Permission granted to revoke an accountant's inadvertent election out of the installment method

Plain-English summary

When property is sold for payments spread over more than one year, the seller
normally reports the gain gradually under the "installment method" as payments
come in, but the seller can choose to "elect out" and report all the gain up
front. That election out is generally irrevocable without IRS consent. Here an
S corporation was sold (with a § 338(h)(10) election treating it as an asset
sale), and part of the price was a cash payment, an escrow amount, and a
contingent earn-out paid over three years. The company's accountant, on his own
and without the shareholders' knowledge, prepared the final short-year return in
a way that reported the escrow amount up front, which accidentally elected the
company out of the installment method. The shareholders submitted affidavits
showing the election out was the accountant's error, not a tax-avoidance choice,
and asked the IRS for permission to revoke it. The IRS granted permission to
revoke the election out (retroactively) within 75 days, requiring the company to
file amended returns and corrected Schedules K-1 so the gain can be reported on
the installment method.

Ruling snapshot

• Question: May the taxpayer revoke an inadvertent election out of the
  installment method that its accountant made in error?
• Outcome: Approved (permission to revoke granted; amended returns required
  within 75 days)
• Key authorities: IRC § 453(d); Treas. Reg. § 15A.453-1(d)(4); IRC
  § 338(h)(10)

Full text (IRS public release)

Internal Revenue Service                                       Department of the Treasury
                                                               Washington, DC 20224

Number: 201909002                                              Third Party Communication: None
Release Date: 3/1/2019                                         Date of Communication: Not Applicable
Index Number: 453.00-00, 453.08-00
                                                               Person To Contact:
----------------------------------------                       -------------------------, ID No. -----------------
------------------------------                                 -----------------------------------------------------
---------------------------------                              Telephone Number:
                                                               ----------------------
                                                               Refer Reply To:
                                                               CC:ITA:B05
                                                               PLR-113720-18
                                                               Date:
                                                               October 16, 2018


LEGEND

Taxpayer                     =      ---------------------------------------- --------------------------
Shareholder 1                =      --------------------------
Shareholder 2                =      ----------------------
Date 1                       =      -----------------------
Year 1                       =      -------

-------------------------:

This letter responds to Taxpayer’s request, dated March 21, 2018, for a private letter
ruling for permission to revoke its election out of the installment method, pursuant to
§ 453(d)(3) of the Internal Revenue Code and § 15A.453-1(d)(4) of the Temporary
Income Tax Regulations, in connection with the sale of Taxpayer.

FACTS

Taxpayer was an S corporation owned by Shareholder 1 and Shareholder 2 (collectively
referred to as “shareholders”). All the stock in Taxpayer was sold on Date 1 to an
unrelated corporation. The buyer and the shareholders jointly made an election under
§ 338(h)(10) to treat the sale of the stock as if Taxpayer sold all of its assets and then
immediately liquidated.

In return for the sale of Taxpayer, the shareholders received (1) a cash payment on
Date 1, (2) an additional cash payment to be paid in 12 months placed in escrow,
subject to certain claims and indemnification (escrow amount); and (3) a contingent
earn-out of future payments – based on post-sale performance objectives – to be paid
in increments over the three years following the end of Year 1.
PLR-113720-18                                2



Soon after Date 1, Taxpayer’s accountant prepared a draft final short year Form 1120S
for the year ending Date 1 (short year return) for Taxpayer. Shareholder 1, an officer of
Taxpayer, signed the draft short year return. Taxpayer’s accountant filed the short year
return with the Internal Revenue Service before the effective due date of the short year
return. Excepting Shareholder 1, no other party to the sale transaction reviewed the
short year return.

On the short year return, Taxpayer’s accountant reported the gain on the deemed sale
of assets using both the cash payment at closing on Date 1 plus the escrow amount.
Taxpayer’s accountant did not include the contingent earn-out amounts to be paid over
three years as part of the sale proceeds. Taxpayer effectively elected out of the
installment method under § 453 by including the escrow amount on the short year
return.

Shareholder 1 filed his federal income tax return for Year 1 consistent with the treatment
on Taxpayer’s return, relying on the K-1 from Taxpayer to govern his reporting. Thus,
Shareholder 1 reported as income his portion of the sales proceeds – both the cash
received upon the sale of Taxpayer and the escrow amount, but none of the contingent
earn-out.

Shareholder 2 determined that his K-1 inadvertently included the escrow amount as part
of the amount realized from the sale of Taxpayer. Instead of following the K-1,
Shareholder 2 filed his federal income tax return for Year 1 reporting only his portion of
the cash received upon the sale of Taxpayer, intending to report the escrow amount and
any contingent earn-outs when received in years following Year 1.

