T.C. Memo. 1996-183

UNITED STATES TAX COURT

DONALD L. CHIAPPETTI, AND MARY K. CHIAPPETTI, Petitioners v.

COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 12534-94. Filed April 16, 1996.

Robert Ong Hing and Gregory Ong Hing, for petitioners.

Ann M. Welhaf, for respondent.

MEMORANDUM FINDINGS OF FACT AND OPINION

CHIECHI, Judge: Respondent determined the following deficiencies in petitioners' Federal income tax:

Year Deficiency

1990 $4,793

1991 9,618

The sole issue for decision is whether petitioners had gross
- 2 -

1 Although the purchase contract defined Donald C. Chiappetti as

the "Buyer", certain sections of that contract refer to him as

the "Purchaser".

income of $14,522 and $38,248 for 1990 and 1991, respectively,

attributable to a certain covenant not to compete. We hold that

they did. 

FINDINGS OF FACT

Some of the facts have been stipulated and are so found.

Petitioners resided in Scottsdale, Arizona, at the time the

petition was filed.

From approximately 1982 through 1988, petitioner Donald L.

Chiappetti (petitioner) practiced dentistry as an employee of his

wholly owned corporation, Chiappetti Professional Corporation

(CPC).

Pursuant to a written purchase contract dated December 31,

1988 (purchase contract), CPC sold certain of its assets to

petitioner's son, Donald C. Chiappetti, a dentist. The purchase

contract defined CPC as the "Seller" and Donald C. Chiappetti as

the "Buyer".1 Section 1 of the purchase contract provided that

"Seller agrees to sell and Buyer agrees to buy * * * only those

items described in Exhibit A attached hereto and incorporated

herein". Exhibit A attached to the purchase contract identified

the "Dental Practice Assets to be purchased by Donald Craig

Chiappetti from Chiappetti Professional Corporation". That

exhibit and section 4 of the purchase contract allocated the
- 3 -

purchase price to be paid by Donald C. Chiappetti under the

purchase contract to various items, including an item referred to

in that exhibit as a "Covenant Not to Compete executed by Dr.

Donald L. Chiappetti" and an item referred to in that section as

a "Covenant Not to Compete". 

The purchase contract contained the following language with

respect to a covenant not to compete:

Section 7. Covenant Not to Compete. In connection with the sale of the above-mentioned assets,

Donald L. Chiappetti (the sole shareholder of Seller)

agrees that he will not, for a period of five (5) years

from the date of closing, engage in the practice of

general dentistry within a ten (10) mile radius of the

office located at 7125 E. Lincoln Drive, Scottsdale,

Arizona 85253. Donald L. Chiappetti agrees to honor

the spirit of this covenant and specifically agrees not

to solicit patients treated at said location in the

event he practices elsewhere in the future.

Purchaser agrees that, in the event of a default

by him on any Promissory Note to Seller, that [sic]

Purchaser will not engage in the practice of general

dentistry within a radius of ten (10) miles from the

above referenced location for a period of five (5)

years from the date of default. Purchaser further

agrees that, in the event of such default, any Covenant

Not to Compete that has been provided by Donald L.

Chiappetti will be of no further force and effect.

Although petitioner signed the purchase contract on behalf

of CPC as its "President", because Donald C. Chiappetti wanted

petitioner to execute the above-quoted covenant not to compete in

his individual capacity, that covenant was executed by "Donald L.

Chiappetti, Individually". (We shall refer to the covenant not

to compete that is contained in section 7 of the purchase con-
- 4 -

tract as the covenant not to compete, and all references to the

purchase contract are to all provisions (including the covenant

not to compete) contained in, and exhibits attached to, that

contract.) The covenant not to compete contained in section 7 of

the purchase contract was valid and enforceable.

