Repeal of the Installment Method of Accounting for Accrual Basis Taxpayers and the Impact on the Sale of a Partnership Business. Earlier this month, President Clinton signed into a law an extenders bill that provides, among other things, for the extension of certain expiring tax credit provisions. As usual, in order to pay for the cost of the tax benefits contained in the legislation, the bill contains revenue raising provisions. One of such provisions is the repeal of the installment method of accounting for accrual basis taxpayers.
As stated in my editor's column for the January- February issue of the Journal of Passthrough Entities, this provision stinks! Installment reporting, even for accrual basis taxpayers, has been a staple planning technique for as long as this author can remember. In many circumstances, the technique is what allows for the transfer of a business where the buyer is unable to provide the cash to pay the purchase price and, consequently, the seller does not have the cash to pay the tax generated by the sale of the business.
An installment sale is a sale of property where you receive at least one payment after the tax year of the sale. The rules for installment sales do not apply if you. FindLaw; Corporate Counsel; Finance; Congress Prohibits the Use of the Installment Sale Method of Reporting Gain For Accrual Basis Taxpayers. Topic 705 - Installment Sales. An installment sale is a sale of property where you will receive at least one payment after the tax year in which the. Repeal of the Installment Method of Accounting for Accrual Basis Taxpayers and the Impact on the Sale of a Partnership Business. Find out more about this topic, read. Installment sales are a powerful tool in the real estate tax planning arsenal. Michael Gray, CPA explains how installment sales can be used to your advantage.
To raise the revenue needed to extend the research and development credit and other tax breaks, Congress repealed installment-sale reporting for accrual-method. In United States income tax law, an installment sale is generally a 'disposition of property where at least 1 loan payment is to be received after the close of the. Private Letter Ruling No. 2006-48012 (PLR 200648012) Internal Revenue Service (IRS) Private Letter Ruling (PLR) Issue: December 1, 2006. June 7, 2006. What is an 'Installment Sale' A method of sale that allows for partial deferral of any capital gain to future taxation years. Installment sales require the buyer to.
Elimination of installment reporting for accrual basis taxpayers may very well prevent many non- abusive business transactions from being consummated. Sure, there may be circumstances where bank financing is available, but in many transactions it is not. In this author's opinion, Congress should have looked elsewhere for its revenue raising. Installment reporting is not abusive- -in many circumstances it is an economic necessity. Hopefully, Congress will consider the repeal of this provision, so it can be remembered as having a one- year life, much like carryover basis at death had a one- year life in the late 7. However, as of now, the repeal of the installment method of accounting for accrual basis taxpayers is with us.
Installment Sale Method Of Reporting In Teaching
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This month's Partner's Perspective will examine certain, of what likely may be many, issues that may arise in connection with the sale of a business that is operated in the partnership format. Installment Reporting and the Sale of a Partnership Business.
The new legislation does not apply to cash method taxpayers. Therefore, where it is necessary to sell a partnership's business on the installment basis (e. Needless to say, this form of transaction often is resisted by buyers, because of issues relating to undisclosed and contingent liabilities. However, in situations where the owner of a business operated in partnership format is himself on the cash method of accounting (which is generally the case where the owner is an individual), installment method reporting will be available for the sale of partnership interests. One of the traps one will now have to sidestep, however, when attempting to utilize the installment method of reporting is encountered upon the sale of an interest in a single- member LLC. Let's examine one such transaction.
Assume George has been operating a women's clothing store since 1. For liability protection purposes, the store has been operated as a single- member LLC since 1. LLCs should be treated as disregarded entities.
George sells half his LLC interest to Mark on the installment basis at a time when the LLC has the following balance sheet: Basis. Value. Building. Original cost$3,0. Accumulated depreciation( 2,0. Inventory. 60. 0,0. Short- term capital assets. Goodwill and going concern value- 0- 1,5. As of the beginning of the last year of the 2.
George's sale of 5. LLC would have yielded a gain of $2,1. Code Sec. 7. 51 "hot asset") and the remainder would have been long- term capital gain.
Not so fast! First, in Rev. Rul. 9. 9- 5, 1. 99. IRB 8, the IRS ruled that this transaction should be viewed as a sale of an undivided 5. LLC's assets by George and Mark to a newly formed LLC.
As a result, (1) $2. LLC interest would be short- term capital gain with respect to a sale of a 5. Code Sec. 1. 25. 0 capital gains rate. Second, even if the sale of the LLC interest were respected, last August the IRS issued proposed regulations under Code Sec.
