n December 1999, legislation repealed the availability of installment-method reporting for accrual-basis taxpayers. (See “Installment Sale Reporting for Accrual-Method Taxpayers—Gone But Not Forgotten?” JofA, Jun.00, page78.) Section 536(a) of the Ticket to Work and Work Incentives Improvement Act of 1999, which enacted IRC section 453(a)(2), repealed use of the method for sales and other dispositions entered into after December 16, 1999. The repeal generated tremendous controversy because it provided that accrual-basis taxpayers had to include in income currently all gain realized (and to be realized) from the disposition of property, even though the taxpayer would receive some (or all) of the sales proceeds in a future tax year.
Fortunately, the overwhelming hue and cry produced results—in late December 2000, President Clinton signed legislation to retroactively reinstate the installment method for certain accrual-basis taxpayers. The Installment Tax Correction Act of 2000 repealed the provisions in the 1999 act.
The 1999 act repealed the installment method for most accrual-basis taxpayers in these words: “[T]he installment method shall not apply to income from an installment sale if such income would be reported under an accrual method of accounting without regard to this section” (IRC section 453(a)(2)). However, the act did not change prior law on the availability of the installment method for dispositions of farm property, timeshares or residential lots.
Nor did the 1999 act change the availability of the installment method for cash-basis taxpayers. That method remained available to cash-basis individuals selling closely held corporate stock, whether or not the corporation itself was a cash- or accrual-method taxpayer. However, the installment method was unavailable if a purchaser sought to make an IRC section 338(h)(10) election to recharacterize the sale of stock by a cash-basis taxpayer into a sale of assets by an accrual-basis corporation.
Further, the act provided that the right to satisfy a loan with an installment obligation was to be treated as a pledge of that obligation, effective for dispositions occurring after December 16, 1999. Under this rule, installment-sale gain would be accelerated as if the installment obligation had been pledged to secure the loan.
Small businesses complained that the repeal of the installment method obligated them to pay 100% of the capital gains taxes on the sale of their businesses in the year of sale even if the payments from the sale were spread out over several years. Congress agreed the 1999 law did more damage than good—it adversely affected more than a quarter of a million small businesses, decreasing their value by as much as 20%.
The 2000 act reversed the 1999 act. Further, it said that the code would be applied as if the respective 1999 act provisions had never existed.
However, the 2000 act did not repeal the pledge rule.
A taxpayer involved in an installment-sale transaction in a year for which a return has not yet been filed could still use the installment method. However, taxpayers who filed returns—with completed transactions and taxes paid—for the year of sale should amend them to claim refunds by restating their gain on dispositions under the installment method. This approach may require additional guidance, which the IRS has yet to provide.
Section 453(d) states the installment method does not apply to any disposition if a taxpayer “elects out.” Temporary regulations section 15A.453-1(d)(3) provides that an election out is deemed made if a taxpayer reports an amount realized on a sale equal to the selling price (including the full face amount of any installment obligation) on the return filed for the tax year in which the installment sale occurs. Once a taxpayer elects out of the installment method, the election is irrevocable, absent IRS consent. Most likely, the service will either ignore this technicality or issue guidance allowing such revocation for all accrual-basis taxpayers originally unable to use the installment method.
—Lesli S. Laffie, JD, LLM