Dream Until the Dream Come True?[i]

Ask the owner of a closely held business to describe their most recently recurring nightmare and you are likely to get an earful regarding the prospect of an increased federal income tax on their profits, an increased federal tax on the long-term capital gain from the sale of their business, the imposition of a federal mark-to-market tax on the gain accrued in their business at the time of their death, and the imposition of a federal estate tax determined on the basis of a greatly reduced exclusion amount.[ii]

Basically, the worst parts of Mr. Biden’s tax proposals, as set forth in his American Families Plan.[iii]

Ask the same business owner to describe their fondest dream –  no, not that one –  and they may describe a scenario in which they sell their business for cash but, at the same time, are able to defer the recognition of the gain for many years.[iv]

Too Good to be True?

“Can such a dream ever become a reality?” they ask. “Is there a way for me to receive cash for the full value for my business today, have immediate and unfettered use of the cash, yet legitimately defer recognition of the gain from the sale, and payment of the tax?”

It would not be the first time that a business owner will have made this inquiry of their tax advisor. In fact, over just the last few months, I have fielded variations of this question from several taxpayers who are considering the sale of all or a part of their business.

During some of these conversations, the owner informed me that a “friend” of theirs had successfully implemented a strategy to achieve this result; moreover, according to this friend, the IRS has ruled “favorably” on the strategy.

When pressed for more details regarding the form of transaction utilized, the owner described a sale that generally falls under the category of “monetized installment sales.”

Monetized Installment Sale

Although there are variations of this so-called “strategy,” they have some common features, which are illustrated in the following four-party structure:

  • Seller wants to sell Property to Buyer, immediately receive cash in an amount equal to Property’s fair market value and defer the recognition of any gain realized from the sale under the installment method.[v]
  • Seller sells Property to Intermediary[vi] – the “promoter”  of the transaction – in exchange for Intermediary’s unsecured installment obligation in an amount equal to Property’s fair market value; the installment obligation provides for interest only over a fairly long term, followed by a balloon payment of principal, at which point the Seller’s gain from the sale would be recognized.
  • Intermediary immediately sells Property to Buyer for cash;[vii] because of its cost basis for Property, Intermediary does not realize gain on this sale; the cash is held in escrow until Intermediary’s installment obligation to Seller comes due.
  • Seller obtains a loan from Lender, the terms of which “match” the terms of Intermediary’s installment obligation held by Seller; Seller does not pledge Intermediary’s installment obligation as security for the loan;[viii] escrow accounts are established to which Intermediary will make interest payments, and from which the interest owed by Seller will be automatically remitted to Lender.
  • Seller has the non-taxable loan proceeds which they may use currently; Seller will typically invest the proceeds in another business or investment, at least initially, to demonstrate a “business purpose” (purportedly) for the loan.[ix]
  • Seller will report gain on the sale of Property only as Intermediary makes payments to Seller under its installment obligation; in the case of a balloon payment, the gain will be reported and taxed when the obligation matures.
  • Seller will use the payment(s) to repay the loan from Lender.


Although this self-proclaimed tax-deferring strategy has been with us for several years now, it gained momentum – at least in some circles – following the issuance in 2012 of certain internal legal advice by the IRS Office of Chief Counsel (“OCC”).[x] The Field Attorney Advice (“ FAA” ) in question, which is non-precedential, considered the application of the “substance over form” and “step transaction”  doctrines to a fact pattern that included some of the elements described above. That said, it did not address key components of the monetized installment sale transaction.

The taxpayer was a business entity that decided to sell a portion of its assets to raise cash for a bona fide business purpose. The buyer gave the taxpayer installment notes, supported by standby letters of credit, that were nonnegotiable and could only be drawn upon in the event of default. The taxpayer then borrowed money from a lender in an amount less than the buyer’s installment notes and pledged the buyer’s notes as security. Under the anti-pledge rule, described below, this would have triggered immediate recognition of the gain from the sale but for the fact that the assets sold were farm assets, which are exempt from this rule.

