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176. Does an Installment Sale Defer the Tax on Recapture of Accelerated Depreciation? No. Can the Tax on Recapture of Accelerated Depreciation Nevertheless Be Deferred When an Installment Sale Occurs? Yes.
162. Transfer a Family Business to the Next Generation During the Parent's Lifetime, Retain an Asset for Income, Give the Transferee a Stepped-up Basis, Defer the Gain on Sale, Support the Parent with Deductible Rent, and Finance the Transaction, Too
September 2, 2010
I’ve been asked: (1) Can the sole shareholder of a "C" corporation arrange for the sale of the company’s assets, and escape double taxation on the gain? (2) Whether or not that is so, can any or all of the tax be deferred past this year? (3) If it can be deferred, should it be?
My answers, in that order, are "yes", "yes" (except for inventory, to the extent sold at a profit), and "it depends on the seller’s time horizon for spending the principal."
With regard to the double-taxation problem—that is, tax at the corporate level and then again at the shareholder level—the place to start is with IRS Notice 2008-111, which provides a set of four tests for the transaction. The tests are ones a taxpayer wants to fail rather than pass, because if the transaction passes all four tests, the taxpayer is unlikely to escape double-taxation treatment.
The tests are not easy to fail, and that’s the problem. (You’ve heard of "too big to fail." This is "too easy to pass.")
The test which provides some maneuvering room is this one: Is 80% or more of the capital stock of company (by vote or value) sold within 12 months before or after the asset sale?
Properly arranged, the company can sell its assets to an installment sale dealer at approximately book value, and do so with an installment contract. The dealer can re-sell the assets to the ultimate buyer for market value. Then the dealer can purchase 79% or less (by vote and value) of the owner’s stock, and do that with an installment contract, too. More than 12 months later, the dealer can purchase the remaining stock.
Both installment contracts can be collateralized with funds that are held and invested by a financial-services firm or bank selected or approved by the seller, so that, in effect, the gross, pre-tax dollars are invested and producing a return.
If this is your situation, be sure to check with your legal and tax advisers, but my position is that, properly structured, this arrangement can avoid the double-tax problem and defer the tax, as well, for as long as 30 years.
The third question was whether the tax should be deferred. Usually when people ask this, they are thinking of the likelihood of tax-rate increases beginning in 2011. With tax increases coming, they may have been advised to pay the tax now rather than defer it.
I disagree, unless you plan to need to spend the principal within the next two or three years or so. If you have a longer time horizon before needing to spend down the principal, then by all means defer the tax, for two reasons: (1) You can earn money on the tax money in the meantime, and (2) there’s a very good likelihood that future inflation will more than save you the cost of increasing tax rates. That’s because taxes are not adjusted for inflation. When you pay the tax many years into the future, you will pay at the rate that is then applicable, but you can expect to pay the tax with dollars that will be worth far less than the dollar is worth today.
Nearly everyone forgets to think about inflation, but if you have the choice of paying $100,000 in tax today in today’s dollars or paying, say, $33,000 in today’s dollars 30 years from now, which do you choose?—Stan Crow
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The Latest Installment addresses situations, questions and issues which are brought to us in the course of the consideration, negotiation or execution of transactions. We don't use the real names of parties to transactions, and we may edit the statement of the question to try to tell the story better. Please feel free to comment, or to take issue, or to raise your own question or situation. If you do the latter, please do not relate any confidential information.
The Latest Installment blog is edited by Stanley D. Crow, who is president of S.Crow Collateral Corp.