Application of interest charge for installment sale obligations.

• Author: Kinkaid, Amy I.

As the merger and acquisition business continues to prosper, practitioners should be aware of the tax implications and compliance requirements of the interest charge on deferred tax under Sec. 453A that applies to certain installment sale obligations. Because the Sec. 453A interest charge can be substantial and can add significantly to the cost of a transaction, it should be considered when structuring a business agreement.

Interest Calculation Under Sec. 453A

Sec. 453A(a)(1) imposes an interest charge on nondealer installment obligations where the property's sales price exceeds $150,000 and the total amount of all installment sale obligations that arose during the tax year and were outstanding at the end of the tax year exceed $.5 million. The $5 million threshold is applied and calculated at the partner or shareholder level for all passthrough entities. Under Sec. 453A(b)(2), persons treated as a single employer under Sec. 52(a) or 52(b) are treated as one person for purposes of the $5 million threshold. However, in Technical Advice Memorandum 9853002, the IRS ruled that married individuals are not treated as one person in calculating the $5 million threshold.

The interest charge is assessed in exchange for the taxpayer's right to pay the tax on the installment sale income over a period of time. The interest charge is assessed each year the installment note is outstanding as of the end of the year and the outstanding balance exceeds the threshold amount. The interest charge is calculated on the applicable percentage of the deferred tax liability at the end of each year. The applicable percentage is calculated by dividing the aggregate face amount of all installment sale obligations outstanding at the end of the year in excess of $5 million by the aggregate amount of the installment sale obligations outstanding at the end of the tax year.

The deferred tax liability is calculated on the installment note obligation in excess of $5 million outstanding at the end of the tax year. Sec. 453A(c)(3) defines deferred tax liability as the amount of unrecognized gain on the installment note obligation as of the close of the tax year multiplied by the maximum rate of tax in effect for the taxpayer. The maximum rate of tax depends on the type of income subject to tax and is calculated using the long-term capital gains rate when that rate applies.

Sec. 453A(c)(2) provides that the interest charge is based on the Sec. 6621(a)(2) IRS underpayment rate in...