Covenants Not-To-Compete or to Surrender a Right to Future Employment and Early Separation Incentive Payments

Payments for Covenant Not-To-Compete A "covenant not-to-compete" is generally treated as compensation if the covenant is a separately negotiable item in the sales contract and it is intended as remuneration for non-competition. If the "covenant not-to-compete" is actually for goodwill, or to ensure the goodwill purchased, the covenant is an asset and includable in the sales of business assets on PA-40 Schedule D, Sale, Exchange, or Disposition of Property. Any payment received on account of a covenant not to compete constitutes taxable compensation. The personal deliberate failure to act is expressly what has been bargained for. Such personal refraining to engage in competition constitutes the rendition of personal services. The terminology “services rendered” does not have to involve some positive action; just affirmatively refraining from doing something the person has the right to do ( Snap-Drape v. Commissioner , 105 T.C. 16, Ullman v. Commissioner , 29 T.C. 129).

Amounts Paid to Surrender a Right to Future Gainful Employment Payments constitute taxable compensation for the relinquishment of the right to future employment as opposed to deferred compensation attributable to prior employment if: The employment agreement secures for the employee a right to future gainful employment; and The only consideration given by the employee to obtain that right is the promise to work in the future. “Front pay” paid in lieu of reinstatement also constitutes taxable compensation.