The purchase contract contained the following language with

respect to an option to repurchase (option to repurchase):

Section 17. Option to Repurchase. Seller, not

being entirely sure that he wants to retire from the

practice of dentistry, shall have the option of repurchasing the assets described in Section 1, for an

amount equal to $135,000 minus any liens or encumbrances on said assets and upon the same terms and conditions in this Contract except for the Purchase Price

(i.e. Donald Craig Chiappetti will become the "Seller"

and Chiappetti P.C. will become the "Buyer"). The

purchase price under Seller's Option to Repurchase

shall be payable in equal monthly installments over

five years at 10% interest or may be paid, at Seller's

option, totally in cash upon closing or paid over a

period [sic] less than five years in equal monthly installments at 10% interest. Seller may repurchase said

assets after giving Buyer 30 days written notice thereof. In the event of such repurchase, Donald L. Chiappetti shall no longer be subject to the Covenant Not to

Compete, and instead Buyer shall be substituted for

Donald L. Chiappetti in the Covenant Not to Compete. 

Seller's option to repurchase the assets shall expire

on December 31, 1993, if notice of intention to exercise said option has not been given by this date.

The following phrase contained in the option to repurchase refers

to petitioner in his individual capacity, and not to CPC: "not

being entirely sure that he wants to retire". (Emphasis added.)

The purchase contract provided that Donald C. Chiappetti was

to pay CPC a total purchase price of $125,000. Exhibit A at-
- 5 -

tached to the purchase contract allocated the $125,000 purchase

price that Donald C. Chiappetti was to pay for the items that he

was acquiring thereunder, as follows:

Goodwill $5,000

Supplies 5,000

Group assets 4,000

Office furnishings and equipment 6,000

Dental equipment 24,000

All patient and office records belonging

to CPC 5,000

Covenant Not to Compete executed by Dr.

Donald L. Chiappetti 76,000

Total 125,000

Section 4 of the purchase contract made an identical allocation

of the $125,000 purchase price, except that it allocated 

(1) $5,000 to an item referred to as "Patient Records", instead

of "All patient and office records belonging to CPC" and (2)

$76,000 to an item referred to as a "Covenant Not to Compete",

instead of a "Covenant Not to Compete executed by Dr. Donald L.

Chiappetti". 

The covenant not to compete contained in section 7 of the

purchase contract was accurately valued in the purchase contract

at $76,000.

The purchase contract provided that the $125,000 purchase

price was payable as follows: (1) $1,000 payable at closing and

(2) $124,000 payable in 60 equal monthly installments to be

evidenced by a promissory note for that amount. Contemporaneous

with the execution by petitioner of the purchase contract in his

capacity as president of CPC and of the covenant not to compete
- 6 -

2 All Rule references are to the Tax Court Rules of Practice and

Procedure.

3 At trial, we conditionally admitted into evidence certain

stipulated exhibits to which respondent objected on grounds of

relevance (viz., Exhibits 8, 10, and 11). Although we shall

(continued...)

in his individual capacity, Donald C. Chiappetti signed a promissory note for $124,000 payable to CPC (promissory note). Donald

C. Chiappetti paid all amounts due under that promissory note.

Petitioner, who was then 55 years old, retired from the

practice of dentistry upon execution by him, of (1) the purchase

contract in his capacity as president of CPC and (2) the covenant

not to compete in his individual capacity.

In its Federal income tax returns (returns) for 1990 and

1991, CPC reported income of $14,522 and $38,248, respectively,

attributable to the covenant not to compete. CPC's income for

both 1990 and 1991 was offset by deductions CPC took in its

respective returns for those years, including net operating loss

carryforwards. As a result, CPC had no income tax liability for

1990 or 1991.

OPINION

Petitioners bear the burden of proving that respondent's

determinations in the notice of deficiency (notice) are erroneous. Rule 142(a);2 Welch v. Helvering, 290 U.S. 111, 115 (1933). 

