New York Advisory Opinion TSB-H-80(520)I: Is income received for a restrictive covenant (non-compete agreement) entered into when selling an unincorporated business subject to New York's unincorporated business tax?

Plain-English summary

Leon Bonfiglio asked the Department whether income he received in exchange for a restrictive covenant (a non-compete agreement) he entered into as part of selling an unincorporated business was subject to New York's unincorporated business tax (UBT).

Tax Law section 705 defines unincorporated business gross income as the sum of items of income and gain, in whatever form paid, includible in federal gross income for the year - explicitly including income and gain "from liquidation of the business." The Department reasoned that a restrictive covenant given as part of a business sale is the surrender of an intangible asset, property right, or right of value directly tied to that sale - it has no independent existence apart from the transaction. Because the covenant derives its entire significance and value from the sale of the business, payment received for it is, in substance, income or gain from liquidating the business.

Accordingly, the Department concluded that payment for the restrictive covenant had to be included in unincorporated business gross income for the tax year(s) in which it was actually received, making it fully subject to the unincorporated business tax.

What this means for you

Business owners selling an unincorporated business with a non-compete clause

Don't assume a separately-labeled "restrictive covenant" or "non-compete" payment escapes the unincorporated business tax just because it's not called "sale proceeds" - if the covenant's value comes entirely from the business sale itself, the payment is treated as taxable liquidation income just like the rest of the sale proceeds.

Sellers structuring a deal with allocated non-compete consideration

Expect payments allocated to a restrictive covenant tied to selling your unincorporated business to be taxed in the year(s) received, the same as other consideration from the sale - allocating value to the covenant doesn't create a different tax result under this analysis.

Accountants advising on unincorporated business sales

Include restrictive-covenant payments in the seller's unincorporated business gross income calculation for the year received, treating them as gain from liquidation of the business under section 705.

Common questions

Q: Does labeling part of a business-sale payment as "non-compete consideration" avoid the unincorporated business tax?
A: No - under this ruling, a restrictive covenant tied to a business sale derives its value from that sale, so payment for it is treated as taxable gain from liquidating the business.

Q: When is this income taxed - the year the business sale closes, or when payments are actually received?
A: The ruling ties inclusion to the taxable year(s) in which the covenant payment is actually received, which may extend across more than one year if payments are spread out.

Q: Does this analysis depend on how large the restrictive-covenant payment is relative to the rest of the sale price?
A: The ruling doesn't turn on relative size - its reasoning rests on the covenant deriving its entire value from the sale transaction, regardless of how the parties allocate the overall purchase price.

Source

• Landing page: https://www.tax.ny.gov/pubs_and_bulls/advisory_opinions/income_ao_1980.htm
• Opinion: https://www.tax.ny.gov/pdf/advisory_opinions/income/h80_520i.pdf

Original ruling text

New York State Department of Taxation and Finance

Taxpayer Services Division
Technical Services Bureau

TSB-H-80 (520)I
Income Tax
March 2, 1981

STATE OF NEW YORK
STATE TAX COMMISSION
ADVISORY OPINION

PETITION NO. I800625A

On June 25, 1980, a Petition for Advisory Opinion was received from Leon Bonfiglio, 67­
12 50th Avenue, Woodside, New York 11377.
The issue raised is whether income received in exchange for a restrictive covenant entered
into in connection with the sale of an unincorporated business is subject to the Unincorporated
Business Income Tax imposed under Article 23 of the Tax Law.
Section 705 of the Tax Law provides that the unincorporated business gross income, the
starting point in determining the unincorporated business taxable income, of an unincorporated
business is "...the sum of the items of income and gain of the business, of whatever kind and in
whatever form paid, includible in gross income for the taxable year for federal income tax purposes,
including income and gain...from liquidation of the business .... "
The consideration received in exchange for the restrictive covenant constitutes income
includible in gross income for Federal income tax purposes. Such a covenant constitutes the
surrender of an intangible asset, property right or right of value directly connected with the sale of
the business. Inasmuch as the covenant derives its significance and value from the entire transaction,
it follows that the payment therefor constitutes income or gain "...from liquidation of the business
.... "
Accordingly, payment received with respect to such a restrictive covenant is includible, for
the taxable years in which it is received, in unincorporated business gross income, and is thus subject
to tax under Article 23 of the Tax Law.

DATED: September 16, 1980

s/LOUIS ETLINGER
Deputy Director
Technical Services Bureau