Certified Specialist In Taxation Law

    This law is extremely important for accrual basis sellers of businesses and certain accrual basis sellers of real property who sell their businesses or real property on the installment method of accounting.

    An accrual method taxpayer is generally required to recognize income when all the events have occurred that fix the right to the receipt of the income and the amount of the income can be determined with reasonable accuracy. The installment method of accounting provides an exception to this general principle of income recognition by allowing a taxpayer to defer the recognition of income from the disposition of certain property until payment is received. Sales to customers in the ordinary course of business are not eligible for the installment method, except for sales of property that is used or produced in the trade or business of farming and sales of timeshares and residential lots if an election to pay interest under section 453(l)(2)(B)) is made.

    A pledge rule provides that if an installment obligation is pledged as security for any indebtedness, the net proceeds of such indebtedness are treated as a payment on the obligation, triggering the recognition of income. Actual payments received on the installment obligation subsequent to the receipt of the loan proceeds are not taken into account until such subsequent payments exceed the loan proceeds that were treated as payments. The pledge rule does not apply to sales of property used or produced in the trade or business of farming, to sales of timeshares and residential lots where the taxpayer elects to pay interest under section 453(l)(2)(B), or to dispositions where the sales price does not exceed $150,000.

    An additional rule requires the payment of interest on the deferred tax that is attributable to most large installment sales.

    No provision.

    No provision, but S. 1792, as passed by the Senate, generally prohibits the use of the installment method of accounting for dispositions of property that would otherwise be reported for Federal income tax purposes using an accrual method of accounting and modifies the installment sale pledge rule to provide that entering into any arrangement that gives the taxpayer the right to satisfy an obligation with an installment note will be treated in the same manner as the direct pledge of the installment note.

    Prohibition on the use of the installment method for accrual method dispositions S. 1792 generally prohibits the use of the installment method of accounting for dispositions of property that would otherwise be reported for Federal income tax purposes using an accrual method of accounting. The provision does not change present law regarding the availability of the installment method for dispositions of property used or produced in the trade or business of farming. The provision also does not change present law regarding the availability of the installment method for dispositions of timeshares or residential lots if the taxpayer elects to pay interest under section 453(l).

    The provision does not change the ability of a cash method taxpayer to use the installment method. For example, a cash method individual owns all of the stock of a closely held accrual method corporation. This individual sells his stock for cash, a ten year note, and a percentage of the gross revenues of the company for next ten years. The provision does not change the ability of this individual to use the installment method in reporting the gain on the sale of the stock.

Modifications to the pledge rule

    S. 1792 modifies the pledge rule to provide that entering into any arrangement that gives the taxpayer the right to satisfy an obligation with an installment note will be treated in the same manner as the direct pledge of the installment note. For example, a taxpayer disposes of property for an installment note. The disposition is properly reported using the installment method. The taxpayer only recognizes gain as it receives the deferred payment. However, were the taxpayer to pledge the installment note as security for a loan, it would be required to treat the proceeds of such loan as a payment on the installment note, and recognize the appropriate amount of gain. Under the provision, the taxpayer would also be required to treat the proceeds of a loan as payment on the installment note to the extent the taxpayer had the right to "put" or repay the loan by transferring the installment note to the taxpayer's creditor. Other arrangements that have a similar effect would be treated in the same manner.

    The modification of the pledge rule applies only to installment sales where the pledge rule of present law applies. Accordingly, the provision does not apply to (1) installment method sales made by a dealer in timeshares and residential lots where the taxpayer elects to pay interest under section 453(l)(2)(B), (2) sales of property used or produced in the trade or business of farming, or (3) dispositions where the sales price does not exceed $150,000, since such sales are not subject to the pledge rule under present law.

     Effective date. -- The provision is effective for sales or other dispositions entered into on or after the date of enactment.

    The conference agreement includes the provision in S. 1792.

UPDATE

BILL WOULD REVERSE REPEAL OF INSTALLMENT METHOD FOR ACCRUAL METHOD

The Ticket to Work and Work Incentives Improvement Act of 1999, Pub. L. 106-170, repealed the use of the installment method by accrual method taxpayers on or after December 17, 1999. Thus, an accrual taxpayer wishing to sell a business or an asset must pay tax on the total gains in the first year of the sale, even if the actual proceeds are not received in that year. Small business owners argue that the repeal creates hardships for them by reducing the value of small businesses sold in their entirety. In response to this concern, Rep. Wally Herger (R-Cal.), a member of the House Ways and Means Committee, has cosponsored a bill to undo the repeal. H.R. 3594, titled the Installment Tax Correction Act of 2000, would be effective only for sales and other dispositions occurring on or after the date of enactment.

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For questions or comments regarding this web site Michael D. Daniels

                    Last modified: January 14, 2008