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New Tax Law Restricts Installment Sales Method by Accrual Basis Taxpayers
Although 1999 has not been a landmark year for tax changes, President Clinton did sign the Ticket To Work and Work Incentive Act of 1999. The act has several provisions that may affect your future tax liability.

The most significant provision is Internal Revenue Code Section 536(a) which disallows installment sale reporting by accrual method taxpayers. The installment sale reporting was an advantageous tax technique, which allowed for the gain on a sale of an asset to be deferred. The gain was deferred if the asset was sold by taking on a note. A proportionate amount of gain was recognized annually when the note payments were received. The new provision requires that the entire gain and tax liability be recognized in the year the event took place. The change creates a burden for taxpayers since many times the buyer will not purchase an asset outright with cash, and the income tax liability of the resulting sale will exceed the cash, which the seller initially receives.

To alleviate the hardship, a sale of assets should be structured so the seller receives a large percentage of the sale proceeds in the year of the sale. When such a sale contract is not feasible, there are resources to help taxpayers cope with large tax liabilities. The seller can use the installment note to secure and to obtain a loan from a third-party. The loan can equal a substantial percentage of the installment obligation that has to be taken back from the buyer. The seller should borrow only the amount that exists as a deficiency between the current year tax liability and installment amount received. Generally the interest paid to the third party lender will be a tax deduction on the sellers tax return. To expedite a third party loan, it may be beneficial to require the buyer to obtain a letter of credit or have the buyerís payments on the installment note paid directly to the third party lender.

Another way to avoid limitations of the new provision is for a cash basis owner of a business to sell the stock of the business rather than the assets of the business. Since most individuals report on the cash basis and not the accrual basis, when the taxpayer holds the stock personally the installment method may be available.

However, the sale of stock approach may not be beneficial if the seller plans to continue the operation of the existing business. In addition, the sale of stock is less attractive to a prospective buyer who is interested in obtaining a higher basis in assets purchased. There are certain instances where the new provision does not prohibit installment sales even if the seller is on the accrual basis.

Assets that may be disposed of under the installment sale are, regardless of accounting method, are assets in or produced in the trade or business of farming, and certain timeshares in the ordinary course of business and certain residential lots, (only if the taxpayer (or related person) is not to make any improvements with respect to the lots).

Installment reporting is prohibited in the following instances regardless of the sellers accounting method:

• The sale of personal property by a person who normally sells property of the same type on the installment plan;
• The sale of real property held for sale to customers in the ordinary course of business;
• Any disposition of personal property under a revolving credit plan; Stock or securities traded on an established securities market; or
• To the extent provided in the Internal Revenue Regulations, property other than stock or securities of a kind regularly traded on an established market.
• The above is a brief summary on the rules for installment sale transactions. This section of the Internal Revenue Code is quite complex, if you are planning on disposing of all or a portion of your business assets, please contact your Sheehan & Company tax advisor to assist you in structuring this type of a transaction tax efficiently.