Monetized Installment Sale

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A monetized installment sale is a special type of installment sale whereby a seller of appreciated assets attempts to defer U.S. Federal income tax liability over a period of years while currently receiving cash or other liquid assets via a monetization transaction, such as a loan.

In United States income tax law, an installment sale is generally a "disposition of property where at least 1 loan payment is to be received after the close of the taxable year in which the disposition occurs." The term "installment sale" does not include, however, a "dealer disposition" or, generally, a sale of inventory. The installment method of accounting provides an exception to the general principles of income recognition by allowing a taxpayer to defer the inclusion of income of amounts that are to be received from the disposition of certain types of property until payment in cash or cash equivalents is received. The installment method defers the recognition of income when compared with both the cash and accrual methods of accounting. Under the cash method, the taxpayer would recognize the income when it is received, including the entire sum paid in the form of a negotiable note. The deferral advantages of the installment method are the most pronounced when comparing to the accrual method, under which a taxpayer must recognize income as soon as he or she has a right to the income.

Income tax in the United States form of taxation in the USA

Income taxes in the United States are imposed by the federal, most state, and many local governments. The income taxes are determined by applying a tax rate, which may increase as income increases, to taxable income, which is the total income less allowable deductions. Income is broadly defined. Individuals and corporations are directly taxable, and estates and trusts may be taxable on undistributed income. Partnerships are not taxed, but their partners are taxed on their shares of partnership income. Residents and citizens are taxed on worldwide income, while nonresidents are taxed only on income within the jurisdiction. Several types of credits reduce tax, and some types of credits may exceed tax before credits. An alternative tax applies at the federal and some state levels.

Contents

Pursuant to section 453 of the Internal Revenue Code, installment sale treatment allows a seller to defer recognition of a portion of the gain on the sale of an asset where at least one payment is to be received by the seller after the close of the taxable year in which the sale occurs. In a monetized installment sale, the seller defers recognition of tax on the installment sale payments while 'monetizing' the installment note via a separate, tax free borrowing.

The Internal Revenue Code (IRC), formally the Internal Revenue Code of 1986, is the domestic portion of federal statutory tax law in the United States, published in various volumes of the United States Statutes at Large, and separately as Title 26 of the United States Code (USC). It is organized topically, into subtitles and sections, covering income tax, payroll taxes, estate taxes, gift taxes, and excise taxes; as well as procedure and administration. Its implementing agency is the Internal Revenue Service.

Although the tax is deferred until the receipt of payment under the installment contract, an interest charge is imposed on installment sales above $5,000,000, except in the case of agricultural assets, which has no limitation. [1]

Used by public companies

Because of the lack of limitation on agricultural assets, installment sales generally, and monetized installment sales in particular, have been popular among public companies selling their timberland assets.

Notable[ citation needed ] monetized installment sales that public companies have reported from 1999 to the present have included:

1. The $43.25 Million Monetized Installment Sale by GREIF, Inc. [2]

2. The $617 Million Monetized Installment Sale by Kimberly Clark. [3]

3. The $350 Million Monetized Installment Sale by Plum Creek. [4]

4. The $1.47 Billion Monetized Installment Sale by OfficeMax. [5]

These transactions typically are structured with the help of an advisor in connection with the imminent sale of the appreciated asset. Among public companies, the closing of the transaction has been contingent upon the company's receipt of a private ruling from the Internal Revenue Service (IRS). [6]

Internal Revenue Service review

The Internal Revenue Service's (IRS's) analysis in the above referenced memorandum focused on the step transaction doctrine and the substance over form doctrine. The IRS concluded that the transaction was permissible and that the judicial doctrines of substance over form and step transaction did not apply in that case. While the monetization component of the transaction had an unusual interest rate, it concluded:

"Taxpayer needed to sell its Asset and structured the sale in a way that minimized its taxes... Substantively, the steps of the Transaction matched their form: an installment sale coupled with a monetization loan. The Transaction allowed Taxpayer to take advantage of tax deferral on the asset sale, which is a permitted result under I.R.C. §§ 453 and 453A." [6]

Because a monetized installment sale is subject to these standard levels of review, it is important that all components of the transaction (i.e. the installment sale and the subsequent loan) be structured in accordance standard commercial documentation and terms.

An article on the transaction was published, "Monetizing Installment Sale Transactions," 31 Corporate Taxation 29, in November 2004.

Alternatives

While monetized installment sales are used to defer taxable gain while maintaining near liquidity, a related transaction may be employed to achieve other objectives. For example, a structured sale based on Private Letter Ruling 150850-07 [7] </ref> is common where the seller wants to defer tax but receive a guaranteed income stream from a high quality payer such as an insurance company or other highly rated financial institution.[ citation needed ]

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Revenue recognition

The revenue recognition principle is a cornerstone of accrual accounting together with the matching principle. They both determine the accounting period in which revenues and expenses are recognized. According to the principle, revenues are recognized when they are realized or realizable, and are earned, no matter when cash is received. In cash accounting – in contrast – revenues are recognized when cash is received no matter when goods or services are sold.

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A structured sale is a special type of installment sale pursuant to the Internal Revenue Code. In an installment sale, the seller defers recognition of gain on the sale of a business or real estate to the tax year in which the related sale proceeds are received. In a structured sale, the seller is able to pay U.S. Federal income tax over time while having the seller's right to receive those payments guaranteed by a high credit quality alternate obligor. This obligor assumes the buyer's periodic payment obligation. Transactions can be arranged for amounts as small as $100,000.

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Installment sales method

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<i>Warren Jones Co. v. Commissioner</i>

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References

  1. ↑ "26 CFR 15a.453-1 - Installment method reporting for sales of real property and casual sales of personal property". Law.cornell.edu. Retrieved 13 January 2018.
  2. ↑ "GREIF INC (Form: 8-K)". Investquest.com. Retrieved 13 January 2018.
  3. ↑ "Kimberly Clark Sale" (PDF). Files.shareholder.com. Retrieved 13 January 2018.
  4. ↑ "Plum Creek Sale" (PDF). Investor.weyerhaeuser.com. Retrieved 13 January 2018.
  5. ↑ "Office Depot - Max - Investor Relations -Timber Notes FAQs". Investor.officedepot.com. Retrieved 13 January 2018.
  6. 1 2 "General Counsel Memorandum 20123401f" (PDF). Internal Revenue Service, U.S. July 18, 2012. Retrieved 13 January 2018.
  7. ↑ "Draft letter sample : Number: 200836019" (PDF). Internal Revenue Service, U.S. Retrieved 13 January 2018.
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