January 2000

New Tax Law Forbids Installment Sales Method by Accrual Basis Taxpayers

The Ticket to Work and Work Incentive Act of 1999 (H.R. 1180), signed by President Clinton on December 17, 1999, includes a provision that denies the use of installment reporting by accrual method taxpayers, effective for transactions on or after December 17. The provision, section 536, disallows installment sales reporting of the sale of an asset by accrual method taxpayers (most businesses and all with inventories), representing a significant trap for CPAs who are unaware of the change in the law.

When a business winds up or sells assets, it may finance the sale as well as defer some of the income by taking back a note. This is particularly true of small businesses, where financing may not be readily available to the purchaser. Prior to the change in the law, the business could defer income and the related tax by reporting the gain in installments, recognizing gain as the note was collected. This resulted in a deferral of the income tax and was consistent with the cash collected from the sale.

The new provision immediately recognizes the gain. This is a potential trap for the CPA who advises an accrual method client on the installment sale of an asset using the old law because there is immediate recognition of gain and tax liability, with deferred receipt of cash with which to pay the tax. Tax liability could easily exceed cash generated from the sale in the first year, severely distressing the business and its owners and possibly resulting in a claim against the CPA.

In winding up a business, cash-method owners can continue installment reporting of the gain when they sell their underlying stock in the corporation rather than have the accrual-method corporation sell the assets. Because the individual owner is on the cash method, this technique is not restricted by the change in the law. This may be more difficult (and less profitable) than selling the underlying business assets when a business is winding up, and it is generally not available when a business is continuing.

In addition to section 536, three other provisions of the act are of interest to CPAs:

* Section 531 raises the estimated tax safe harbor for taxpayers with adjusted gross incomes of more than $150,000 to 108.6 percent of prior year's taxes. (Despite opposition from the AICPA, Congress seems determined to adjust these rates annually depending on revenue needs.)
* Section 501 extends the minimum tax relief for individuals through 2001 by allowing nonrefundable personal credits to offset the minimum tax. This will avoid placing many middle income taxpayers who have education, child, and other personal credits in a minimum tax situation. The AICPA brought this problem to the attention of Congress and recommended such relief.
* Section 502 extends the research credit until June 30, 2004, and includes funding mechanisms to reach congressional budget objectives. The provision states that "research tax credits that are attributable to the period beginning on July 1, 1999, and ending on September 30, 2000, may not be taken into account in determining any amount required to be paid for any purpose.... On or after October 1, 2000, such credits may be taken into account through the filing of an amended return, an application for expedited refund, an adjustment of estimated taxes, or other means that are allowed by the Code." In other words, the credit is available now but would not be paid until later. *