cery Co., 304 U.S. 282, 295 (1938); Silverman v. Commissioner, 538 F.2d 927, 933 (2d Cir. 1976), affg. T.C. Memo. 1974–285. Mr. Reilly computed the value of the covenant not to compete under the comparative business valuation method and a discounted net cash-flow analysis. Utilizing this comparative approach, Mr. Reilly computed Mister Donut's discounted net cash-flow under two scenarios. Scenario 1 assumed that the covenant was in place, and petitioner could not reenter the Asian and Pacific doughnut market. Scenario 2 assumed that the purchaser did not receive a covenant, and petitioner would reenter the market and compete. Mr. Reilly attributed the difference in the sum of Mister Donut's discounted net cash-flows under these two scenarios to the covenant not to compete. Mr. Reilly then added the income. tax benefits of amortization over the covenant's estimated enforceable period of 5 years to determine the portion of the $2,050,000 sale price to be allocated to the covenant. Mr. Reilly performed these calculations twice, once assuming the most likely competition scenario from petitioner in the event it reentered the Asian and Pacific market, and a second time assuming the worst case competition scenario from petitioner.23 Mr. Reilly estimated the values of the covenant under the most likely competition scenario and the worst case competition scenario at $620,000 and $630,000, respectively. He then reconciled these differences and arrived at a final value of $620,000. We find two difficulties with Mr. Reilly's report and his calculations. First, we are unsure whether Mr. Reilly's calculations and valuation of the covenant not to compete erroneously assumed that petitioner could reenter these Asian and Pacific markets again as "Mister Donut", despite the fact that petitioner had conveyed its existing franchise agreements, trademarks, and Mister Donut System to Duskin in the purchase agreement. For instance, Mr. Reilly testified at trial that "The value of the [Duskin's] business would be reduced by $620,000, due to the most likely competition from Mister Donut." But petitioner had already transferred its rights to Mister Donut in the operating and nonoperating 23 Under the worst case of competition from petitioner, Mr. Reilly projected that petitioner's reentry into the Asian and Pacific market would be so competitive that the purchaser of petitioner's Mister Donut franchise business would be unable to open new franchises after 1 year. countries. Assuming no covenant existed, and petitioner had chosen to reenter the doughnut market in these territories, it would have had to do so under a different name.24 Second, Mr. Reilly computed the value of the covenant not to compete under both the most likely and the worst cases of competition without factoring in the likelihood of petitioner's competition into his calculations. Although Mr. Reilly's report stated that there existed a less-than-50-percent chance of petitioner's reentering the Asian and Pacific market for such franchise operations, his calculations ignored the fact that competition was unlikely even without a covenant. Based on our review of the record, we conclude that $300,000 of the sale price should be allocated to the covenant not to compete. Respondent concedes that the amount allocable to the covenant not to compete constitutes foreign source income for purposes of computing petitioner's foreign tax credit limitation pursuant to section 904(a). Finally, petitioner incurred $107,491 of expenses in connection with the sale to Duskin but did not allocate any portion of the expenses to the sale of the covenant not to compete. At trial, Mr. Schaefer testified that "It was my conclusion that we were selling assets, trademarks, good will, and selling expenses should be allocated to those *** ** assets being sold. The covenant not to compete is-I equate to kind of a performance contract. We weren't selling anything; therefore, selling expenses should not be allocated to it." On brief, respondent argues that to the extent a portion of the sale price is allocated to the covenant and treated as foreign source income, a pro rata share of the selling expenses must necessarily be allocated to the covenant, thus reducing petitioner's foreign source income. See sec. 862(b). Section 1.861-8(b)(1), Income Tax Regs., provides that deductions are allocated to the class of gross income to which they are definitely related. Section 1.861–8(b)(2), Income Tax Regs., provides that a deduction is "definitely related" to a 24 In response to respondent's pretrial inquiry, petitioner stated that future competition from petitioner could reduce the net income of a buyer of Mister Donut's Asian and Pacific franchise operations by 40-45 percent. Petitioner attributed this reduction to the following: (1) Formulas for the bakery mixes, 10 percent; (2) ability to control suppliers, 30 percent; and (3) knowledge of the business and doughnut market, 5 percent. However, only the impact of the third factor, which petitioner determined would reduce a buyer's net income by only 5 percent, would presumably be attributable to the covenant not to compete, as the supplier contracts and trade secrets were assets sold to Duskin. class of gross income "if it is incurred as a result of, or incident to, an activity or in connection with property from which such class of gross income is derived." Accordingly, we hold that a pro rata portion of the selling expenses must be allocated to petitioner's sale of the covenant not to