The prospect of a tax cut in 2017 under a new president and Congress is one more reason why business owners who are considering selling their company may want to defer receipt of the proceeds until January of 2017. Taxpayers selling other qualifying assets may want to do this as well.
Under proposed tax cuts envisioned by a new Republican-controlled administration, the possibility of a significant reduction in capital gains tax rates is highly probable. If capital gains rates are reduced, it would be an even greater incentive to use a deferred payment strategy such as an installment sale. In fact, for sales that involve the receipt of payments in more than one tax year, installment sale treatment is required unless a taxpayer opts out of such treatment.
Many business owners will structure sales of their companies using an installment sale strategy in which payments of the purchase price are deferred, resulting in a corresponding delay in capital gains taxes due. Sometimes there are future contingent or escrowed payments that exist in the sales contract that create an installment sale opportunity. The sale must be structured so that it occurs in one tax year, while payment occurs in at least one other tax year. (For example, a sale on Dec. 28, 2016, followed by full payment on Jan. 3, 2017, is an installment sale).
Capital gains taxes are deferred until the tax year in which each payment is made toward the underlying obligation. It’s important to note that there may be some income from the sale that must be taxed in the year of sale, regardless of whether any cash is actually received. (This would include ordinary gain on the recapture of prior depreciation taken on business assets).
Some other caveats:
- The buyer’s debt cannot be payable on demand or available for trade on an established securities market.
- The buyer’s debt cannot be secured directly or indirectly by cash or a cash equivalent, examples of which would be a Treasury note or a certificate of deposit.
- Certain types of property are not eligible for the installment method, including most sales of property by a dealer or sales of securities on an established market.
- If the total installment obligations of a taxpayer exceed $5 million in a given tax year, the taxpayer will have to pay interest on the taxes deferred related to the portion of the installment obligations exceeding $5 million. Given today’s low interest rate environment, this should not deter one from utilizing an installment sale if possible.
There are business and financial risks relating to installment sales that you should not ignore.
One obvious risk of an installment sale is that the buyer will not be able to make the payments, perhaps due to a lack of success in running the acquired company. You need to feel comfortable that you will be paid, even if the payment is only a week after the sale. Sometimes buyers do not want to deal with the hassle of creating extra agreements to acquire the business/asset, but if you’re in the process of selling your business or other qualifying asset before year’s end and have comfort that you will be paid after closing, you may want to consider structuring the transaction to receive the funds in early January.
For more help with making tax decisions, download and review one of these tax planning guides.
Any accounting, business, financial, legal or tax advice contained in this communication, including attachments and enclosures, is not intended as a thorough, in-depth analysis of specific issues or as a substitute for a formal opinion, nor is it sufficient to avoid tax-related penalties. There are complex considerations involved with all tax strategies. Sellers are advised to consult with their legal and tax advisors before entering into any agreement.