Petitioners attempted to satisfy their burden through testimonial

and documentary evidence.3
- 7 -

3(...continued)

unconditionally admit those exhibits into evidence as relevant,

we note that petitioners do not rely on them on brief, and we did

not find them helpful and thus did not rely on them in reaching

our holding herein. 

The only witnesses were petitioner and his son, Donald C.

Chiappetti. Petitioner's testimony was self-serving and conflicted with certain provisions in the purchase contract that are

directly apposite to the issue in this case. Similarly, Donald

C. Chiappetti's testimony served the interests of his father and

conflicted with those same provisions in the purchase contract. 

Under such circumstances, we are not required to, and we generally do not, rely on their testimony to sustain petitioners' burden

of proving error in respondent's determinations. See Geiger v.

Commissioner, 440 F.2d 688, 689-690 (9th Cir. 1971), affg. per

curiam T.C. Memo. 1969-159; Wood v. Commissioner, 338 F.2d 602,

605 (9th Cir. 1964), affg. 41 T.C. 593 (1964); Tokarski v. Commissioner, 87 T.C. 74, 77 (1986); Hradesky v. Commissioner, 65

T.C. 87, 90 (1975), affd. per curiam 540 F.2d 821 (5th Cir.

1976).

In the notice, respondent determined that the amounts paid

during the years at issue by Donald C. Chiappetti to CPC that

were attributable to the covenant not to compete represented

income to petitioner. It is well settled that consideration paid

for a bona fide covenant not to compete is income to the seller. 

Sonnleitner v. Commissioner, 598 F.2d 464, 466 (5th Cir. 1979),
- 8 -

affg. T.C. Memo. 1976-249; Montesi v. Commissioner, 340 F.2d 97,

100 (6th Cir. 1965), affg. 40 T.C. 511 (1963); Hamlin's Trust v.

Commissioner, 209 F.2d 761, 765 (10th Cir. 1954), affg. 19 T.C.

718 (1953); see Yandell v. United States, 315 F.2d 141, 142-143

(9th Cir. 1963) (per curiam). "Money paid as consideration for a

covenant not to compete is regarded as income received in place

of that which the taxpayer might otherwise have earned in the

field of enterprise from which the covenant excludes him [or

her]." Montesi v. Commissioner, supra.

As we understand petitioners' principal position, they argue

that CPC, and not petitioner, entered into the covenant not to

compete for which Donald C. Chiappetti paid $76,000 because that

covenant was binding on CPC and therefore obligated CPC, and not

petitioner, to refrain from practicing dentistry and from soliciting its patient base, which petitioners describe as CPC's most

important asset, as provided in that covenant. Respondent contends that the income from the covenant not to compete is attributable to petitioner because (1) that covenant obligates

petitioner in his individual capacity, and not CPC, to refrain

from practicing dentistry and from soliciting patients as provided therein, and (2) he cannot escape tax on that income by

assigning it to his wholly owned corporation. We agree with

respondent.

We find nothing in the covenant not to compete or in any
- 9 -

4 The terms of the covenant not to compete could not be more

clear when they provided in pertinent part that:

Donald L. Chiappetti (the sole shareholder of Seller)

agrees that he will not, for a period of five (5) years

from the date of closing, engage in the practice of general

dentistry within a ten (10) mile radius of the office

located at 7125 E. Lincoln Drive, Scottsdale, Arizona

85253. Donald L. Chiappetti agrees to honor the spirit of

this covenant and specifically agrees not to solicit patients treated at said location in the event he practices

elsewhere in the future.

* * * Purchaser further agrees that, in the event of such

default, any Covenant Not to Compete that has been provided by

Donald L. Chiappetti will be of no further force and effect. 

