New Tax Law: A Potential Trap For CPAs.

A bill signed by President Clinton in December disallows installment sales reporting of the sale of an asset for taxpayers who are on the accrual method of accounting for federal income tax purposes. Section 536 of HR 1180 is effective for sales or dispositions on or after December 17, 1999.

Because the installment method of accounting is not available for most sales of inventory, this change is most likely to affect business dispositions. For example, a taxpayer selling its assets, may finance the sale by taking back a note from the purchaser. Before the change in the law, a taxpayer could defer at least a portion of the tax by reporting the gain from the sale in installments, recognizing the 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.

Under the new law, the gain will be immediately recognized. This is a potential trap for any CPA who advises an accrual method client on the installment sale of an asset using the old law--there will be immediate recognition of gain and tax liability, with deferred receipt of cash with which to pay the tax. The tax liability from the sale could exceed the cash generated by several times in the first year, severely distressing the business and its owners, and resulting in a claim against the CPA.

When selling a business, cash-method owners can continue to take advantage of installment reporting of the gain if they sell their underlying stock in the business rather than having an accrual-method business sell the assets (cash-method taxpayers are not restricted by the new law). This may be more difficult...