                                                                               FILED
                              NOT FOR PUBLICATION                              AUG 29 2011

                                                                            MOLLY C. DWYER, CLERK
                       UNITED STATES COURT OF APPEALS                        U.S. COURT OF APPEALS



                               FOR THE NINTH CIRCUIT


 LARRY E. HOWARD, et al.,                         No. 10-35768

                 Plaintiffs - Appellants,         D. C. 2:08-cv-00365-RMP

     v.                                           MEMORANDUM*

 UNITED STATES OF AMERICA,

                 Defendant - Appellee.


                     Appeal from the United States District Court
                          for Eastern Washington, Spokane
                Rosanna Malouf Peterson, Chief District Judge, Presiding

                          Argued and Submitted July 13, 2011
                                 Seattle, Washington

Before: CLIFTON and N.R. SMITH, Circuit Judges, and KORMAN, Senior
District Judge.**

          Dr. Larry E. Howard and Joan M. Howard (jointly, the “Taxpayers”) appeal the

district court’s grant of summary judgment in favor of the United States on their claim



 *
      This disposition is not appropriate for publication and is not precedent except
as provided by 9th Cir. R. 36-3.
**
      The Honorable Edward R. Korman, Senior District Judge for the U.S. District
Court for Eastern New York, Brooklyn, sitting by designation.
for a refund of a tax deficiency and interest payment. The Taxpayers maintain that the

goodwill proceeds from the sale of Dr. Howard’s dental practice were personal assets

subject to federal income taxation as long-term capital gain. The government

contends that the goodwill proceeds belonged to Dr. Howard’s professional service

corporation (the “Howard Corporation”), which the Internal Revenue Service properly

recharacterized as a dividend payment. We have jurisdiction under 28 U.S.C. § 1291,

and we review the district court’s grant of summary judgment de novo. Bagdadi v.

Nazar, 84 F.3d 1194, 1197 (9th Cir. 1996).

      Goodwill “is the sum total of those imponderable qualities which attract the

custom of a business,—what brings patronage to the business.” Grace Brothers v.

Comm’r, 173 F.2d 170, 175–76 (9th Cir. 1949). For purposes of federal income

taxation, the goodwill of a professional practice may attach to both the professional

as well as the practice. See, e.g., Schilbach v. Comm’r, 62 T.C.M. (CCH) 1201(1991).

Where the success of the venture depends entirely upon the personal relationships of

the practitioner, the practice does not generally accumulate goodwill. See Martin Ice

Cream Co. v. Comm’r, 110 T.C. 189 at 207–08 (1998). The professional may,

however, transfer his or her goodwill to the practice by entering into an employment

contract or covenant not to compete with the business. See, e.g., Norwalk v. Comm’r,

76 T.C.M. (CCH) 208, *7 (1998) (finding that there is no corporate goodwill where


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“the business of a corporation is dependent upon its key employees, unless they enter

into a covenant not to compete with the corporation or other agreement whereby their

personal relationships with clients become property of the corporation”) (emphasis

added); Martin Ice Cream Co., 110 T.C. at 207–08 (finding that “personal

relationships . . . are not corporate assets when the employee has no employment

contract [or covenant not to compete] with the corporation”) (emphasis added);

Macdonald v. Comm’r, 3 T.C. 720, 727 (1944) (finding “no authority which holds that

an individual’s personal ability is part of the assets of a corporation . . . where . . . the

corporation does not have a right by contract or otherwise to the future services of that

individual”) (emphasis added). In determining whether goodwill has been transferred

to a professional practice, we are especially mindful that “each case depends upon

particular facts. And in arriving at a particular conclusion . . . we . . . take into

consideration all the circumstances . . . [of] the case and draw from them such

legitimate inferences as the occasion warrants.” Grace Brothers v. Comm’r, 173 F.2d

170, 176 (9th Cir. 1949).

