Business deal gone bad

My partner and I sold our business after ten years to a larger company. The deal was both a cash buy out plus a five year employment contract. The employment contract was drawn seperately but still part of the sale non the less. Our salaries were that of our earnings while in business.

After 1 year, the business over-extended itself and filed chapter 11. They closed 3 of the 4 departments, leaving us with 4 years of a five year contract left. Our department was one of the three that they shut down. Although the cash buy out covered all of our inventory and tools, the employment contract was a loss.

We were unable to re-establish our business as all of our employees were scooped up by our competition along with our customer base. My partner and I sought other employment but took losses in our salaries.

The five year employment contract was a major portion of the sale agreement , what, if any tax relief are we eligable for with regard to the remaining four years of our contract?

The tax aspects of losing the last four years of employment under the contract depend on how you structured and reported the sale of the business.

1. If, in determining your gain or loss from the sale of the business, you showed as amount received for the business the amount of cash you received in the transaction, and did not include the value of the employment contract, then there is no deduction allowed for the loss of the employment. In this case, the only tax relief would be that you do not have income to report from the employment.

2. If, however, you included the value of the employment contract in computing the gain or loss from the sale of the business, then the loss of 80% of the contract would decrease the gain or increase the loss by 80% of the value of the contract you had included in the computation of gain or loss.

If “2,” above is the case, then the way you would handle this depends on whether or not you used the installment method of reporting gain from the sale. If you did not use the installment method, then probably the best way to hand this would be to report the loss of contract as a bad debt.