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Tax Effects of sale of Hsui's process to preserve fresh frui

Hsui, who is single, is the owner of a sole proprietorship. Two years ago, Hsui developed a process for preserving fresh fruit that gives the fruit a much longer shelf life. The process is not patented or copyrighted, but only Hsui knows how it works. Hsui has been approached by a company that would like to buy the process. Hsui insists that she receive a long-term employment contract with the acquiring company as well as be paid for the rights to the process The acquiring company offers Hsui a choice of two options: (1) $850,000 in cash for a 10-year covenant not to compete at $45,000 per year or (2) $850,000 in cash for a 10-year covenant not to compete and $45,000 per year for 10 years in payment for the process. Which option should Hsui accept? What is the tax effect on the acquiring company of each approach?

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Hsui tax consequences:

If she accepts the covenant not to compete, the income will all be ordinary to her as it is received. There is even a small possibility that self employment tax could be assessed on the payments.

If she accepts payments for the sale ...

Solution Summary

The solution explains the tax effects of the proposed transaction from Hsui's position and that of the buyer.