[Emphasis added.]

other portion of the purchase contract that expressly or impliedly supports petitioners' argument that CPC was bound by that

covenant to refrain from practicing dentistry and from soliciting

its patient base as provided therein. The covenant not to compete specifically and unambiguously referred to Donald L. Chiappetti, petitioner herein, and obligated him, and not CPC, to

refrain from engaging in the practice of dentistry and from

soliciting patients as provided therein. It also provided that

in the event the buyer Donald C. Chiappetti were to default under

the purchase contract, that covenant "that has been provided by

Donald L. Chiappetti" would no longer be in effect.4 Neither the

covenant not to compete nor any other provision in the purchase

contract provided that CPC would be released from the covenant

not to compete in the event that the buyer Donald C. Chiappetti

were to default under the purchase contract. Although petitioner
- 10 -

5 We acknowledge that the following phrase contained in the

option to repurchase may at first blush appear to be confusing: 

"Seller, not being entirely sure that he wants to retire from the

practice of dentistry, shall have the option of repurchasing the

assets described in Section 1". We have found that the phrase

"not being entirely sure that he wants to retire" (emphasis

added) is a reference to petitioner in his individual capacity. 

However, the option to repurchase provides that the seller, i.e.,

CPC (not petitioner), was entitled to repurchase the assets sold

pursuant to that contract, including the covenant not to compete. 

In any event, what is significant to us in resolving the issue

herein is that the option to repurchase specifically and unambiguously releases petitioner, and not CPC, from the covenant not to

compete in the event that that option were exercised.

executed the purchase contract on behalf of CPC as its president,

at the insistence of the buyer Donald C. Chiappetti, petitioner

Donald L. Chiappetti executed the covenant not to compete in his

individual capacity.

Other provisions in the purchase contract also undermine

petitioners' principal position herein. Thus, the purchase

contract provided in section 17 that if the option to repurchase

the items described in section 1 thereof were exercised, "Donald

L. Chiappetti shall no longer be subject to the Covenant Not to

Compete".5 Neither the covenant not to compete nor any other

provision in the purchase contract provided that CPC would be released from the covenant not to compete in the event that CPC

were to exercise the option to repurchase.

It is also significant that exhibit A attached to the

purchase contract that allocated the $125,000 purchase price that

Donald C. Chiappetti was to pay for the items he was acquiring
- 11 -

6 We note that sec. 4 of the purchase contract and exhibit A

attached thereto allocated $5,000 of the $125,000 purchase price

to an item described as "Goodwill" and $5,000 to an item described as "Patient Records" in sec. 4 and as "All patient and

office records belonging to CPC" in exhibit A.

thereunder specifically allocated $76,000 of the purchase price

paid by Donald C. Chiappetti to the "Covenant Not to Compete

executed by Dr. Donald L. Chiappetti" (emphasis added), that is

to say, to the agreement of petitioner, and not CPC, to refrain

from practicing dentistry and from soliciting its patients as

provided therein. Neither that exhibit nor any other provision

in the purchase contract allocated $76,000 (or any other portion

of the purchase price) to what petitioners' claim was CPC's

obligation to refrain from soliciting its patient base. In fact,

there is no reference whatsoever in the purchase contract to an

item called a "patient base" of CPC.6

Petitioners also argue that, because the $125,000 that

Donald C. Chiappetti paid under the purchase contract, including

the $76,000 that was allocated by that contract to the covenant

not to compete, was paid to CPC, and not to petitioner, the

covenant not to compete was an asset of CPC. We disagree. 

Regardless who received the income attributable to the covenant

not to compete, the true earner of that income is liable for the

tax on it and cannot escape that tax by assigning the income to

another taxpayer. See Lucas v. Earl, 281 U.S. 111 (1930). In

the instant case, petitioner in his individual capacity, and not
- 12 -

CPC, agreed to refrain from practicing dentistry and from soliciting patients as provided in the covenant not to compete. 

Consequently, we find that petitioner, and not CPC, must recognize the income that Donald C. Chiappetti paid for petitioner's

agreement to so refrain, even though he may have paid it to CPC.

