd. without published

opinion 815 F.2d 75 (6th Cir. 1987); Warsaw Photographic

Associates, Inc. v. Commissioner, 84 T.C. 21 (1985); Ullman v.

Commissioner, 29 T.C. 129 (1957), affd. 264 F.2d 305 (2d Cir.

1959); General Ins. Agency, Inc. v. Commissioner, supra.

       Petitioners reported the sale of a covenant not to compete

on Form 8594 attached to the return.       The agreement provides

that, after retiring, petitioner would not solicit State Farm’s

policyholders for 1 year, or petitioner would forfeit the
                               - 24 -

termination payment.   If petitioner had competed against State

Farm after retiring, he would not have received a termination

payment.   We find that petitioner entered into a covenant not to

compete with State Farm and that a portion of the termination

payment was paid for the covenant not to compete.

     Proceeds allocable to a covenant not to compete are properly

classified as ordinary income.   See General Ins. Agency, Inc. v.

Commissioner, 401 F.2d at 329.   Petitioner did not allocate any

portion of the termination payment to the covenant not to

compete, and it is unnecessary for us to make such an allocation

because the termination payment is classified as ordinary income.

     We have considered all arguments by the parties and amicus,

and, to the extent not discussed above, conclude they are

irrelevant or without merit.

     To reflect the foregoing,

                                              Decision will be

                                         entered for respondent.