The OCC acknowledged that, in form, the transaction comprised an installment sale and a loan that monetized the installment obligation. The question presented to the OCC was whether the substance of the transaction was essentially a sale for cash because, shortly after the asset sale, the taxpayer obtained the amount of the sale price in cash, through the loan proceeds, all while deferring the recognition of gain and the payment of the resulting tax.

The OCC concluded that the asset sale was a real transaction carried out to raise cash for the taxpayer. The letter of credit provided security for the taxpayer in the event the buyer defaulted on its installment obligation. The monetization loan was negotiated with a different lender than the one that issued the letter of credit. The economic interests of the parties to both transactions changed because of the transactions. The transactions reflected arm’s-length, commercial terms, each transaction had independent economic significance, and the parties treated the transactions separately, as an installment sale and a monetization loan. Thus, the substance over form and step transaction doctrines were inapplicable.

Not to be deterred by the differences between the facts and circumstances of the FAA and those of the above-described four-party structure, several promoters have represented the FAA to taxpayers as an endorsement by the IRS of the monetized installment sale.[xi]

Something is Rotten

As often occurs with “too good to be true” strategies, the sponsors thereof often draw attention to themselves through somewhat aggressive marketing. That has certainly been the case for monetized installment sales, which have drawn the attention of the IRS.

Thus, in 2017, as part of its investigation into whether a prominent promoter of such transactions should be “liable for civil penalties . . . for promoting abusive tax schemes,” the IRS issued a third party summons, which the promoter then sought to quash, contending that “the IRS is not really investigating [the promoter], but rather is using the investigation as a pretext to obtain the identities of persons or entities who are parties to [the promoter’ s] transactions so that the IRS can investigate them.”[xii]

The Court rejected the promoter’s petition to quash the IRS summons, and granted the IRS’s motion to enforce the summons. In reaching its decision, however, the Court pointed out that it was not opining on the legality or tax treatment of the transactions.[xiii]

Pew, It Stinks

At this point, the status of the IRS’s investigation of the above-referenced promoter is unclear.[xiv] Last week, however, the OCC released a Chief Counsel Advice memorandum (“CCA”)[xv] which was prepared in late 2019 in response to a request from within the IRS for an analysis regarding monetized installment sale transactions.

To better understand the CCA’s analysis, it may be helpful to briefly review the installment sale rules.

Installment Sales

Congress recognized long ago that it may not be appropriate to tax the entire gain realized by a seller in the taxable year of the sale when the seller has not received the entire purchase price for the property sold; specifically, where the seller is to receive a payment from the buyer in a taxable year subsequent to the year of the sale, whether under the terms of the purchase and sale agreement,[xvi] or pursuant to a promissory note given by the buyer to the seller in full or partial payment of the purchase price.[xvii]

In cases where the payment of the purchase price is thus delayed, the seller has not completed the conversion of their property to cash or a cash equivalent; rather than having the economic certainty of cash in their pocket, the seller has, instead, assumed the economic risk that the remaining balance of the sale price may not be received. It is this economic principle that underlies the installment method of reporting.[xviii]

A sale of property where at least one payment is to be received after the close of the taxable year in which the sale occurs is known as an “installment sale.”[xix] For tax purposes, the gain from such a sale is reported by the seller using the installment method.[xx]

Under the installment method, the amount of any payment which is treated as income to the seller for a taxable year is that portion (or fraction) of the installment payment received in that year which the gross profit from the sale (basically, the gain realized) bears to the total contract price.

Stated differently, each payment received by a seller is treated in part as a return of their adjusted basis for the property sold, and in part as gain from the sale of the property.


The seller’s gain from a sale that is reported under the installment method is recognized upon the seller’s receipt of payment; thus, one must be able to identify when such a payment has been received.

For purposes of the installment method, the term “payment” includes the actual or constructive receipt of money by the seller.[xxi] In this instance, the seller has converted their interest in the property sold to cash.[xxii]

Receipt of a promissory note or other evidence of indebtedness which is secured directly or indirectly by cash or a cash equivalent will be treated as the receipt of payment of the amount specified in the evidence of indebtedness. In this instance, there is no credit risk associated with holding the buyer’s note and awaiting the scheduled payment of principal.

