## Facts

- Milton and Elaine Tolmach filed joint federal income tax returns for 1983 and 1984.
- Milton Tolmach was a senior partner in a law firm that performed collection work for the health care industry.
- The firm dissolved in 1976 after other partners voted to dissolve without Tolmach’s participation and formed a successor firm that continued the practice and took control of the former firm’s assets and operations, excluding Tolmach.
- Litigation in New York state court resulted in an accounting and a valuation of the former firm that attributed a substantial portion of value to goodwill and calculated Tolmach’s ownership share.
- The parties ultimately settled: the successor firm agreed to pay Tolmach $1.7 million through monthly payments for his interest and an additional lump-sum payment stated to be for goodwill.
- Payments were made to Tolmach in 1983 and 1984.
- Tolmach reported the payments as long-term capital gain from the sale of his partnership interest and argued that most of the amounts were attributable to goodwill.
- The settlement agreement designated substantially all periodic payments as payments for Tolmach’s share of unrealized receivables and stated they were intended to qualify as guaranteed payments under I.R.C. § 736(a)(2).
- The Commissioner determined deficiencies for 1983 and 1984 after recharacterizing the amounts as ordinary income under § 736(a)(2).

## Issues

1. Whether payments made under the dissolution/accounting settlement were made in liquidation of Tolmach’s partnership interest (I.R.C. § 736) or constituted consideration for a sale of that interest (I.R.C. § 741).
2. If § 736 applied, whether the periodic payments were guaranteed payments under § 736(a)(2) (ordinary income) or payments for goodwill under § 736(b)(2)(B) (potential capital-gain treatment).

## Decision

- The Tax Court held the payments were made in liquidation of Tolmach’s partnership interest and were governed by I.R.C. § 736, not I.R.C. § 741.
- The court held the periodic payments were § 736(a)(2) guaranteed payments, not payments for goodwill under § 736(b)(2)(B).
- The court sustained the Commissioner’s deficiencies for 1983 and 1984.

## Legal Principles

- Payments to a retiring or departing partner made pursuant to partnership dissolution and an accounting are generally analyzed as liquidation payments under I.R.C. § 736 rather than as consideration for a sale under I.R.C. § 741.
- Under § 736(a)(2), amounts designated and structured as guaranteed payments—particularly where tied to unrealized receivables—are treated as ordinary income to the recipient.
- Goodwill receives § 736(b)(2)(B) treatment only if the partnership agreement provides for payments with respect to goodwill; external valuations emphasizing goodwill do not control federal tax characterization absent the required agreement terms.
- Contractual allocation language in the governing settlement documentation can be decisive in classifying dissolution payments under § 736.

## Conclusion

The Tax Court treated the post-dissolution settlement as a liquidation of Tolmach’s partnership interest and taxed the periodic payments as ordinary-income guaranteed payments under § 736(a)(2), rejecting capital-gain treatment under § 741 and rejecting goodwill characterization under § 736(b)(2)(B).


Tolmach v. Commissioner, 62 T.C.M. (CCH) 1102 (T.C. 1991)