Effect of installment-method repeal on accrual-method S corporations.

• Author: Josephs, Stuart R.

Under new Sec. 453(a)(2), the installment method can no longer be used by accrual-method sellers of property for sales after Dec. 16, 1999, except for sales of farm property and timeshares or residential lots, if a taxpayer elects to pay interest on the deferred tax.

Affected sellers should attempt to finance the buyer's installment note to obtain cash at least equal to the tax on the total gain, which no longer will be deferred.

This new provision will have a particular effect on accrual-method S corporations owned by cash-method shareholders; see Tax Clinic, "Congress Repeals Installment Reporting for Accrual Taxpayers," TTA, March 2000, p. 142. The full gain on asset sales by S corporations, not subject to the corporate built-in gains (BIG) tax, will be currently taxable to the shareholders. The full gain on asset sales subject to the BIG tax will be currently taxable to the corporation. This gain, less the BIG tax (under Sec. 1366(f)(2)), also will be currently taxable to the shareholders.

On the other hand, the installment method will be available to the shareholders if they sell their S stock. If the purchasing corporation alone elects deemed asset sale treatment under Sec. 338(g), the full gain on this deemed asset sale also will be taxable to the old S target on a one-day C return (Temp. Regs. Sec. 1.338-10T(a)(3)). If, instead, both the purchasing corporation and all of the S shareholders (including those who are not selling their S stock), elect deemed asset sale and deemed liquidation treatment under Sec. 338(h)(10), the results described below may apply.

Caution: Under Prop. Regs. Sec. 1.338(h)(10)-1, a new target is deemed the obligor on installment obligations that a purchasing corporation actually issued, and the old target is deemed to receive these obligations from the new target, which were actually received by the old target's shareholders in exchange for their stock. In the deemed liquidation, a selling shareholder who actually received an installment obligation in the stock sale is deemed to receive that obligation as part of his liquidating distribution. The other shareholders are deemed to receive none of the installment obligation.

Effective Jan. 6, 2000, temporary regulations replaced final and Prop. Regs. Sec...