However, a payment does not include the receipt of the buyer’ s promissory note –  an “installment obligation”[xxiii] – that is payable at one or more specified times in the future, whether or not payment of such indebtedness is guaranteed by a third party, and whether or not it is secured by property other than cash or a cash equivalent.[xxiv]

In the case of such a note, the seller remains at economic risk until the note is satisfied. Thus, that portion of the seller’s gain that is represented by the note will generally be taxed only as principal payments are received.

It goes without saying that sellers will usually welcome the deferral of gain recognition and taxation that the installment sale provides. At the same time, however, sellers have sought to find a way by which they can currently enjoy – by eliminating the credit risk of non-payment – the as-yet-unpaid cash proceeds from the sale of their property without losing the tax deferral benefit.


Previously, sellers sought to borrow money by using the buyer’s installment obligation as collateral for the loan. In this way, the seller was able to immediately access funds in an amount equal to the proceeds from the sale of their property, while continuing to report the gain from the sale under the installment method as the buyer made payments on the installment obligation; the loan that was secured by the installment obligation would be repaid as the installment obligation itself was satisfied.

In response, Congress amended the installment sale rules[xxv] to provide that if any indebtedness is secured by an installment obligation, the net proceeds of the secured indebtedness will be treated as a payment received on the installment obligation as of the later of the time (a) the indebtedness becomes “secured indebtedness,” or (b) the proceeds of such indebtedness are received by the seller.[xxvi]

For purposes of this rule, a seller’s indebtedness is secured by an installment obligation to the extent that payment on such indebtedness is secured by an interest in the installment obligation. A payment owing to the lender will be treated as directly secured by an interest in the buyer’s installment obligation to the extent “an arrangement” allows the seller to satisfy all or a portion of the indebtedness with the installment obligation.[xxvii] It is significant – insofar as monetized installment sales are concerned – that Congress intended for “[o]ther arrangements that have a similar effect [to] be treated in the same manner.”[xxviii]

OCC’s Analysis

The CCA begins by stating that monetized installment sale transactions have certain features “that make the transactions problematic,” and “that the theory on which promoters base the arrangements is flawed” and “raises a number of issues.”

The CCA then addresses certain characteristics that often appear in such transactions:

No genuine indebtedness. According to the CCA, at least one promoter contends that, under their plan, the seller (the taxpayer seeking to defer the recognition of gain) receives the proceeds of an “unsecured nonrecourse loan” from a lender.

“How can a nonrecourse loan be unsecured?” the CCA asks. A “borrower” who is not personally liable for the purported loan, and who has not pledged any collateral to secure the loan, has no reason to repay the loan. Therefore, the “loan proceeds” should be treated as income.

Debt secured by escrow. Another promoter, the CCA continues, states that the lender can look only to the cash escrow established by the promoter for payment (see above). In that case, the cash escrow is security for the loan to the taxpayer.

Because the seller-taxpayer economically benefits from the cash escrow – they are not at economic risk for the loan – they should be treated as receiving payment under the “economic benefit” doctrine for purposes of the installment sale rules.

Debt secured by promoter’s note. Alternatively, the monetization loan to the seller-taxpayer is secured by the right to payment from the escrow under the installment note from the promoter. This would result in deemed payment under the pledging rule (see above), pursuant to which loan proceeds are treated as payment of the promoter’s note.

Section 453(f). The intermediary does not appear to be the true buyer of the asset sold by the taxpayer. Under the installment sale rules,[xxix] only debt obligations from an “acquirer” (the buyer) can be excluded from the definition of “payment” for purposes of such rules.

Debt instruments issued by a party that is not the acquirer would be considered a payment to the seller that requires the recognition of gain.

Cash Security. To the extent the installment note from the intermediary to the seller is secured by a cash escrow, the taxpayer-seller is treated as receiving payment irrespective of the pledging rule.[xxx]

FAA 20123401F is distinguishable. The situation addressed in the FAA (described above) did not involve an intermediary. Further, although the loan to the seller was secured by the buyer’s installment notes, the pledging rule was not applicable because of the exception for sales of farm property, which applied in that case.

Where Does That Leave Us?

