Tax Tip of the Week
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For the week of
February 21, 2000
The tax is due before the money is received
On December 17, 1999, President Clinton signed into law the
Tax Relief Extension Act. A provision in this new law requires many taxpayers to pay the tax on certain property
sales before the money is received.
Many small businesses use the accrual method of accounting. This simply means that you record and pay taxes based
on when the sale takes place or the expense is incurred. The cash method of accounting allows you to record the
sale and claim the expense when cash changes hands. Accrual method taxpayers were allowed to use the installment
method of reporting if they sold the assets of a business. The new law no longer allows this favorable treatment.
What this means to the small businessperson is that more money is needed in the year of sale to pay the income
taxes. This can squash an otherwise workable buy/sell agreement.
Look at this example:
Let's assume the sale price of the business is $600,000 and that the cost basis is $100,000. This means that the
seller will pay taxes on $500,000 of gain. Let's also assume that the money was to be received in ten equal installments
of $60,000 per year (ignoring interest for this example). Under the tax rules prior to December 17, 1999, the seller
could pay the taxes as the money was received over the next ten years. As long-term capital gain, the seller's
tax on the $60,000 received in the year of sale would be about $10,000. Under the new rules, the tax on the entire
$500,000 of gain would be due in the year of sale. This could amount to about $100,000 even though the seller received
only $60,000 in cash.
The problem with the new law is that it makes selling a small business much more difficult. Most potential buyers
can't afford a large cash outlay in the year of purchase, and many banks will not finance the purchase of these
small businesses.
There has been a bill introduced in the Senate
to repeal this new law. It may be that the law will not get repealed. There are still some planning options worth
consideration. If you are selling or buying a small business, give us a call. We will explore your options with
you.
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without further details and/or professional assistance.
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