[Congressional Record (Bound Edition), Volume 149 (2003), Part 4]
[Extensions of Remarks]
[Pages 5593-5594]
[From the U.S. Government Publishing Office, www.gpo.gov]




      INTRODUCTION OF THE INSTALLMENT SALE PROTECTION ACT OF 2003

                                 ______
                                 

                           HON. WALLY HERGER

                             of california

                    in the house of representatives

                        Thursday, March 6, 2003

  Mr. HERGER. Mr. Speaker, I am today introducing legislation that 
would restore effective use of the installment method of accounting to 
long-term service business owners who sell their business interests.
  The installment method of accounting allows a seller to pay tax on 
the gain from a sale as the seller receives the sale proceeds. This tax 
treatment matches the time for paying the tax to when the seller has 
the cash with which to pay that tax.
  As many Members are aware, in the 106th Congress, we acted on a 
recommendation from the Clinton Administration to repeal the 
installment method of accounting for accrual basis taxpayers. Only 
after such change became law did we discover that we had effectively 
eliminated the installment method of accounting for many small business 
owners and, as a result, made it much more difficult for those business 
owners to sell their businesses. These business owners were forced to 
pay the entire federal income tax due on the sale of their business in 
the year of sale, even though the proceeds of the sale would be 
received over several years. This up-front demand by the government 
forced business owners to borrow to pay the tax or to accept lower sale 
prices in order to induce buyers to pay enough up-front to cover the 
seller's tax. To its credit, the Congress admitted its mistake and 
retroactively restored the installment method to accrual basis 
taxpayers in the Installment Tax Correction Act of 2000 (P.L. 106-573), 
which was enacted on December 28, 2000.
  While restoring the installment method for accrual method taxpayers 
in 2000 was the right thing to do, it did not go far enough in 
remedying the installment sale problems of business owners. Despite the 
clear policy decision by Congress in 2000 to permit sellers of 
businesses to use the installment method, some long-term business 
owners continue to be required to pay a significant portion of total 
taxes upon entering into an installment sale of their business, even 
though they have not yet received any significant part of the sale 
proceeds.
  An exception to the installment sale method of accounting requires 
taxpayers to pay all tax attributable to depreciation recapture in the 
year of a sale. This depreciation recapture rule was adopted in 1984 in 
order to prevent taxpayers from engaging in ``churning'' transactions, 
sale/leasebacks, and other tax shelter transactions involving real 
estate and equipment. However, the recapture provision was expanded 
well beyond its original purpose in 1993 in connection with legislation 
relating to the treatment of intangibles. Unfortunately, Congress may 
not have fully appreciated the consequences to sellers of business 
interests.
  In 1993, the Congress adopted rules to clarify the amortization of 
acquired intangibles (e.g., goodwill, going concern value). The

[[Page 5594]]

1993 change required intangibles to be written off over a 15-year 
period, but specified that any gain on the sale of the intangibles 
attributable to previous amortization deductions would be treated as 
depreciation recapture. As a result, tax on this gain must be paid 
immediately in the year of sale. Because these new rules generally 
applied to intangibles acquired after August, 1993, business owners are 
now only just beginning to feel the effects of the recapture rule. This 
rule is having a particularly adverse effect on service businesses, 
because intangibles such as goodwill and going concern value represent 
a major portion of the value of those businesses.
  For a simplified example, take the case of a business owner who 
purchased an interest in an architectural firm for $100 in 1993, 
substantially all of the value of which was attributable to going 
concern value. The owner, who has actively participated in the 
business, retires in 2009 and sells the business for $200, payable in 
ten equal annual installments. This sale would produce $100 of capital 
gain (at an assumed tax rate of 20%) and $100 of ordinary income (at an 
assumed tax rate of 33%), generating a total tax of $53. Because of the 
intangibles recapture rule, the seller will have to pay $35, or 66% of 
the total tax, in the first year, despite having received only 10% of 
the sale proceeds in that year. This result is clearly inequitable and 
defeats the purpose of allowing business owners to use the installment 
method of reporting gain from the sale of the business. Moreover, the 
result is especially harsh in cases where a business owner is retiring 
and selling the business.
  My bill would allow a long-term active participant in a service 
business to report intangibles recapture gain on the installment basis 
along with other gain from the sale. The legislation would not change 
the character of any gain. As such, intangibles recapture gain would 
continue to be ordinary income to reflect the fact that it previously 
gave rise to an ordinary deduction. The bill is limited to long-term 
participants because they are the individuals who would otherwise be 
likely to suffer the greatest hardship under the recapture rule and who 
are most likely to be relying on installment sale payments to 
supplement their retirement income.
  Specifically, my bill would allow an individual who has been an 
active participant for five of the prior seven years in a business in 
which capital is not a material income-producing factor (i.e., a 
service business) to report on the installment basis any intangibles 
recapture income resulting from the disposition of an interest in the 
business.
  Because this proposal does not apply to depreciation recapture from 
tangible property, the proposal does not conflict with the original 
goals of Congress in adopting the depreciation recapture exception to 
the installment sale rules. Specifically, this is not a change that 
would permit tax sheltering through any sort of ``churning'' 
transactions,
  While this proposal does not address all of the potential cases in 
which the installment sale method is unavailable upon the sale of a 
business, it does go a long way towards addressing one of the most 
egregious situations. I urge my colleagues to support this worthy 
legislation.

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