Imputed interest on installment sales

Okay.... I posted this question before, but need some urgent help!

I sold my business and some of the proceeds were put into an escrow account to be available to the purchaser for legal fees in a pending lawsuit against the business; ie, the lawsuit is my problem, not theirs. The funds are held by an investment manager and invested in equities. I pay income tax on the income and get it at the end, if there is any money left in the escrow account at the end.

My lawyer and accountant both say there is imputed interest on the escrow account because there is ALWAYS imputed interest on an escrow account when no actual interest is paid by the buyer to the seller.

When I posted before several people here told me that I was getting a fair market return on my money, and that was equivalent to, so there was no imputed interest. The buyer wasn't getting anything on the money, so why would he pay interest?

My lawyer and accountant say that makes good sense, but good sense doesn't matter. There is ALWAYS imputed interest on an escrow account regardless of whether is it sensible or not; they have never heard of an exception.

So, has anyone heard of an exception? My return is due next Thursday, and I have to go one way or another. Thanks.

Reply to
kevin
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Except for a couple of things. First, the money is yours. It's not a loan. If you put your own money in an escrow account for yourself, there is no imputed interest. There is no tax effect of paying money to yourself.

Second, there is actual interest that you are paying tax on. So no additional interest is necessary.

Exactly.

There may be some facts we're not aware of. But based on the story you've told, your lawyer and accountant are just wrong.

Reply to
Stuart A. Bronstein

But can you cite a code or a case where an escrow account didn't pay either imputed interest or actual interest? They acknowledge this should be an exception, but can't see the IRS treating it as such since there are NO exceptions.

Reply to
kevin

The escrow account is his money. So the investment income and the actual interest are his income. Unless he is on an accrual basis, imputed interest is straw man. So, as usual, I agree with Stu.

The geneal rule is "cash basis taxpayers do not pay imputed anything". The major exception to my limited knowledge is Zero Coupon Bonds. Are you a cash basis taxpayer? That's a very important question because the rules are different for accrual basis taxpayers.

Dick

Reply to
Dick Adams

I agree with Stuart. I think you should be asking YOUR experts to show you the law supporting their position. I think the law they will find will say if you make a loan to another, and you are paid less than FMV interest, there will be imputed interest. That is a far cry from what is occurring in this case. In this case, there is no loan, and thus no interest flowing to the other party to test whether it is FMV interest.

Reply to
Wallace

Then they're lazy or don't think they'll get you to agree to pay enough money for them to do proper research. Send me $7500 and I'll give you the most authoritative answer you could get.

Reply to
Stuart A. Bronstein

snip

Cash basis taxpayers are on the accrual basis, sometimes, when it comes to interest. If interest is not paid at least annually it will be accrued. That is why you pay tax annually on a CD with over a year term.

With imputed interest there may or may not be any actual interest paid. What is imputed may be part of what non-tax law considers to be principal. For example, I sell a lot to Mr. Doe for $100,000. $50,000 to be paid at closing (10/07/2009) and $50,000 to be paid on

12/31/2011. No interest is charged in the contract. IRS considers the $50,000 scheduled to be paid 12/31/2011 to be part interest and part principal at the October 2009 Applicable Federal Rate for short-term loans. I would then accrue part of that interest ratably over the life of the loan and pay tax on it when it accrues.

In this case, if the amount in escrow is restricted in such a way as to make it an installment payment taxable when received, then I could see where imputed interest might be required. With rates as low as they were for most of 2008, I have to wonder how much interest we are really talking about.

But if Kevin has enough control of the escrow that the actual (i.e. not the imputed) interest income it earns is taxable to him in the year the interest is earned, then it would seem that the amount in escrow does not qualify as an installment payment taxable in a later year. Perhaps he does not have an installment sale after all.

There are some expections to imputed interest - short time and diminimis amount.

I think that without the contract and other details, we really cannot advise him. If he does not believe his current accountant and current lawyer, then he needs to consult another local professional who can have access to all the documents and facts. If it is so much money that the amount of imputed interest is bothering him this much, he certainly should be able to afford to pay another professional to look at it.

Drew Edmundson, CPA Cary, NC

Reply to
Drew Edmundson

There is nothing to impute when you are the owner of the funds. You sold your business. You report the sale and any gain based on the total amount received (not an installment sale). You set up an escrow account as a contingency against future legal expenses that you are on the hook for. The escrow account may or may not throw off income. If it has income, you declare it. If it has no income, you declare no income. If you incur legal expenses paid out of the escrow account, you take a business deduction for those expenses.

So, I say to you and your advisors, give me a citation that says you have to impute interest on your own money!