compete. An appropriate order will be issued. ESTATE OF MARY K. WETHERINGTON, DECEASED, MARY LOUISE RIPPLE, PERSONAL REPRESENTATIVE, PETITIONER v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT Docket No. 19235-94. Filed February 10, 1997. R extended the time for P to pay estate tax under sec. Debra K. Smietanski, for petitioner. OPINION COLVIN, Judge: This matter is before the Court on petitioner's motion to stay proceedings. In the motion, petitioner asks the Court to postpone entry of decision until either: (1) An extension of time to pay petitioner's Federal estate tax under section 6161(a) is no longer in effect and any appeal of respondent's denial of an extension is final, or (2) petitioner fully pays its outstanding Federal tax liability and related interest, whichever happens first. The parties agree that, if we grant the motion, petitioner may deduct interest that it would not be allowed to deduct if we had entered a decision. Sec. 6512(a). We conclude that it is appropriate to delay entry of decision until an extension of time for the payment of petitioner's estate tax under section 6161 is no longer in effect and any administrative appeal of respondent's denial of such an extension is final, or until petitioner fully pays its Federal tax liability and related interest, whichever occurs first. This is a case of first impression. However, in a related context, we delayed entry of decision where the taxpayer elected to defer payment of estate tax for 10 years under section 6166. Estate of Bailly v. Commissioner, 81 T.C. 949 (1983). Section references are to the Internal Revenue Code as amended. Rule references are to the Tax Court Rules of Practice and Procedure. Background Mary K. Wetherington (decedent) died on April 8, 1990. Her estate consisted almost exclusively of agricultural real property in Hillsborough County, Florida. Petitioner filed decedent's estate tax return on September 9, 1991. Petitioner paid Federal estate tax of $61,000 on April 2, 1991, and $97,793.77 on August 18, 1992. On March 3, 1995, petitioner sold part of decedent's real property. Petitioner paid estate taxes of $498,321.93 on March 6, 1995. Under section 6161(a)(1), the Secretary may extend the time in which a taxpayer must pay estate tax for up to 12 months. Under section 6161(a)(2), the Secretary may grant an extension, for reasonable cause, up to 10 years from the due date of the return. Respondent extended the time for petitioner to pay estate tax under section 6161(a) for 1 year, and possibly for a second year, because petitioner's assets were not liquid, and petitioner could not pay the balance due. Petitioner applied for a further extension under section 6161(a), which is pending as of December 18, 1996. Respondent determined a deficiency in estate tax. Petitioner filed a petition to contest that determination. The parties have settled all issues in this case (except those in the motion before us). Petitioner had no deficiency or overpayment. Petitioner owed $98,707.93 of the tax shown on the return plus interest of $292,878.72 when petitioner filed this motion. Discussion A. Background 1. Sections 6161 and 6166 A taxpayer generally may deduct interest on unpaid Federal and State estate taxes from the gross estate as an expense of administration. Sec. 2053(a). Interest may accrue on unpaid estate taxes because the estate has an extension of time to pay tax under section 6166 or section 6161(a). An executor may elect to pay estate tax in 10 equal installments, starting at the end of a 5-year period during which only interest is payable, if a closely held business constitutes more than 35 percent of the adjusted gross estate. Sec. 6166(a)(1). Petitioner did not make an election under section 6166. The Secretary may extend the time in which a taxpayer is required to pay estate tax (up to 12 months) if there is reasonable cause under section 6161(a)(1) and the accompanying regulations.1 Under section 6161(a)(2), the Secretary may grant an extension, for reasonable cause, up to 10 years from the due date of the return. Interest which arises because the Secretary permitted a deferred payment of Federal estate tax under section 6161(a) is deductible from the gross estate as an administrative expense under section 2053(a)(2). Estate of Bahr v. Commissioner, 68 T.C. 74, 83 (1977) (Court reviewed). 1 Sec. 6161(a) provides: SEC. 6161. EXTENSION OF TIME FOR PAYING TAX. (a) AMOUNT DETERMINED BY TAXPAYER ON RETURN. (1) GENERAL RULE.-The Secretary, except as otherwise provided in this title, may extend the time for payment of the amount of the tax shown or required to be shown, on any return or declaration required under authority of this title (or any installment thereof), for a reasonable period not to exceed 6 months (12 months in the case of estate tax) from the date fixed for payment thereof. Such extension may exceed 6 months in the case of a taxpayer who is abroad. (2) ESTATE TAX.-The Secretary may, for reasonable cause, extend the time for payment of(A) any part of the amount determined by the executor as the tax imposed by chapter 11, or (B) any part of any installment under section 6166 (including any part of a deficiency prorated to any installment under such section), for a reasonable period not in excess of 10 years from the date prescribed by section 6151(a) for payment of the tax (or, in the case of an amount referred to in subparagraph (B), if later, not beyond the date which is 12 months after the due date for the last installment). |