Discussion:Installment Sales over $5 Million

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Discussion Forum Index --> Tax Questions --> Installment Sales over $5 Million

Andyblue (talk|edits) said:

6 January 2007
I have a client that sold stock in a company for $5 Million down plus up to $10 million in future, contingent payments based on certain events occuring. The $10 million is highly contingent and could end up being anywhere from Zero to $10 million. First question is whether in a community property state, since the stock sold was community property, can the $10 million deferred maximum gain come in under the $5 million rule if it is held by the husband and wife? Second, does the $5 million amount determine only the requirement to impute interest on the deferred amount or does it also determine whether the installment sale initially needs to be based on the maximum contingent price? I understand TAM 199853002 has some interesting information on this, but I have been unable to obtain a copy of it. If a valuation has been prepared showing the estimated value of the future contingent payments being $2 million, can the installment sale be reported as showing the FMV as the deferred amount?

Many Thanks


FTF65 (talk|edits) said:

January 6, 2007
The TAM that you cited (TAM 9853002) is relevant. Since I couldn't find a link to it, here it is in brief: the TAM involved a husband and wife that each separately owned stock in an S Corporation. The husband an wife did not live in a community property state and filed separate returns. The S Corporation sold all of its assets to a third-party in exchange for a contingent installment note. Payments under the note were based on a percentage of cash flow but only up to a maximum amount (based on an appraisal of the assets) and only for a period of ten years. At the end of the ten-year period, all payments stopped regardless of whether the maximum was reached. When the husband (taxpayer) filed his separate return, he paid interest on the deferred tax liability based on his share of the installment note (using the contingent maximum amount) in excess of $5 million. In year 5, the taxpayer realized that he was probably not going to collect the maximum amount under the terms of the note so he recomputed the interest on the deferred gain and filed an amended return for year 2 (the earliest open year) to request a refund. This TAM was requested to address two issues: (1) is taxpayer entitled to refund of interest paid under Sec. 453A where such interest is based on a contingent sale price that ultimately will not be received and (2) whether taxpayer and his spouse are considered a single taxpayer for purposes of the $5 million limitation.

If you have an interest with respect to the first issue (which is a question that you did not ask), see this article which covers this aspect of the TAM as well as some of the basic concepts of contingent installment sales: http://www.wtexec.com/tax/usdtax/usdtaxarticles/contcons.html (note: I am not affiliated with this web site in any way).

The second issue is your first question. Based on the TAM, the answer to the question is certainly maybe probably "yes." Although the TAM ruled in favor of the taxpayer, the reason for my ambivalence is that the TAM involves shareholders of an S Corporation in a non-community-property state and separately filing taxpayers, where as your question is specific to directly-owned property in a community-property state and (I'm assuming) joint-filing taxpayers. That being said, the TAM did make some optimistic statements. In addressing the revenue agent's argument that the husband and wife should be treated as a single taxpayer under Sec. 52(a), the TAM disagreed - "...if Congress had intended that married taxpayers be treated as one taxpayer for purposes of applying the $5M limitation...it could have easily provided for this in express terms rather than resort to a strained and unlikely interpretation of sections 52 and 1563." The TAM also notes that there are numerous other provisions in the Code that specifically address the treatment of married taxpayers and that where "Congress is silent on this point, as in section 453A, we do not believe that an allocation between married individuals can be implied." The TAM also cites Sec. 1, which imposes tax on every married individual, as evidence that married taxpayers are treated as separate taxpayers under the Code.

The answer to your second question (assuming I understand it) is "no." The $5M limitation has nothing to do with the determination of a contingent installment sale's face value.

As to your third question - I believe the answer is a tenuous "yes." I believe this primarily because I think that the use of the FMV puts you on par with a taxpayer the chooses to elect out of installment sale treatment (note: if you elect out of the installment method, you have to recognize the FMV of the note). On the other hand, the TAM and other practitioner opinions seem to support the theory that when there is a "stated maximum sales price," this is the amount that should be used for purposes of determining the amount of deferred gain and therefore the interest charge.

I think this is the longest post I have ever made - any longer and I will have to send you an invoice.

Andy@gladvisors.com (talk|edits) said:

7 January 2007
FTF65: I should pay your invoice, thanks for the information and interpretation. I previously found the same article you did, which was the only thing I could find on the net that was helpful. I will get a copy of the TAM, which sounds like what we might hang our hat on. The client has 2 other partner-shareholders, both married couples, so a lot of $ are at stake. I had floated the idea of electing out of installment sale treatment, but if the clients are willing to take the audit risk (or possibly litigate a ground-breaking interpretation) I think we might take the aggressive approach and use the FMV of the contingent payments rather than the stated maximum sales price. If I understand 453A correctly, and the deferred gain after the down payment in Year 1 is less than $10 million, and I can argue that the entire $10 million falls inside of the $5 million exception, the taxpayers would not have to pay the calculated interest on the deferred payments. Thanks again for all of your help.

FTF65 (talk|edits) said:

January 7, 2007
Andy - glad I could help. Assuming that the max price is $10M or less - I don't even think that you need to rely on the FMV of the note to get the answer that you want - but it is a good "back-up" argument. If it were my client, and the note had a maximum selling price of $10M (as in your case), I would be inclined to argue that the husband and wife are each entitled to the $5M for a combined limitation of $10M. I think this is supported by the TAM discussed above as well as the fact that the married couple could "theortically" drop the stock into an LLC, elect to treat the LLC as a partnership for federal tax purposes under Rev. Proc. 2002-69, and then treat the installment note at the partner level as described in Notice 88-81 (note: in the partnership context, the $5M limitation is applied to each partner so, again, the husband and wife would be entitled to a $10M combined limitation).

FYI - I know that, in the past, Tim Doyle (the moderator for the TaxAlmanac) has added documents to the Almanac's research resources when I posted links to source documents that were not already there. You might try contacting him (via this site) and asking if he can add the TAM as well as Notice 88-81, which also isn't there.

Andyblue (talk|edits) said:

8 January 2007
Thanks again. The max price is actually $15 million, $5 million down and a maximum contingency payment (starting no earlier than 2009)of $10 million. I think I still need to rely on the $5 million rule.

FTF65 (talk|edits) said:

January 8, 2007
I didn't say that very well. For the sake of clarity: $15M max price less $5M downpayment = $10M contingent note receivable outstanding as of the end of the tax year (I am assuming that they have no other installment receivables). If H&W are treated as separate taxpayers, the $5M limitation applies to each for a total of $10M so interest charge rule is not applicable.

Andyblue (talk|edits) said:

8 January 2007
Thanks, this has been very helpful

Taximan (talk|edits) said:

7 February 2007
May I add a twist to this conversation? I have a similar situation, and I have determined that my client will save almost $300,000 in taxes by electing out of the installment sale and paying the tax up front. The one major hesitation I have is that a good portion of the sales price is contingent.

The installment rules require that if there is a change in the installment price, any loss is treated in the same fashion as the original transaction. If there was a reduction in the sales price i.e., the contingencies did not work out, will the client be stuck with a capital loss? That is my interpretation, but I have not found much to go on.

Dennis (talk|edits) said:

7 February 2007
Arrowsmith Andrew Mitchell Chart

Taximan (talk|edits) said:

7 February 2007
Thanks Dennis

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