Code Sec. 1. 25. 0 capital gains rate if the partnership were to sell all its assets. Note- -It was the position of Congress in the legislative history to the 1. Tax Act that this look- through rule applied to the sale of a partnership interest, even without the issuance of regulations, although many tax professionals might disagree with this conclusion.)Let's now examine the impact on this transaction of the revocation of the installment method of reporting for accrual method taxpayers.
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Prior to the new legislation, the portion of the gain attributable to the inventory was not eligible for installment reporting, but the remaining gain would be so eligible. Note, it may have been possible to allocate any cash received at closing as payment for inventory (to the extent of the value of the inventory) and, consequently, increase the timing benefits of the installment method. See Rev. Rul. 6. 8- 1. CB 1. 95.)After the legislation, a sale of an LLC interest by a cash method taxpayer, such as George, still would be eligible for installment reporting. However, Rev. Rul.
George is not deemed to sell an LLC interest, but is deemed to sell assets. Unfortunately, the assets are being sold by an accrual basis business. And one would expect that the IRS will take the position that, notwithstanding that the LLC is not recognized for federal tax purposes prior to the sale and is deemed to be owned by George directly, George is an accrual basis taxpayer with respect to the LLC's business. Note- -a taxpayer that operates a sole proprietorship having inventory is required to utilize the accrual method of accounting with respect to such business, even though he is likely to be on the cash method with respect to his other income and deductions.)Therefore, if installment reporting is desired, one would have to assert that the IRS's position in Rev.
Rul. 9. 9- 5 is in error and the sale of the membership interest should be respected, or find a method of planning around the IRS's position. The latter approach probably makes more sense. The key is to make sure there is a recognized sale of an LLC interest.
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For example, let's suppose that George decides to do some estate planning prior to the sale of the 5. LLC interest to Mark and transfers a 1% LLC interest to a child or a trust for a child's benefit. Now, a sale of a membership interest to Mark should be regarded as such, and installment reporting should be available (other than with respect to the inventory portion of the LLC interest). Note that a recognized sale of an LLC interest, rather than an asset sale, has other side benefits besides the availability of installment reporting.
Under the asset purchase scenario, because of George's continuing interest in 5. LLC," the IRS takes the position in the proposed regulations under Code Sec. Mark is not eligible for amortization with respect to the goodwill he purchased. On the other hand, if there is a recognized purchase of an LLC interest, Mark's basis in the purchased goodwill would come via a Code Sec.
The second additional benefit of the transaction being characterized as a purchase of an LLC interest is elimination of the applicability of the Code Sec. As discussed in detail in this Partnership Tax Planning and Practice Guide at 6. Sec. 7. 04(c) variation") by means of certain (1) special allocations of depreciation away from the property- contributing partner to the non- property contributing partner and (2) special allocations of gain to the property- contributing partner on an eventual sale of the contributed property to the extent of the remaining Sec.
In the case of George and Mark, these rules would raise their head under the Rev. Rul. 9. 9- 5 depiction of the transaction, because there is a deemed property contribution to a newly formed partnership. In this situation, there would be a Sec. Mark (5. 0% of $1,0. Without discussing the Code Sec. George has contributed a building with a basis of $5.
Mark would expect to be allocated $8. The Code Sec. 7. 04(c) rules would attempt to allocate tax depreciation to Mark equal to his share of book depreciation (i.
However, because there is only $5. Where such a problem exists, the Code Sec. Code Sec. 7. 04(c) variation- -(1) the traditional method; (2) the curative method; and (3) the remedial method. Note- -there may be other acceptable methods; however, the three noted methods are safe harbors under the regulations.)Under the traditional method, no adjustment is made for the ceiling rule problem and Mark is "short" of the depreciation he would expect to be allocated (and could end up being allocated tax gain on sale in excess of economic gain). The curative method requires special allocations of other LLC depreciation deductions (or other deductions or income) to be made to the extent of the ceiling rule problem over the remaining tax life of the contributed property. The remedial method is similar to the curative method in eliminating the ceiling rule problem, but does so over the remaining book life of the contributed property.
The timing differences between the three methods can be substantial. Depending on whose "ox is being gored," it may be necessary to negotiate the Code Sec. For example, if the property- contributing partner does not control tax decisions, it is necessary for such a partner to negotiate the Code Sec. Also note that the IRS takes the position that curative and remedial allocations cannot be made with respect to goodwill. Prop. Reg. ยง1. 1. Accordingly, while Mark would be able to obtain substantial deductions with respect to the portion of the real estate deemed contributed by George (the amount of which would be determined based on the Code Sec. George. (As noted above, the anti- churning rules would also be a bar to goodwill amortization in this case.
However, the anti- churning rules would be inapplicable, if the business had been formed after August 1. The complexity of the Code Sec. In such a case, the purchasing partner obtains his deductions via a Code Sec.