Personal Goodwill Valuation Demystified: Safeguarding Your Business Tax Planning, M&A & Litigation

At a glance 

• The main takeaway: In today’s increasingly scrutinized business environment, it’s not uncommon that leveraging personal goodwill has been overlooked. However, accurately identifying and quantifying personal goodwill in valuations can help to reduce risk and unlock financial benefits.
• Impact on you: With the IRS tightening its scrutiny, shifting tax rules, and courts demanding greater precision, any mistake in valuing personal goodwill can leave your business vulnerable to audits, lawsuits, and shareholder conflicts.
• Next steps: Aprio’s Business Valuation & Investigation Services team helps clients navigate these complexities by providing rigorous, tailored analyses that support sound decision-making in estate planning, M&A, tax compliance, and litigation.

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In many privately held businesses, particularly those led by founders, the departure of the owner can result in a substantial loss of value. Much of this value is tied to the owner’s personal expertise, relationships, reputation, and skillset. This intangible asset is known as personal goodwill.

While commonly overlooked, personal goodwill can significantly impact the outcomes of M&A transactions, estate and gift tax planning, and litigation. Whether you’re structuring a corporate sale, preparing a tax filing, or advising on a divorce, understanding how to identify and quantify the value of personal goodwill can help reduce risk and unlock real financial benefits.

What Is Personal Goodwill?

Personal goodwill is the portion of a business’s overall goodwill that is attributable to the individual owner, rather than the company itself. It encompasses the value of:

• The owner’s reputation and credibility
• Client or referral relationships that rely on the individual
• Specialized skills or knowledge that are difficult to replicate
• The owner’s personal ability to generate new business or maintain existing clients

By contrast, enterprise goodwill is tied to the business as an ongoing entity — its brand, workforce, processes, technology, and infrastructure — and can generally be transferable to a buyer.

Why It Matters: Key Use Cases for Personal Goodwill Valuation

1. M&A Deal Structuring and Tax Efficiency

In asset sales involving closely held C or S corporations, personal goodwill plays a significant role in tax planning. When personal goodwill is properly identified and allocated to the individual owner rather than the company, the proceeds from the sale can be classified as long-term capital gains. This classification is beneficial because it avoids the double taxation often associated with corporate asset sales.

2. Divorce and Shareholder Disputes

Many state courts exclude personal goodwill from the marital estate or buyout consideration, which can significantly impact the outcomes in divorce and shareholder disputes. This is especially relevant in professional practices — such as law firms, medical groups, and consultancies — where business value is closely tied to an individual’s reputation and relationships. Properly identifying and separating personal goodwill ensures an accurate and equitable division of assets, preventing overvaluation and unnecessary financial burden in partner buyouts or dissolutions. This approach better reflects the true, transferable value of the business.

3. Estate and Gift Tax Planning

For owner-led businesses, distinguishing and valuing personal goodwill can play a crucial role in reducing taxable assessments during ownership transfers or succession planning. By carefully separating personal goodwill from enterprise goodwill, business owners can qualify for valuation discounts, such as key person or lack of marketability discounts, reflecting the unique risks tied to the owner’s departure and the challenges in selling certain business interests.

This approach is especially valuable in family business succession planning. By excluding personal goodwill from the overall business valuation, it can lower tax liabilities in generational transfers. For example, strategies like Grantor Retained Annuity Trusts (GRATs) or gifting minority shares in professional firms can minimize estate tax impacts. The key to ensuring the benefits of personal goodwill include accurate valuation, proper documentation, and staying compliant with tax laws.

How Is Personal Goodwill Valued?

While there is no universal formula, several established qualitative and quantitative approaches can help allocate the value between personal and enterprise goodwill.

Qualitative Factors to Consider:

1. Do clients choose the business because of the owner?
2. Are referral sources tied to the owner or the firm?
3. Would revenue continue after the owner leaves?
4. Are there non-compete or employment agreements in place?
5. Are there formal succession plans or training programs in place?

These questions can help build a narrative around the owner’s personal contribution and provide support for your valuation.

Quantitative Approaches to Consider:

1. With-and-Without Method: This approach evaluates the business’s value in two scenarios: with the owner actively involved and without the owner’s participation. The difference in valuation between these two cases is attributed to personal goodwill. It’s especially effective when the owner’s direct involvement drives key revenue streams or client retention.
2. Income-Based Adjustments: The income approach estimates earnings generated by the business owner’s unique contributions and applies discount rates to reflect risks, such as customer loss or the owner’s eventual exit. Additionally, the valuation is limited to the owner’s working years, ensuring the results reflect their direct economic influence on the business.
3. Multi Period Excess Earnings Method: This approach involves assigning income to all contributing assets, including tangible assets, workforce, customer relationships, and intellectual property. Any residual earnings that cannot be attributed to enterprise assets are assigned to personal goodwill. This method is especially useful for companies with diverse revenue sources.
4. Residual Goodwill Approach: This method starts by calculating the total goodwill of the business, then subtracts the value of enterprise goodwill (derived from brand strength, systems, contracts, or other tangible business elements). This approach works well in industries where enterprise goodwill is already well-documented, such as franchises or businesses with standardized operations.

By combining these methods with qualitative factors, such as customer loyalty or succession planning, a comprehensive and defensible valuation of personal goodwill can be achieved.

Industry Examples: Where Personal Goodwill Shows Up Most

Common Pitfalls and Risks in Valuing Personal Goodwill

• Overgeneralizing: Assigning an arbitrary percentage to personal goodwill (e.g., 50% of goodwill is personal) without adequate analysis or supporting evidence is a frequent misstep. These oversimplifications rarely withstand scrutiny in court or during tax audits, potentially jeopardizing the integrity of the valuation.
• Overlooking Documentation: Proper evaluation of personal goodwill involves a thorough review of relevant documentation, such as employment contracts, client agreements, and referral sources. These records are essential in assessing the transferability of goodwill and must be carefully analyzed to avoid inaccuracies.
• Neglecting Industry Norms: The balance between personal relationships versus systemic reliance varies significantly across industries. For example, industries like Software as a Service (SaaS) companies typically rely more on scalable systems and processes, minimizing the role of personal goodwill. Conversely, sectors such as wealth management are highly relationship-driven, where personal goodwill often constitutes a substantial portion of the overall business value.

The bottom line

The business landscape is rapidly evolving, with increased IRS scrutiny, changes in tax exemptions, and more rigorous court evaluations brings unprecedented focus to the importance of accurately addressing personal goodwill in valuations. Missteps in this area, such as inadequate documentation or assumptions not supported by industry norms, may expose businesses to challenges during tax audits, legal proceedings, or disputes with shareholders. Ignoring these risks not only complicates transitions but also diminishes the reliability of valuations, potentially hindering the decision-making processes in critical areas like mergers, acquisitions, or litigation.

Aprio’s Business Valuation & Investigation Services team regularly supports clients in navigating personal goodwill across estate planning, M&A, tax compliance, and litigation. Our advisors bring both technical rigor and practical judgment to help ensure valuations are defensible, insightful, and strategically aligned with each client’s goals.

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