TAC FINAL 10-29-2012
2012 Dilemma: Installment Sale vs. Higher Capital Gains Rates
Unless Congress and the President can agree to change the law beforehand, the
“Bush tax cuts” will expire as scheduled on January 1, 2013. As a result, many
taxpayers will face higher tax rates on income, dividends and capital gains.
Currently, the top capital gains rate is set at 15%. If the Bush tax cuts expire, the top
capital gains rate will jump to 23.8%.1 This presents a dilemma to business owners
seeking to take advantage of existing low rates.
When negotiating the sale of a business, the seller often must agree to defer all or a
portion of the sales price in exchange for a promissory note from the buyer. When
this occurs, the seller may either recognize the gain immediately or defer the tax
associated with any gain realized on the sale until the seller actually receives the
payment, using the installment method of accounting.2 The installment method
requires that a pro-rata share of the total gain realized on the sale be attributed to
each installment payment and the seller recognizes the gain allocated to each
payment when it is received.3
Deferring portions of the tax gain from the sale of a business into later years is
generally a beneficial tax strategy for a seller. But with capital gains rates possibly
rising in 2013, deferring gains into tax years after 2012 could adversely affect that
strategy.4
With all this uncertainty, what should a seller do? Fortunately, the tax code allows a
seller to delay the decision regarding installment sale treatment until 2013. When a
sale qualifies for installment reporting, a seller must use the installment method
unless the seller affirmatively elects not to report on that basis.5 The election out of
installment sale treatment must be made on or before the due date (including
extensions) of the seller’s tax return for the year of sale.6 This election is irrevocable
without consent of the IRS.7
An accrual-basis seller that elects out of installment sale treatment must treat the
full-face amount of the note, except for any portion deemed imputed interest, as a
3.8% of this amount comes from the investment tax under the health care law.
Installment sale treatment does not apply to sales of publicly traded property. I.R.C. § 453(k)(2).
Interest charges apply when the aggregate amount of a seller’s installment sale obligations arising
during a year exceeds $5 million. I.R.C. § 453A(b)(2). The installment method applies to income
from a sale and cannot be used to defer recognition of a loss.
3 I.R.C. § 453(c).
4 Another reason a seller may elect out of installment sale treatment occurs when a seller has large
capital loss carryovers expiring in the near future.
5 I.R.C. § 453(d). In addition, an exception to the installment method may apply when the sale is to
related parties.
6 I.R.C. § 453(d)(2).
7 I.R.C. § 453(d)(3).
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TAC FINAL 10-29-2012
payment received in the year of the sale to determine the gain recognized.8 A cashbasis seller that elects out of installment sale treatment, on the other hand, must
treat the fair market value of the note as a payment received in the year of the sale
when determining gain recognized.9
It is anybody’s guess what the tax rates will be after 2012; they will depend on the
outcome of the elections, the state of the economy, political will and many other
factors. Nevertheless, because of the available option to elect out of installment sale
treatment, the seller of a business in 2012 can wait until the due date (including
extensions) of its 2012 tax return to make that decision. This would allow sellers to
see if Congress adjusts the scheduled increase in the capital gains rates before
deciding the tax treatment of the sale.
8
9
Reg. § 15a.453-1(d)(2)(ii)(A).
Id.