Category: Sales & Exchanges
Subject: Installment Sale
Title: Annuity Contract as Payment in Year of Sale
IRC Sections: 453
Filename: 1287.html
Date Produced: 11/95 Copyright 1998, The Tax Resource Group. All rights reserved. Telephone
800-578-3498. Internet: www.taxresourcegroup.com Background
Individual taxpayer (TP) and spouse own 100% of the stock of Corporation
X. The stock will be sold in exchange for cash and an annuity contract issued
by a third party insurance company. TP intends to report the gain from the
sale under the installment method. Issue
For installment reporting purposes, is the annuity contract viewed as a
payment when received or as amounts are paid out under the annuity contract? Answer
The entire annuity contract is viewed as immediate payment for purposes
of installment reporting. Discussion
Installment reporting works because receipt of the buyer's "evidence
of indebtedness" (in other words the buyer's note) does not constitute
a payment for purposes of the installment sale rules. Temp. Reg. Sec. 15A.453-1(b)(3)(i).
There is no such special rule for an evidence of indebtedness issued by
a third party; accordingly, if the seller receives a promise to pay issued
by someone other than the buyer, that promise is treated as a payment for
purposes of the installment sale rules. It seems to me that an annuity contract is nothing more than a promise
to pay. Since in this case the contract will be issued by someone other
than the seller, i.e., an insurance company, receipt of the annuity contract
will be deemed an immediate payment. Alternatives
The buyer is motivated by the need to secure the seller's promise to pay.
The following alternatives present themselves. 1. It would be acceptable under the installment reporting rules for the
seller to receive a note from the buyer subject to a guaranty arrangement
or a standby letter of credit meeting certain requirements. As a practical
matter, it seems to me that the letter of credit would be the most readily
available alternative. The seller should consult an attorney as to whether
this would be advisable from a legal point of view. If the seller is interested
and the buyer is willing to go along, the letter of credit must meet the
requirements as set forth in Temp. Regulation Section 15A.453-1(b)(3)(iii)
as set forth below.
The term "standby letter of credit" means a non-negotiable,
nontransferable (except together with the evidence of indebtedness which
it secures) letter of credit, issued by a bank or other financial institution,
which serves as a guarantee of the evidence of indebtedness which is secured
by the letter of credit. Whether or not the letter of credit explicitly
states it is non-negotiable and nontransferable, it will be treated as non-negotiable
and nontransferable if applicable local law so provides. The mere right
of the secured party (under applicable local law) to transfer the proceeds
of a letter of credit shall be disregarded in determining whether the instrument
qualifies as a standby letter of credit. A letter of credit is not a standby
letter of credit if it may be drawn upon in the absence of default in payment
of the underlying evidence of indebtedness. 2. The seller's obligation could be secured by a mortgage on some valuable
property owned by the buyer (other than cash or its equivalent). It is very
common for an installment obligation to be secured by some asset owned by
the buyer. The questions are as follows. A) What would give the seller sufficient comfort? B) What is the buyer willing and able to do? Again, the buyer needs legal advice as to the advisability of this option. | 
