Capital Gains Tax provision signed:
President Clinton signed H.R. 1180 on December 17, thus Section 536, which denies the use of installment reporting by accrual method, is effective as of that date.
As you know, prior to December 17th 1999, a business seller could take back a note and the business could defer tax by reporting the gain as the note was collected. Therefore, any gains on installments can no longer be deferred and will be immediately taxable.
The Tax Relief Extension Act of 1999, H.R. 1180, passed the House of Representatives on November 18, 1999 and the Senate, S. 1792 on November 19, 1999. The President is expected to sign the measure into law. One provision substantially changes the availability of the installment method to accrual taxpayers.
Present Law
An accrual method taxpayer is generally required to recognize
income when all events have occurred that fix the right to receive
income and the amount of income can be determined with reasonable
certainty. The installment method of tax accounting provides
an exception to this rule. The general principle of the installment
method provides for non-recognition of income from the disposition
of income until payments are received. Effectively deferring
the recognition of income from a closed transaction until the
future. Sales to customers in the ordinary course of business
of inventory items are not eligible for the installment method.
Conference Agreement
S. 1792 generally prohibits the use of the installment method
of accounting for dispositions of property that would otherwise
be reported for Federal income tax purposes using the accrual
method of accounting.
To the best of our knowledge, the provision does not change the
ability of cash method taxpayers to use the installment method.
For example, a cash method taxpayer owns all of the stock of
a closely-held accrual method corporation. The taxpayer disposes
of the stock for a combination of
cash, stock in the acquiring corporation and a note payable over
10 years. The provision does not change the ability of this individual
to use the installment method in reporting the gain on the disposition
of the stock.
The provision will most impact those entities which are accrual method sellers of real estate or segments of their business. Under present law, these sellers could elect the installment method for dispositions of eligible property and defer the recognition of income until the payments were received from the buyer. This provision eliminates this election and the gains will be recognized in the year of sale.
Present Law
A pledge rule provides that if an installment obligation is pledged
as security for any indebtedness, the net proceeds (the net proceeds
equal the gross loan proceeds less the direct costs of obtaining
the loan) of such indebtedness are treated as payment on the
obligation, triggering the recognition of income. The pledge
rule does not apply to sales of property used or produced in
the trade or business of farming, to sales of timeshares and
residential lots, pursuant to the election in IRC 453(1)(2)(B),
and where the gross proceeds do not exceed $ 150,000.
The change in the tax law will certainly affect the structure of proposed sales. Brokers should work with tax lawyers and accountants to determine how the law can effect individual deals and what steps, if any, can be taken to reduce taxes.
The International Business Brokers Association (IBBA) is working on keeping it's members updated and educated to better serve buyers and sellers. Seek one out for your transaction guidance.
My personal opinion is that this could greatly affect small businesses that traditionally have sold with seller financing. There may be times when the seller would have sold a business for 10-30% cash to first mortgage. Now, that may not be enough to cover tax indebtedness.
December 19, 2000
It was announced that the previous capitol gains taxes to be paid in installments would be reinstated.
According to Rep. Wally Herger, R-Calif the ruling in some cases reduced the sales price of a business by 20 percent or more of the approximately 260,000 business sales that take place each year.
More importantly, this will be retroactive to December 18, 1999. Great news for sellers of 2000 even though they may have sold at a reduced price.
In my opinion, this will bring business prices back in line to what they were two years ago and encourage owner financing again. Those of you buyers sharp enough to buy last year feeling this would be repealed, can now sell the business at a profit! As a buyer this year, if you've got 30-50% cash down payment, good credit, assets and a personal business plan, an owner should give you serious consideration now.
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