It is obvious the IRS has some serious issues with monetized installment sales. I think most reasonable taxpayers and responsible advisers would share the IRS’s concerns.[xxxi]

Unfortunately, Mr. Biden and Congress are hoping to enact significant income tax increases for the ordinary income and capital gains realized by individuals (including business owners),[xxxii] and for the domestic and foreign income realized by corporations.

In such an environment, some individuals may become more receptive – or susceptible – to strategies that promise to significantly reduce, or defer the payment of, their tax liability without compromising their economic situation.

It is likely that some variant of the monetized installment sale will be among the options recommended by promoters of such tax-saving strategies, but there will also be other, less complicated, plans offered.

For example, it will certainly be the case that some folks will try to take advantage of the sometimes-blurred distinction between a sale of property and a loan secured by such property. These individuals may be motivated by a desire to defer gain recognition to a time by which they believe an unfavorable tax rate may be reversed, or they be interested in satisfying the long-term holding period for the property to be sold (assuming it is still meaningful), or they may simply want to defer gain for its own sake.

Whatever the individual’s reason, their tax adviser will have to be careful to alert them to the risk that the IRS may recharacterize their transaction, and to educate them as to the consequences thereof.

[i] With apologies to Aerosmith, it does not work that way, does it?
[ii] I must admit, this sounds scary. Say I make a $100 profit in my business; it is taxed at 39.6%, leaving me with $60.4. I decide that my hard-earned money should work for me, so I invest the $60.4 in a new business. This business appreciates to $100. Before I can sell the business, I meet with what may be described as an untimely death. (The fates can be cruel.) A 39.6% tax is imposed on the $39.6 gain that has accrued in the business between the date of my investment and the date of my death (as though I had sold the business) –  my estate pays this tax of $15.68. The remaining $84.32 in my estate, which represents my taxable estate, is subject to a 40% estate tax, or $33.73. The $50.59 that remains will pass to the beneficiaries of my estate.

So, after realizing a total economic benefit of $139.6 –  the initial pre-tax profit of $100 plus the appreciation of $39.6 on the investment of my after-tax $60.4 –  what remains after tax is $50.59; in other words, an effective lifetime tax rate of approximately 63.8%. (Mind you, I have ignored employment taxes, surtaxes and state and local income taxes. What’s more, unless the basic exclusion amount is introduced into the negotiations over the American Families Plan, it will remain at $10 million until 2026, at which point it will revert to its pre-2018 level of $5 million.)
[iii] https://www.whitehouse.gov/briefing-room/statements-releases/2021/04/28/fact-sheet-the-american-families-plan/.
[iv] “When you wish upon a star, Makes no difference who you are, Anything your heart desires, Will come to you, If your heart is in your dream, No request is too extreme, When you wish upon a star, As dreamers do.”

Have you ever heard the 1978 Gene Simmons version of the Disney classic? Yep, the guy (aka “The Demon”) from Kiss. No? Don’t bother.
[v] IRC Sec. 453.
[vi] A person who facilitates these transactions in exchange for a fee.
[vii] In fact, the Intermediary may have the Property direct deeded from Seller to Buyer.
[viii] On its face, the arrangement does not trigger the anti-pledge rule under IRC Sec. 453A.
[ix] Intermediaries suggest that this be done, at least for an “initial period,” to demonstrate a business purpose for the loan. The implication is that, after a period of “cleansing,” the investment may be liquidated, and the funds used for any purpose at all.
[x] FAA 20123401F. https://www.irs.gov/pub/irs-lafa/20123401F.pdf . The Chief Counsel is the principal legal adviser to the IRS Commissioner and, as such, provides legal guidance and interpretive advice to the IRS and to the Treasury Department.
[xi] They also packaged and marketed the strategy, often using more colorful names, such as “M453.”
[xii] S. Crow Collateral Corp. vs. U.S., No. 1:17-mc-09828-EJL-REB, 2018 BL 484991 (D. Idaho 2018); aff’ d 782 At the
[xiii] Interestingly, the promoter requested a Technical Advice Memorandum (“TAM”) regarding the merits of its installment purchases. By the time of the Court’s holding, the IRS had not issued a TAM and the promoter contended that “the IRS’s decision not to do so proves that the . . .  investigation is illegitimate.”  The Court declined to adopt this position.
[xiv] “The mills of the gods grind slowly, but they grind small.” Ancient Greek proverb.
[xv] CCA 202118016. This is written advice prepared by the Office of Chief Counsel and issued to field or service center employees of the IRS or Office of Chief Counsel.
[xvi] For example, where an amount otherwise payable by the buyer is held in escrow for the survival period of the seller’s reps and warranties (to secure the buyer against the seller’s breach of such), or where there are earn-out payments to be made over a number of years (say, two or three) based on the performance of the property (almost always a business).
[xvii] There are many reasons why a buyer will give a note to the seller rather than borrowing the funds from a financial institution; for one thing, the buyer may have greater leverage in structuring the terms of the note vis-à-vis the seller. In addition, the buyer will often seek to offset the note amount by losses incurred as a result of the seller’s breach of a rep or covenant.
[xviii] In general, there is a direct correlation between the economic certainty of a seller’s “return on investment” on the sale of property and the timing of its taxation; where the delayed payment of the sales price creates economic risk for the seller, the taxable event will be delayed until the payment is received.
[xix] IRC Sec. 453; Reg. Sec. 15a.453-1.
[xx] The installment method does not apply to the sale of certain assets; for example, cash method accounts receivable, inventory, assets that generate depreciation recapture, and marketable securities. These are either items of ordinary income, or items that represent cash equivalents.