       In the instant case, Dr. Howard worked for the Howard Corporation pursuant

to an employment contract by which he agreed “to practice dentistry solely as an

employee of the [Howard] Corporation and . . . [to] devote his entire professional time

to the affairs of the [Howard] Corporation.” Under this agreement, the Howard


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Corporation retained “complete control and authority with respect to the acceptance

or refusal of any client” and “all files . . . and other records concerning clients of the

[Howard] Corporation . . . belong[ed] to . . . the [Howard] Corporation.” In addition

to the employment contract, Dr. Howard agreed not to “engage . . . in any

business . . . competitive to that of the [Howard Corporation,]” as “long as [Dr.

Howard] h[eld] any stock [in the Howard Corporation]” and for a period of three years

thereafter. Under these circumstances, while the relationships that Dr. Howard

developed with his patients may be accurately described as personal, the economic

value of those relationships did not belong to him, because he had conveyed control

of them to the Howard Corporation.

       Pursuant to the underlying purchase agreement, the buyer obtained the goodwill

of the dental practice. The purchase agreement provides that “[t]he personal goodwill

of the [p]ractice . . . [was] established by Dr. Howard . . . [and] is based on the

relationship between Dr. Howard and the patients.” To preserve the value of the

goodwill, Dr. Howard entered into a restrictive covenant with the buyer, (the

“Covenant Not to Compete”). In accordance with the Covenant Not to Compete, both

Dr. Howard and the Howard Corporation agreed “not to practice dentistry . . . within

a radius of ten . . . miles from the [practice] . . . until three . . . years from the date [Dr.

Howard and the Howard Corporation] discontinue[] . . . dentistry [at the practice.]”


                                               4
Along with the Covenant Not to Compete, the Howard Corporation executed a

provider agreement with Bryan K. Finn, DDS, PS, the buyer’s professional service

corporation.

       The Taxpayers make two arguments based on the language of the purchase

agreement. First, they rely on the declaration that the goodwill “represents a personal,

non-corporate asset that is being conveyed individually by Dr. Howard . . . .” The

argument that this clause is dispositive of the issue whether the goodwill belonged to

the Howard Corporation or to Dr. Howard is without merit. By now it is well settled

that “the incidence of taxation depends upon the substance, not the form of [a]

transaction.” Comm’r v. Hansen, 360 U.S. 446, 463 (1959). As a result, we “look[]

to the objective economic realities of a transaction rather than to the particular form

the parties employed.” Frank Lyon Co. v. United States, 435 U.S. 561, 573 (1978).

Self-serving language in a purchase agreement is not a substitute for a careful analysis

of the realities of the transaction.

       Second, the Taxpayers contend that the purchase agreement impliedly

terminated both the employment contract and the non-competition agreement, thereby

transferring the accumulated goodwill of the practice back to Dr. Howard. This

argument appears to be inconsistent with the agreement entered into between the

Howard Corporation and the buyer by which the Howard Corporation arranged for Dr.


                                           5
Howard to provide “dental treatment on the patients of [the buyer.]” Dr. Howard was

compensated for the services he rendered to the buyer by the Howard

Corporation—an arrangement that lasted for approximately three years and during

which the Howard Corporation paid all of Dr. Howard’s operating expenses.

Nevertheless, even if we accept the premise that the purchase agreement terminated

both the employment contract and the non-competition agreement, such a release

would constitute a dividend payment, the value of which would be equivalent to the

price paid for the goodwill of the dental practice. See 26 U.S.C. § 316(a) (a

“dividend” is “any distribution of property made by a corporation to its

shareholders”); 26 U.S.C. § 301(b)(1) (“the amount of any distribution shall be the

amount of money received, plus the fair market value of . . . property received”); 26

U.S.C. § 301(c)(1) (“that portion of [a] distribution which is a dividend . . . shall be

included in gross income”).

      Finally, the Taxpayers concede that Dr. Howard chose to conduct his business

as a C corporation to take advantage of tax benefits that accrued to him over the years.

As one of the members of the panel aptly observed at oral argument, “so having then

made himself available to the advantages of using the corporation, and having entered

into the agreements that he did with the corporation, then why should we try then to

allow him . . . out of what he got himself into.” Audio Recording of Oral Argument,


                                           6
Howard v. United States, No. 10-35768 (9th Cir. July 13, 2011). Dr. Howard has

offered no compelling reason why he should be let out of the corporate structure he

chose for his dental practice.

      The judgment of the district court is AFFIRMED.




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