Is this an installment sale?

Accountant is right. Lawyer is wrong. Besides, when you report the total sale in 2009 and do not file Form 6252, you have elected out of an installment sale.

No, I didn't file a 6252, but the lawyer thinks the IRS will demand I treat it as an installment sale anyhow so they can tax the imputed interest.

I would like the accountant to be right, but do you have a code section, a case, or a line of reasoning to support him?

I believe this is probably true, but am interested in a cite.

The OP's situation is extremely common in corporate acquisitions so I a little surprised the lawyer was unfamiliar with it. If the money had not gone into escrow, and the buyer was agreeing to a future contracted payment, then it would be an installment sale.

Steve

What do you mean "imputed interest"? Isn't the excrow account earning real interest?

Seth

Agree with accountant and esteemed colleagues here agreeing with accountant.

An installment sale occurs when more than one payment from the payor are to be received not in same year. In this case, the whole shebang is being received, the amount required to be put into escrow notwithstanding.

ChEAr$, Harlan Lunsford, EA n LA

1. You don't have a contract calling for payment over more than one tax year.
2. You said you received full payment. The escrow account is yours and merely exists for contingencies.
3. A taxpayer elects out of an installment sale by not filing Form 6252 and reporting the total gain on the proper form or schedule.

What I am trying to tell you is that even if your lawyer is right and the accountant and I am wrong, it doesn't matter if you elect out.

The buyer pays in one year, so the seller should recognize the income in the same year.

Technically, I think, the sales price goes to the seller who agrees to put it into a trust pending litigation. As such it is a grantor trust (see IRC §671-679). And as a grantor trust, the seller is taxed on it as if it were all his outright.

Stu

Neither of them think I have to recognize the income this year for what went in the escrow account; they both say that I recognize the money in the escrow account when I actually receive it and have control over it. That is kinda important, as I will probably never get much of it.

The issue is over whether I have to figure imputed interest when I get it (the contract didn't include any interest, since it is my money...) and whether it is proper for me to be paying taxes on the accounts income.

What the lawyer is missing is that there is NO REQUIREMENT that you have an installment sale taxed as such. I know it sounds odd, but you can always elect to have an installment sale taxed completely at the time of sale. In fact, I have several clients who have sold inherited property - which got a step up in basis - on the installment sale and have elected to fully report it in the year of the sale. Since there is NO GAIN associated with the sale, there is no need to report it in subsequent years. Though they do still have to report any interest they receive.

The trap here is what to do should the buyer default and the seller repossess, but that is not the question you asked.

I also am not sure I understand the attorney's issue with imputed interest. Imputed interest should only be an issue when either there is no stated interest rate on the instrument OR the stated interest rate is below the AFR. Frankly, I don't see this as an issue in your case.

I also noted that you have asked for a cite, this could be problematic. It is virtually impossible to prove a negative - for example, You cannot prove that you were not in my office in Annapolis, MD at 10AM this morning? You may be able to prove that you were in police custody in Jamaica at that time, and THAT precludes your being in my office. BUT proving that you weren't here is not possible.

So, instead of asking us or the accountant to prove a negative, get the attorney to prove his positive - have HIM produce the code section (primary authority) or Revenue Ruling, Treasury Regulation, Revenue Procedure, legal case cite or whatever (secondary authority) to support his position.

If you allow everyone who KNOWS something, especially those that know because they recall hearing about a similar incident, to drive your actions, you're asking for trouble in the long run.

If you can't get any where like this, then I would suggest you ask BOTH the attorney and accountant for a written opinion letter. This will put them both on notice that their advice is being relied on, and it will put both parties on the hook if that advice is wrong. You should also be aware that you will likely be expected to pay for these letters.

Good luck, Gene E. Utterback, EA, RFC, ABA

The accountant does not think not think I must pay all the tax now; he thinks that tax isn't owed on the escrow account principle until (or, if) it reverts to me. His reasoning is that I don't have control over it, so I don't have to pay tax on it until I do.

Did you actually sell your business, or just get a deposit from the buyer?

The money in escrow should be earning at least bank account interest, and someone has to report that income....

Constructive receipt? From Pub 538:

"Income

"Under the cash method, you include in your gross income all items of income you actually or constructively receive during the tax year. If you receive property and services, you must include their fair market value (FMV) in income.

"Constructive receipt. Income is constructively received when an amount is credited to your account or made available to you without restriction. You need not have possession of it. If you authorize someone to be your agent and receive income for you, you are considered to have received it when your agent receives it. Income is not constructively received if your control of its receipt is subject to substantial restrictions or limitations. "

-Mark Bole

I actually sold it. I have no interest in the business now.

