## Facts

- Jackson Investment Company and West Shore Company were partners in George W. Carter Company, a construction partnership, along with retiring partner Ethel M. Carter.
- Upon Ethel M. Carter’s retirement, the partners executed an amendment to the limited partnership agreement.
- The amendment acknowledged prior agreements did not provide for goodwill payments, but provided that the partnership would nevertheless pay Ethel M. Carter “in respect to goodwill.”
- The partnership agreed to pay $60,000 in three annual installments.
- Of the $60,000, $19,650 was allocated to Ethel M. Carter’s 15% interest in partnership assets, and $40,350 was designated as “a guaranteed payment, or a payment for good will.”
- For tax years 1956–1958, Jackson Investment and West Shore deducted their shares of the $40,350 amount as current partnership expenses.
- The Commissioner disallowed the deductions and assessed deficiencies against each company, treating the goodwill amount as a nondeductible payment for a partnership property interest under I.R.C. § 736(b).

## Issues

1. Whether payments designated as “goodwill” to a retiring partner are deductible under I.R.C. § 736(a) as distributive shares or guaranteed payments, or instead are nondeductible distributions under § 736(b) as payments for an interest in partnership property.
2. Whether a goodwill payment can be treated as deductible under § 736(a) because earlier partnership agreements did not grant the retiring partner a contractual right to goodwill.

## Decision

- The Ninth Circuit reversed the Tax Court.
- The court held that the $40,350 designated for “goodwill” was a payment for the retiring partner’s interest in partnership property within I.R.C. § 736(b).
- Because the payment fell under § 736(b), it was treated as a partnership distribution in exchange for property and was not currently deductible by the partnership or the remaining partners.
- The Commissioner’s deficiency determinations were sustained.

## Legal Principles

- I.R.C. § 736 separates retirement payments into (a) amounts treated as distributive shares or guaranteed payments (potentially deductible) and (b) amounts treated as distributions made in exchange for the retiring partner’s interest in partnership property (not deductible as current expenses).
- Goodwill constitutes partnership property for purposes of § 736(b) when the payment is made “in respect to goodwill” as part of liquidating a retiring partner’s interest.
- Tax characterization under § 736 turns on the substance of what the payment purchases (an interest in partnership property versus an allocation of income), not solely on labels used in the agreement or the absence of goodwill provisions in prior agreements.
- A fixed amount paid in connection with retirement and expressly tied to goodwill is treated as a § 736(b) property payment rather than a § 736(a) guaranteed payment.

## Conclusion

The court held that a partnership’s fixed payments to a retiring partner expressly attributable to goodwill are § 736(b) distributions for a property interest and therefore are not currently deductible under § 736(a), even if earlier partnership agreements did not provide the partner a goodwill right.


Comm’r v. Jackson Inv. Co., 346 F.2d 187 (9th Cir. 1965)