The IRS issued a mixed ruling to a taxpayer involved in a contingent payout sale under the installment sale method. In the ruling, a Subchapter S corporation sold assets. Part of the sales price included future payments contingent on earnings of the buyer.
The installment sale rules provide for deferral of income tax on gains from the sale of property when payments will be made in future years. In calculating gains each year, the seller's basis in the sold asset(s) are allocated to each payment as it is received. However, when, due to contingent payment provisions, the total price cannot be determined but the payment period is fixed, the taxpayer's basis (including selling expenses) is allocated to the tax years in which payments are to be received in equal annual increments. Treas.Regs. §15a.453-1(c)(3)(i).
In the ruling, the taxpayer applied for a special basis allocation that would allow it to apply its basis earlier than provided under the above contingent payment rule. The IRS allowed the revised method.
However, the IRS also indicated that Code Section 453A interest on the contingent payment amount would be imposed. Code Section 453A generally provides that interest is chargeable on tax deferred on the installment method to the extent that the deferred payments exceed $5 million. By charging interest on the contingent payment, the IRS is effectively saying that interest could be payable on payments that may never be received. This seems unfair, and clearly is an unfavorable application of the provision. Further, it is not clear how a taxpayer could even apply this in situations where the amount of the future contingent payment is unknown.