The contract provides that I pay tax on the income on the account.

My accountant contends that I don't have constructive receipt since I have no control over the money. It is being used by the purchaser to pay expenses associated with the lawsuit. (My only control is to take it to arbitration if he uses the funds for something other than the lawsuit) I only have to pay taxes on whatever is left when the escrow account liquidates.

My lawyer agrees with that. However he says that eventhough the contract is clearly not an installment sale, the IRS will claim it is anyhow and tax me on imputed interest. He recommends that I simply treat as an installment contract to avoid problems; my accountant says it isn't an installment sale and I can't call it one even if I wanted to because the amount I will ultimately receive is unknown.

I don't understand where imputed interest comes in to play. It's not a gift, it's not a no-interest loan. It's your money, and you will be paying tax on the actual interest. Where is the imputed interest?

You just don't have the right to take control over the principal at the moment.

Stu

When the amount ultimately to be received is unknown, you recognize no gain until you have recovered basis.

I agree with Stu's comments on the recognition of interest.

Anyway, here is one answer specific to your situation that I found in a textbook on installment sales:

It sounds to me like you have a "substantial restriction" and based on this, I would agree that you have an installment sale with unstated (imputed) interest that you will need to claim when you eventually get the some money out of escrow. But it would only apply the money you actually get, not the money forfeited from escrow to pay off the lawsuit.

-Mark Bole

If it is an installment sale, then there is imputed interest; since no interest was mentioned in the contract, the IRS would imput one. But if it is not an installment sale, then there would be no imputed interest; I would simply get my money at the end and pay capital gains on it. So, I think (hope) we all agree that no gain is recognized until the end, but there is a difference of opinion here (as well as between my accountant and lawyer) over whether it is an installment sale.

Mark... Four differences between the example you gave and my situation is that the contract states that the company paid me the money and deposited it on my behalf into the escrow account, and the contract has me paying taxes on income on the escrow account (since it is my money), the contract has the company paying income tax on money taken out of the escrow account to pay legal expenses (since it is my money paid to them, but they also get a tax deduction for their expenses, so it is a wash), and the company can never under any circumstances get the money back (it goes either to legal fees or to me, while your example the company gets the money back if the seller doesn't get it).

My accountant says these prove it is not an installment sale, my lawyer says these are trivial differences.

There's only imputed interest if there is insufficient real interest.

You are receiving actual interest, that you will recognize for tax purposes. There is no imputed interest because no one is getting the use of the money for less than reasonable interest.

But that's why it's an installment sale - you don't actually get all the money at once. Installment sales only require imputed interest when there is no actual interest. And you are getting actual interest.

If you don't recognize income until you actually receive the money, it is by definition an installment sale.

If the company deducted the money when they put it in trust for you, it's an installment sale if you don't get it all now. But there is no imputed interest.

Stu

OK, my apologies as it appears that I missed something in the OP.

Here's what I think you're saying - please let me know if I'm wrong since my answer is dependent on what I perceive the situation to be.

You sold something that has a legal action pending. A condition of that sale is that you have to leave an amount in escrow to cover future legal claims. You are claiming the interest earned on the money in that escrow account, BUT you cannot directly access the principal in the escrow account until a future date. Presumably when the case settles.

I would agree that you do not have constructive receipt, nor do you have an installment sale.

I'd also opine that since the money can be used to settle future obligations that you MAY have expenses in the future, if claims are actually paid.

Off the cuff, with the caveat that if you were my client I would have to do the research on this before I could give you a solid opinion, I think you may have several options -

You may be able to claim the money as income now and deduct any claims in the future as expenses - OR

You may be able to book the money as a contingent liability, perhaps deferred income, to report it as income later, when received, and claiming any related expenses against it. This might work similarly to an attorney's retainer account. Attorney's frequently collect retainer money from clients, park it in a separate account, have limited control over it, can move it to their operating account as it is earned, and pay tax on it as they access it.

I'm not sure either option is totally appropriate to your situation since I don't have all the details of your particular situation.

I've gone back and read your original post and I don't see any mention of how much gain is involved here. If the gain is small I'd be tempted to just report the sale as complete now and be done with it. If the gain is large I'd be tempted to defer income until such time as I actually receive it. THEN I'd be certain to book the income as well as any related payments in settlement of the suit.

Again, without being properly engaged (read that paid) and doing the research neither I nor anyone else on the board can give you a definitive answer.

Best of luck, Gene E. Utterback, EA, RFC, ABA

And apparently, even the attorney and accountant he *does* pay can't give him a definitive answer either!

-Mark Bole