Sometimes I am amazed to the extent people will go to minimize, defer or avoid taxes altogether.
I get it, though. When that alarm clocks goes off in
the morning, there is no government bureaucrat there to prepare your breakfast
or drive you to work. Fair share rings trite when yours is the only share
visible for miles.
I am looking at an IRS Chief Council Advice.
Think of the Chief Counsel as the attorneys advising
the IRS. The Advice would therefore be legal analysis of an IRS position on something.
This one has to do with something called Monetized
Installment Sale Transactions.
Lot of syllables there.
Let’s approach this from the ground floor.
What is an installment sale?
This is a tax provision that allows one to sell approved
asset types and spread the tax over the years as cash is collected. Say you
sell land with the purchase price paid evenly over three calendar years. Land
is an approved asset type, and you would pay tax on one-third of your gain in
the year of sale, one-third the following year and the final third in the third
year.
It doesn’t make the gain go away. It just allows one
to de-bunch the taxation on the gain.
Mind you, you have to trust that the buyer can and
will pay you for the later years. If you do not trust the buyer’s ability (or
intention) to do so, this may not be the technique for you.
What if the buyer pays an attorney the full amount,
and that attorney in turn pays you over three years? You have taken the
collection risk off the table, as the monies are sitting in an attorney’s
escrow account.
You are starting to think like a tax advisor, but the
technique will almost certainly not work.
Why?
Well, an easy IRS argument is that the attorney is acting
as your agent, and receipt of cash by your agent is the equivalent of you
receiving cash. This is the doctrine of “constructive receipt,” and it is one
of early (and basic) lessons as one starts his/her tax education.
What if you borrow against the note? You just go down
to Fifth Third or Truist Bank, borrow and pledge the note as collateral.
Nice.
Except that Congress thought about this and introduced
a “pledging” rule. In short, a pledge of the note is considered constructive
receipt on the note itself.
Not to be deterred, interested parties noticed a Chief
Council’s Memorandum from 2012 that seemed to give the OK to (at least some of)
these transactions. There was a company that need cash and needed
it right away. It unloaded farm property in a series of transactions involving
special purpose entities, standby letters of credit and other arcane details.
The IRS went through 11 painful pages of analysis, but
wouldn’t you know that – at the end – the IRS gave its blessing.
Huh?
The advisors and promoters latched-on and used this Memorandum
to structure future installment sale monetization deals.
Here is an example:
(1) Let’s say I want to sell something.
(2) Let’s say you want to buy what I am selling.
(3) There is someone out there (let’s call him
Elbert) who is willing to broker our deal – for a fee of course.
(4) Neither you or I are related to Elbert or give
cause to consider him our agent.
(5) Elbert buys my something and gives me a note.
In our example Elbert promises to pay me interest annually and the balance of
the note 30 years from now.
(6) You buy the something from Elbert. Let’s say
you pay Elbert in full, either because you have cash in-hand or because you
borrow money.
(7) A bank loans me money. There will be a
labyrinth of escrow accounts to maintain kayfabe that I have not borrowed
against my note receivable from Elbert.
(8) At least once a year, the following happens:
a. I
collect interest on my note receivable from Elbert.
b. I
pay interest on my note payable to the bank.
c. By
some miraculous result of modern monetary theory, it is likely that these two
amounts will offset.
(9) I eventually collect on Elbert’s note. This
will trigger tax to me, assuming someone remembers what this note is even about
30 years from now.
(10) Having
cash, I repay the bank for the loan it made 30 years earlier.
There is the monetization: reducing to money,
preferably without taxation.
How much of the original sales price can I get using
this technique?
Maybe 92% or 93% of what you paid Elbert, generally speaking.
Where does the rest of the money go?
Elbert and the bank.
Why would I give up 7 or 8 percent to Elbert and the
bank?
To defer my tax for decades.
Do people really do this?
Yep, folks like Kimberly Clark and OfficeMax.
So what was the recent IRS Advice that has us talking
about this?
The IRS was revisiting its 2012 Memorandum, the one that
advisors have been relying upon. The IRS lowered its horns, noting that folks were
reading too much into that Memorandum and that they might want to reconsider
their risk exposure.
The IRS pointed out several possible issues, but we
will address only one.
The company in that 2012 Memorandum was transacting
with farmland.
Guess what asset type is exempt from the “pledging”
rule that accelerates income on an installment note?
Farmland.
Seems a critical point, considering that monetization is
basically a work-around the pledging prohibition.
Is this a scam or tax shelter?
Not necessarily, but consider the difference between
what happened in 2012 and how the promoters are marketing what happened.
Someone was in deep financial straits. They needed
cash, they had farmland, and they found a way to get to cash. There was
economic reality girding the story.
Fast forward to today. Someone has a big capital gain.
They do not want to pay taxes currently, or perhaps they prefer to delay
recognizing the gain until a more tax-favorable political party retakes
Congress and the White House. A moving story, true, but not as poignant as the
2012 story.
For the home gamers, this time we have been discussing
CCA 2019103109421213.