Petitioners further argue that, because exhibit A attached

to the purchase contract that allocated the $125,000 purchase

price to various items acquired thereunder referred to the covenant not to compete as an asset of CPC, the $76,000 that Donald

C. Chiappetti paid to purchase that covenant is income to CPC

from the sale of that asset. Petitioners' argument is without

merit. Regardless whether the purchase contract referred to the

covenant not to compete as an asset of CPC, it was petitioner,

and not CPC, who promised to refrain from practicing dentistry

and from soliciting patients as specified in that covenant. 

Consequently, petitioner, and not CPC, must recognize the income

attributable to that promise. See Montesi v. Commissioner, 340

F.2d at 99-100.

Petitioners also contend that if petitioner, and not CPC,

had been the person obligated by the covenant not to compete,

that covenant would have had little or no value, since petitioner

intended to, and did, retire from the practice of dentistry at

the time the purchase contract was executed. Therefore, according to petitioners, in order for that covenant to have been
- 13 -

accurately valued at $76,000, CPC, and not petitioner, must have

promised not to compete. Petitioners' contention that the covenant not to compete had little or no value flies in the face of

the parties' stipulation that "the $76,000 value placed upon the

covenant not to compete in the purchase contract was an accurate

value of the covenant." On the present record, petitioners have

failed to show why they should be relieved of that stipulation. 

See Rule 91(e). As for their contention that petitioner's intention to retire and his actual retirement at the time the purchase

contract was executed would have made any agreement by him not to

compete of little or no value, petitioners have failed to prove

that petitioner was certain that he wanted to retire or that he

would remain retired. In fact, the option to repurchase contained in the purchase contract recited that petitioner was "not

* * * entirely sure" that he wanted to retire. Petitioner also

testified that it was his son, Donald C. Chiappetti, who insisted

that petitioner execute the covenant not to compete in his individual capacity, presumably because of his son's concern about

future competition from his father. Based on the instant record,

we have no basis for finding that the covenant not to compete,

which by its terms binds only petitioner, and not CPC, should

have been valued at some amount other than the $76,000 that

petitioner, CPC, and Donald C. Chiappetti allocated to it in the
- 14 -

7 Petitioner argues that, at the very least, the majority of the

$76,000 allocated in the purchase contract to the covenant not to

compete should be attributed to CPC's promise to refrain from

practicing dentistry and from soliciting patients as provided in

that covenant, rather than to petitioner's promise to refrain

from doing so. We are unwilling to attribute any amount of the

$76,000 to CPC's alleged promise to refrain from doing those

things because we find on the instant record that petitioners

failed to prove that CPC promised to refrain from so doing or

that any portion of the $76,000 allocated in the purchase contract to the covenant not to compete executed by petitioner in

his individual capacity was attributable to a promise by CPC to

refrain from doing so. 

purchase contract.7

We acknowledge that the purchase contract contains certain

facially inconsistent provisions in that section 1 thereof provided that CPC agreed to sell the items described in exhibit A

attached to the contract, whereas exhibit A identified as one of

the items that CPC was purportedly agreeing to sell the "Covenant

Not to Compete executed by Dr. Donald L. Chiappetti". However,

any such inconsistency is readily resolved by turning to the

provision in the purchase contract that is the operative provision with respect to the covenant not to compete, viz., section 7

of the purchase contract. In that section, petitioner, and not

CPC, agreed to refrain from practicing dentistry and from soliciting patients as provided therein, and, at the insistence of the

buyer, petitioner executed the covenant not to compete in his

individual capacity. There is nothing ambiguous or equivocal in

the covenant not to compete contained in section 7 of the purchase contract. It is unambiguous and unequivocal in obligating
- 15 -

8 Respondent argues that, pursuant to Commissioner v. Danielson,

378 F.2d 771 (3d Cir. 1967), vacating and remanding 44 T.C. 549

(1965) (the Danielson rule), petitioner is bound for tax purposes

by the covenant not to compete that he executed because it was a

valid, enforceable contract and he has not made a showing of

mistake, undue influence, fraud, or duress with respect to that

covenant. As this Court has previously stated, we do not apply

the Danielson rule unless the Court of Appeals to which the case

would normally be appealed has adopted that rule. Elrod v.