Reply to
Alan

I failed to ask "How much money are we discussing?"

Dick

Reply to
Dick Adams

Ok, I feel sorry for you. Here's a bit. In FRAZEE v. COMMISSIONER OF INTERNAL REVENUE, 98 T.C. 554, 586 (1992) the Tax Court said,

"The rationale behind sections 483 and 1274 is to prevent the use of below-market loans to avoid Federal income taxes in seller- financed transactions."

In your case there are no loans, no current debts. If there is any imputed interest to be paid, it will be the other party who will get paid by you later. Because of the delay in his getting paid, part of what you pay him may be imputed interest, for which you should get a deduction.

Then the Tax Court determined that there was no imputed interest in MARSH v. COMMISSIONER OF INTERNAL REVENUE, 73 T.C. 317, 328 (1979), saying,

"Here there is no gain resulting from an exchange of property, payment of indebtedness, relief from liability, or other profit realized from the completion of a transaction, to paraphrase from Helvering v. Bruun, 309 U.S. 461 (1940)."

And see Rev. Rul. 70-120, 1970-1 C.B. 124 where deferred stock payments held in escrow or in reserve were not charged with imputed interest. This actually seems pretty close to your situation in some ways.

Have your lazy or negligent attorney and accountant show you cases where imputed interest was charged on escrow funds that were not for the purchase or sale of something. Section 483 only calls for imputed interest in the case of a sale or exchange.

Reply to
Stuart A. Bronstein

If he's willing to pay my exhorbitant rates to dig up some authority, I don't really care. ;-)

Reply to
Stuart A. Bronstein

It is a substantial amount of money, and will stretch out over 4 or 5 years. So it adds up.

I have no control over the money, except to dispute payments that aren't really related to the lawsuit. That has happened a few times. Otherwise it is just a matter of hanging on until the matter is resolved and getting what is left.

There are no other details. They point to Publication 537 "If an installment sale does not provide for adequate stated interest, part of the stated principal amount of the contract may be recharacterized as interest." My agreement does not provide for any stated interest. They say they have never seen an installment sale in which this principle was not followed, regardless of circumstances. They doubt either the IRS or a court would make me the first exception.

Reply to
kevin

"I have always depended on the kindness of strangers". Geez, am I as needy as Blanche?

Anyhow... The escrow funds are part of the agreement for purchase of my business. I got part in cash and part put into the escrow account. The business is sold regardless of what happens to the escrow account, but it is still FOR the purchase isn't it?

Reply to
kevin

Not any more. The buyer paid the full price so the sale is complete. The escrow is his security for a refund.

Now, if he put the money in escrow, and he retained ownership of it and its interest, then there would be imputed interest because you would have to wait for money he owed you.

But that's not the situation.

Reply to
Stuart A. Bronstein

You put your money into an escrow account. The account receives the interest paid by the bank. That interest is your money, so you pay tax on it (you might prefer to look at it as the bank pays you interest, and the contract says you must deposit that money into the escrow account).

Seth

Reply to
Seth

It took weeks if not months in previous postings to get the information from the OP that the "escrow" account is invested in equity securities, not bank savings accounts. There is no interest, only capital gains or losses.

-Mark Bole

Reply to
Mark Bole

Does that matter? Either way, the buyer is not paying interest.

Reply to
kevin

Not in this case. I suspect Mark's point is that you may not understand exactly what's going on so haven't given us all the relevant facts.

Assuming what you've said is accurate, in this case the money in the escrow account is yours, not the buyer's. The sale is done and over with. You don't pay interest to yourself, or incur imputed interest in your own money sitting in an account.

The only way there would be imputed interest is if the money in escrow still technically belonged to the buyer, and he paid interest on the income going into the account. In that case the delay getting the money to you would mean there would be imputed interest unless he paid you a reasonable amount of interest on the money he owed as a result of the delay.

Reply to
Stuart A. Bronstein

Would private letter rulings be more authoritative? The cost is

$275 - director ruling $625 - if income under 250k $2500 - if income under 1M $10000 - otherwise

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70 using PDF page numbers

Reply to
removeps-groups

My further point is, I think the use of the term "escrow" is misleading here. My layman's understanding of escrow is that some third party assumes a fiduciary duty to preserve deposited sums of money (or software source code, etc.) until both parties agree on how the escrowed items are to be distributed... a two-phase commit, if you will.

In your case, as Stu and others have said, the money is yours, and the other party may not get anything if you lose it all via your equity investments.

I cannot imagine an escrow agent saying, "oops, sorry, I lost all the escrow money in the stock market".

-Mark Bole

Reply to
Mark Bole

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