Commissioner v. Danielson
United States Court of Appeals for the Third Circuit
378 F.2d 771 (1967)

- Written by Kelli Lanski, JD
Facts
Carl and Pauline Danielson and others (the stockholders) (plaintiffs) owned stock in a company engaged in the small-loan business. The stockholders decided to solicit offers to purchase the business. Thrift Investment Corporation (Thrift) offered to pay for all outstanding common stock for $374 per share, plus a covenant-not-to-compete agreement. Thrift unilaterally drafted the relevant agreements and allocated $152 per share to the covenant not to compete and the remainder to the contract for the stock sale. Thrift notified the stockholders that the allocations favored Thrift from a tax standpoint but did not disclose that the stockholders would receive capital-gains treatment or that any amount would be taxable as ordinary income. After consulting with lawyers, the stockholders agreed to the sale. The stockholders reported the entire proceeds from the sale as capital gains, and the commissioner of the Internal Revenue Service (commissioner) (defendant) disallowed the portion of proceeds corresponding to the covenant not to compete, finding it should be taxed as ordinary income. The stockholders asked the United States Tax Court to review the commissioner’s decision, claiming that the stockholders did not really bargain for the covenant-not-to-compete allocation and it should not be analyzed as separate income. The commissioner argued that the stockholders should not be permitted to attack the agreement with Thrift during a tax dispute except in cases of fraud, duress, or undue influence. The tax court ruled for the stockholders, and the commissioner appealed.
Rule of Law
Issue
Holding and Reasoning (Seitz, J.)
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