Was consideration paid to a nonresident for a ten-year covenant not to compete in California California-source income when included in a stock sale?

Plain-English summary

California Legal Ruling 84 made the source of a noncompete payment depend on severability from the stock-sale price.

If a distinct amount was paid for the nonresident seller's promise not to compete in California, that amount was California-source income.

If the noncompete consideration could not be separated from the other intangible consideration, the entire amount was treated as arising from the stock sale and was not taxable by California to the nonresident under the ruling.

Facts addressed by the ruling

The nonresident taxpayer sold a stock interest in a California firm.

Part of the consideration was described as payment for a covenant not to compete in California for ten years.

The ruling addressed whether that portion of the transaction generated California-source income.

Severable noncompete consideration

The covenant required the seller to refrain from competition specifically in California.

When the consideration for that promise could be segregated from the sale of the other intangibles, the ruling sourced the covenant payment to California.

Inseparable consideration

The result changed if the noncompete amount could not be separated from the rest of the transaction.

In that event, the ruling treated the whole amount as arising from the stock sale. It then applied the historical rule that a nonresident's sale of stock was not taxable in California.

What this means for you

Nonresident business sellers

Under the historical ruling, transaction documents and allocation of consideration determined whether a California-specific promise produced California-source income.

Corporate shareholders

A stock sale and a related noncompete covenant did not necessarily share the same source treatment when the covenant had separately identifiable value.

Accountants and transaction advisors

Review the purchase agreement, valuation support, allocation schedules, geographic scope, covenant term, and whether the parties separately state or can substantiate the noncompete consideration.

Common questions

Q: Was every amount in the transaction California-source?

A: No. Only severable consideration for the California noncompete was sourced to California under the ruling.

Q: How long did the covenant last?

A: Ten years.

Q: What if the noncompete price could not be separated?

A: The entire amount was treated as arising from the stock sale.

Q: How did the ruling treat the nonresident's stock sale?

A: As not taxable in California on the stated facts.

Q: Did the ruling provide a valuation method for separating the covenant?

A: No.

Citations and references

• No statute or case citation is printed in the official ruling.

Source

• Landing page: California FTB Legal Rulings
• Official HTML: Legal Ruling 84

Original ruling text

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Legal Ruling 1958-84

California Franchise Tax Board
Legal Ruling No. 084

June 17, 1958

Income From California Sources

Income from a covenant not to compete in California, if severable from the sale of other intangibles, is income from sources within California.

Taxpayer, a nonresident, sold his stock interest in a California firm. Part of the consideration received by taxpayer was for his covenant not to compete in California for a period of ten years. Advice is requested whether the income from a covenant not to compete in California constitutes income from sources within California.

Consideration for a covenant not to compete in California, if severable from the sale of other intangibles, is income from sources in California. If, on the other hand, the consideration cannot be so segregated, the entire amount arises from the sale of the asset; under such circumstances the sale of stock by a non-resident would not be taxable in California.

Last updated: 09/24/2025