Taxpayer’s accountant provided an affidavit indicating that the accountant made the
erroneous computation of gain (cash payment at closing plus the escrow amount). The
affidavit states that the decision to elect out of the installment method under § 453 was
made solely by the accountant, who generated the K-1s for the shareholders.
Taxpayer’s accountant’s affidavit also indicates that the shareholders were unaware
that the return for Year 1 elected out of the installment method.

Shareholder 1 also provided an affidavit indicating that he did not plan or participate in
the decision to elect out of the installment method under § 453 and, although he
followed the K-1, Taxpayer’s accountant’s action was the sole reason the installment
method was not used. Shareholder 2 also provided an affidavit, wherein he states that
he did not plan or participate in the decision to elect out of the installment method under
§ 453 and, in fact, he alerted Shareholder 1 of the erroneous election out, and ultimately
filed his federal income tax return for Year 1 inconsistent with the K-1 he received from
Taxpayer.
PLR-113720-18                                3



Taxpayer and the shareholders have represented that the requested revocation of the
election out of the installment method does not have as one of its purposes the
avoidance of federal income taxes and no taxable year of Taxpayer or the shareholders
in which payments were received is closed to assessment or collection pursuant to
§ 6501(a).

LAW AND ANALYSIS

Section 453(a) provides that, generally, a taxpayer shall report income from an
installment sale under the installment method. Section 453(b) defines an installment
sale as a disposition of property for which at least one payment is to be received after
the close of the taxable year of the disposition.

Section 15A.453-1(b)(3)(i) defines “payment” to include amounts actually or
constructively received in the taxable year under an installment obligation.

Section 453(d)(1) and § 15A.453-1(d)(1) provide that a taxpayer may elect out of the
installment method in the manner prescribed by the regulations. Section 15A.453-
1(d)(3) provides that a taxpayer who reports an amount realized equal to the selling
price including the full face amount of an installment obligation on a timely filed tax
return for the taxable year in which the installment sale occurs is considered to have
elected out of the installment method.

Except as otherwise provided in the regulations, § 453(d)(2) requires a taxpayer who
desires to elect out of the installment method to do so on or before the due date
(including extensions) of the taxpayer's federal income tax return for the taxable year of
the sale. Section 15A.453-1(d)(4) provides that an election under § 453(d)(1) is
generally irrevocable. An election may be revoked only with the consent of the Internal
Revenue Service. Section 15A.453-1(d)(4) provides that revocation of an election out
of the installment method is retroactive and will not be permitted when one of its
purposes is the avoidance of federal income taxes.

In the instant case, Taxpayer’s accountant’s erroneous action when preparing
Taxpayer’s short year return led the accountant to inadvertently elect out of the
installment method under § 453. The shareholders were not aware of the accountant’s
action, nor did the shareholders plan or participate in the action. Although Shareholder
1 signed the Taxpayer’s return as an officer of the Taxpayer, he was unaware of
Taxpayer accountant’s action. When the shareholders realized the accountant’s
erroneous computation, Taxpayer filed a request for permission to revoke its election
out of the installment method. The information submitted indicates that Taxpayer and
the shareholders’ desire to revoke the election out of the installment method is due to
inadvertence rather than hindsight by the Taxpayer of shareholders, or a purpose of
avoiding federal income taxes.
PLR-113720-18                                  4




CONCLUSION

Based on careful consideration of all of the information submitted and the
representations made, Taxpayer is granted permission to revoke its election out of the
installment method for the sale of Taxpayer on Date 1, and provide corrected K-1’s to
the shareholders. Permission is granted for the period that ends 75 days after the date
of this letter. In order to revoke its election out of the installment method, Taxpayer
must file an amended federal income tax return for the short year ending on Date 1 and
any other previously filed returns on which a portion of the gain from the sale is
reportable under the installment method. A copy of this letter ruling must be attached to
any amended return.

Except as expressly provided herein, no opinion is expressed or implied concerning the
tax consequences of any aspect of any transaction or item discussed or referenced in
this letter, including the computation of gain to be reported under the installment
method. Likewise, no opinion is expressed or implied concerning the tax consequences
of any aspect of either shareholder’s return for Year 1.

This ruling is directed only to Taxpayer who requested this ruling. Section 6110(k)(3)
provides that it may not be used or cited as precedent.

In accordance with the Power of Attorney on file with this office, a copy of this letter is
being sent to your authorized representative.

The rulings contained in this letter are based upon information and representations
submitted by Taxpayer’s accountant, Shareholder 1, and Shareholder 2, and
accompanied by a penalty of perjury statement executed by appropriate parties. While
this office has not verified any of the material submitted in support of the request for
rulings, it is subject to verification on examination.

                                       Sincerely,


                                       Christina M. Glendening
                                       Senior Counsel, Branch 5
                                       (Income Tax & Accounting)
                                       Office of Chief Counsel



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