Category: Sales and Exchanges Copyright 1998, The Tax Resource Group. All
rights reserved. Telephone 800-578-3498. Internet: www.taxresourcegroup.com Taxpayer is a member of a three-person LLC.
The other two LLC members are currently buying the taxpayer's membership
interest. The LLC reports income on the cash method of accounting. Prior
to the purchase, the LLC will make a distribution to the taxpayer equal
to his share of LLC profits based on a modified accrual method of accounting.
The taxpayer's share of LLC cash basis accounts receivable is approximately
$76,000. The LLC has no inventory. The LLC has some depreciation recapture
associated with its equipment. The taxpayer will receive $384,000 over a ten-year period in exchange for his membership interest. The taxpayer plans to report the transaction using the installment method. Accounts Receivable It is assumed that under the principles set forth at IRC Section 751, the taxpayer will be treated as having sold his proportionate share of partnership assets. Section 453 prohibits installment reporting for various kinds of assets such as inventory. Section 453 also requires immediate recognition for depreciation recapture items. There is no prohibition or immediate recognition provided in the statute or the related regulations for accounts receivable. The issue in this case is whether the taxpayer can sell accounts receivable on the installment method. There is nothing in the statute or regulations that prohibits selling cash basis accounts receivable on the installment method. There is a case, Sorensen v.Comr., 22 TC 321 (1954), in which a taxpayer attempted to sell compensatory stock options on the installment method. In Sorensen, the court found the options to be compensation for services rendered. As such, it would be inappropriate to allow sale of an asset representing compensation to be treated as capital gain and subject to installment reporting. The court did not provide very much in the way of explanation of its reasoning. I think Sorensen represents an unquantifiable risk in this transaction that a court could require the taxpayer to recognize his share of LLC recievables in the year of sale rather than on the installment method.
1. Bulk-sale of business assets including accounts receivable is qualitatively different from the Sorensen facts; thus, this matter is distinguishable from Sorensen. 2. If Congress had wanted a service-related receivables exception in Section 453, it could (and should) have adopted one. There was a major revision of the installment sale rules in 1980 (after Sorensen was decided), and Congress did not see fit to codify the Sorensen holding. |