It should also be noted that a seller may elect out of installment reporting, and thereby choose to report its entire gain in the year of the sale. IRC Sec. 453(d). We may see such elections for 2021 if the tax rate for long-term capital gain increases significantly.
[xxi] Reg. Sec. 15a.453-1(b)(3).
[xxii] The receipt of a promissory note from the buyer which is payable on demand or that is readily tradable is also treated as a payment because of the seller’s ability to readily convert it to cash.
[xxiii] A promise to pay in the future.
[xxiv] A standby letter of credit is treated as a third party guarantee; it represents a non-negotiable, non-transferable letter of credit that is issued by a financial institution, and that may be drawn upon in case of default – it serves as a guarantee of the installment obligation.

In the case of an “ordinary” letter of credit, by contrast, the seller is deemed to be in constructive receipt of the proceeds because they may draw upon the letter at any time.
[xxv] IRC Sec. 453A(d). Interestingly, the anti-pledging rule was limited in its reach to obligations which arise from the installment sale of property where the sales price of the property exceeds $150,000; for purposes of applying this threshold, all sales which are part of the same transaction (or a series of related transactions) are treated as one sale. IRC Sec. 453A(b)(1) and (5).
[xxvi] If any amount is treated as received with respect to an installment obligation as a result of this anti-pledge rule, subsequent payments actually received on such obligation are not taken into account for purposes of the installment sale rules, except to the extent that the gain that would otherwise be recognized on account of such payment exceeds the gain recognized as a result of the pledge.
[xxvii] IRC Sec. 453A(d)(4).

Among the installment obligations excluded from the reach of this provision are those which arise from the sale of property used or produced in the trade or business of farming.
[xxviii] P.L. 106-170; H. Rep. 106-478. Conference Committee report to the Tax Relief Extension Act of 1999.
[xxix] IRC Sec. 453(f).
[xxx] Treas. Reg. Sec. 15a.453-1(b)(3). “Receipt of an evidence of indebtedness which is secured directly or indirectly by cash or a cash equivalent . . . will be treated as the receipt of payment.”
[xxxi] In an article a few years back, in which I assessed (pun intended) the use of such transactions, I quoted “Billy” from the 1987 movie Predator when he says to “Dutch” (played by Arnold Schwarzenegger), “I wouldn’t waste that on a broke-dick dog.” My position has not changed.
[xxxii] And don’t forget the estate tax – it’s just a heartbeat away. “Ba Dum Tsh!”

See here for an overview: https://www.rivkinradler.com/publications/tax-highlights-the-american-families-plan/ . See also my article on the internet at https://www.taxlawforchb.com/2021/01/the-federal-estate-tax-in-2021-what-might-we-expect-what-can-we-do/ .