Commissioner, 87 T.C. 1046, 1065-1066 (1986). Although the U.S.

Court of Appeals for the Ninth Circuit to which an appeal in this

case would normally lie has not adopted the Danielson rule, that

Court has held that, where there is ample evidence to support a

finding that an agreement, knowingly and voluntarily made, with

no suggestion of fraud, is binding on a taxpayer, "The tax

consequence of such an agreement may be challenged by the Commissioner, but not by the taxpayer." (Citations omitted.) Palo

Alto Town & Country Village, Inc. v. Commissioner, 565 F.2d 1388,

(continued...)

petitioner, and not CPC, to comply with its terms. Other provisions in the purchase contract also unambiguously and unequivocally referred to the obligation of petitioner, and not CPC, to

comply with the covenant not to compete contained in section 7

thereof and allocated $76,000 of the total price Donald C. Chiappetti paid under the purchase contract to the covenant not to

compete "executed by Dr. Donald L. Chiappetti". 

This Court applies the so-called strong proof rule when a

taxpayer asserts that an allocation of consideration is other

than that specified in a written contract; that is to say, the

taxpayer must present strong proof, i.e., more than a preponderance of the evidence, that his or her alleged allocation is

correct based on the intent of the persons who were the parties

to that contract and the economic realities.8 See, e.g.,
- 16 -

8(...continued)

1390 (9th Cir. 1977), remanding T.C. Memo. 1973-223; see Baxter

v. Commissioner, 433 F.2d 757, 759 (9th Cir. 1970), affg. T.C.

Memo. 1969-87. Regardless whether we were to apply the standard

set forth in the Palo Alto Town & Country Village case, the

strong proof rule that we generally apply, the Danielson rule, or

even a preponderance of the evidence standard, our holding herein

would remain the same.

Meredith Corp. v. Commissioner, 102 T.C. 406, 438 (1994); Estate

of Durkin v. Commissioner, 99 T.C. 561, 572-573 (1992), supplementing T.C. Memo. 1992-325; Elrod v. Commissioner, 87 T.C. 1046,

1065-1066 (1986); Peterson Machine Tool, Inc. v. Commissioner, 79

T.C. 72, 81-82 (1982), affd. 54 AFTR 2d 84-5407, 84-2 USTC par.

9885 (10th Cir. 1984). The U.S. Court of Appeals for the Ninth

Circuit affirmed our use of the strong proof rule in Schulz v.

Commissioner, 294 F.2d 52, 55 (9th Cir. 1961), affg. 34 T.C. 235

(1960). See also Salyer Grain & Milling Co. v. Commissioner,

T.C. Memo. 1986-165, affd. without opinion 815 F.2d 1265 (9th

Cir. 1987).

Petitioners have failed to present strong proof that CPC,

and not petitioner in his individual capacity, was obligated by

the covenant not to compete contained in section 7 of the purchase contract. We are unwilling to accept the testimony of

petitioner and his son as strong proof that they did not intend

that section to mean what it says or that they did not intend to

allocate $76,000 of the total purchase price that his son was to

pay under the purchase contract to the "Covenant Not to Compete
- 17 -

9 We have considered all of petitioners' other arguments not

discussed herein and also find them to be without merit.

executed by Dr. Donald L. Chiappetti", as they clearly did in

exhibit A to that contract. 

Based on our examination of the entire record before us, we

find that petitioners have failed to sustain their burden of

proving error in respondent's determinations that they must

recognize income of $14,522 and $38,248 for 1990 and 1991, respectively, that is attributable to petitioner's covenant not to

compete.9 We therefore sustain those determinations.

To reflect the foregoing,

Decision will be entered

for respondent.