Genius or Bozo?

Genius or Bozo?

A taxpayer wanted to get into a certain line of business. He could have bought a customer list from X Corp, but he’d have to capitalize that payment. And let’s say that if he did buy the customer list, he’d have to pay an amount based on a formula. The basis of the formula is a percentage of expected gross income generated over some future period of time. So, let’s say we look at 2-years at $250k gross per year and let’s say the percentage is 20%. So we’d have $500k x 20%, or a $100k purchase price for the customer list.

Taxpayer found out that a former employee of X Corp was looking for work. Taxpayer contacted that former employee and learned that the former employee had a covenant not to compete. That employee knew the customers of X Corp very well. In the event former employee breached the covenant, he’d have to turn over to X Corp an amount of damages equal to a percentage of gross income received by the former employee from these “stolen” customers. Basically, the same formula as above for determining the selling price of the customer list.

So, the Taxpayer concocted this scheme: He hired the X Corp former employee, who quickly proceeded to contact all of the X Corp customers. Many of those customers signed up with Taxpayer. As expected, a lawsuit came…about 2-years after the Taxpayer hired the employee. X Corp sued the Taxpayer (and not the employee) for contract/relationship interference. Taxpayer settled with X Corp for $100k and deducted the settlement payment. There is no requirement that the Taxpayer disgorge the “stolen” customers. Taxpayer gets to keep them, although it really is up to each customer if they stay with Taxpayer or not.

Pure Genius, says the Taxpayer – “Had I bought the customer list, I would have had to capitalize the payment. But now I don’t. It’s an ordinary deduction.”

Is the Taxpayer really a Genius or is he a Bozo?

Might work - the suing corporation didn’t transfer its customer list, so taxpayer didn’t purchase an intangible

Brilliant.

Now....you gonna suggest that to your client?? lol

But..... is it ethical

Business ethics could be questionable (could this be a CPA’s employee poaching clients?)… tax rules are a different analysis

Might be a dumb question, but why is X Corp stopping at $100k and not pursing punitive damages?

The issue appears to be heavily dependent on state law. Here's one next door in PA:

https://www.tradesecretsandemployeemobi ... rd-upheld/

Hazards of litigation. It was a settlement.

He took a backdoor approach to obtain a customer list. His intention is clear, how is that deductible?

X Corp sued the Taxpayer (and not the employee) for contract/relationship interference. Taxpayer settled with X Corp for $100k and deducted the settlement payment.

The payment was for contract/relationship interference, not for the customer list.

The settlement payment was more like disgorged profits

There is an undercurrent here that the genius/Bozo planned this, as if he knew in advance how the litigation would be resolved.

It looks like a good unjust enrichment case, in which event damages would be measured by the benefit received by the defendant. Disgorgement would be appropriate, which at a minimum would mean all profits. Oh, and an award of attorney fees...

Now if the genius/Bozo planned on living large and filing chapter 7, ...

The settlement payment was more like disgorged profits

More like that, yes. But under traditional asset valuation methods, when you value an asset, don’t profits factor into the calculation (to a large degree)?

Note that if I steal a vase, I would debit and asset and credit income. And if I use that vase in my business, I’d have to depreciate it.

The payment was for contract/relationship interference, not for the customer list.

But isn’t the practical effect that he got the customers because of the violation and the settlement was in payment for that violation?

Maybe, but maybe not.

You might be saying that the Employee is the one who got the clients and that does fact does not get imputed to the Taxpayer. Thus, as you say, the origin of the claim, as to the Taxpayer, is contract/relationship interference. If we would say that the customer list got stolen, it was stolen by the Employee, who just so happened not to get sued. And the Employee, who now holds the list, is just letting the employer use it with no further conveyance to the Taxpayer (or payment by the Taxpayer to the Employee).

But then again, you might even be saying that the customer list wasn’t even transferred. After all, Corp X still maintains that list, post-settlement, and can call on those customers at any time. It’s just that other parties (namely the Taxpayer and Employee) were impermissibly using the customer list. And after the settlement, if the Taxpayer is still using the customer list, but permissibly (apparently) at that point, it still doesn’t mean the Taxpayer “acquired” the list.

Nice try.

Disgorgement includes the full benefit, which can include profits and the value of the asset. For example, I am litigating a case where a 50% stockholder/President transferred the business to his wholly-owned corporation. Breach of fiduciary duty damages are measured by the loss. Unjust enrichment damages are all benefits, which in my view includes all profits plus the current value of NEWCO, given that the business is the same and constitutes all of NEWCO's assets. (It's a derivative action.)

My point is that this is not a viable planning idea. Judges sitting in equity have enormous power to structure the result.

I vote Bozo.

this sort of intangible (if indeed an intangible) would be similar to one stemming from a 1060-type allocation. In this example, suing corporation would not be eligible for capital gain treatment (they didn't sell anything hence the lawsuit).... so if they didn't sell anything, did "bozo/genius" buy anything?

if genius, it's by lucky guess...

https://www.leagle.com/decision/1982100043hmtcm9571780

so if they didn't sell anything, did "bozo/genius" buy anything?

Well, I alluded to the possible transfer/conveyance of the “intangible” in Post #13. It’s not the like Employee physically stole the customer list (such that there was any type of conveyance, legal or not) and X Corp is searching around looking for it.

Your comments bring to mind the Freda case, the one about Pizza Hut and sausage.

https://www.apexcpas.com/court-rules-on ... e-secrets/

A little bit of genius but a little bit more of bozo.

We are only talking about a deferral on a "deduction" here that provides the same amount in the long run on barely 6 figures. Especially with tax rates likely to rise, what is he really gaining on the float of only $100,000? It's not like he's Bank of America.

Plus, does more profit = more salary and thus more retirement savings in the midst of a market dip?

Finally, when you go around the rules, there are often unintended consequences. What if this somehow comes back to cost him in another, "unexpected" manner?

Even if we assume he can settle the lawsuit with $100,000 and that he is legally allowed to keep the customer list, how many of the customers can he retain? i, for one, wouldn’t stay with a business that has ‘stolen’ my contact information from another business.

But if the employee you always dealt with went to a new firm, you might follow them.