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Sale of sole proprietorship

Forum|Forum|4 years ago
September 17, 2021
2 replies
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Sole proprietor sold 50% of business and is now a partnership.

Total value of sole proprietorship $600,000.00

Sold 50% to buyer for $295,000.00

Received $15,000.00 down, leaving a balance of $280,000.00

In the purchase agreement it states the following:

The sale shall be treated as an installment sale, including 3 separate payments.

First payment of $93,333.33 due December 31, 2020.

Second payment of $93,333.33 due December 31, 2021.

Third payment of $93,333.34 due December 31, 2022.

The sole proprietor is personally financing each installment with a promissory note with interest of 6.25% per annum, computed quarterly for a term of 15 years.

The sole proprietor doesn’t want to spread the gain over 15 years and wants to do it in 3 years. Can the sole proprietor spread over 3 years even though he is financing the payments? He knows he will include interest over the 15 years for each promissory note.

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Best answer by George4Tacks

So, Mike & Bill decide they like to work together. Mike has a thriving business and sells 1/2 to Bill. Bill is a bit shy of cash, so Mike loans Bill enough money each year to make the payment for the business, paying off the sale in 3 years. There is now a personal loan, (unsecured?) between Mike & Bill that is not associated with the new partnership. Bill can establish that the loan was to fund his business interest and could therefore take the interest expense as a UPE on his Schedule E. Mike should be able to take the gain over 3 years, while still receiving P&I from Bill for the 3 separate loans over a longer period.

Does this work for you? I think it does for me.

George4TacksAnswer

Level 15

So, Mike & Bill decide they like to work together. Mike has a thriving business and sells 1/2 to Bill. Bill is a bit shy of cash, so Mike loans Bill enough money each year to make the payment for the business, paying off the sale in 3 years. There is now a personal loan, (unsecured?) between Mike & Bill that is not associated with the new partnership. Bill can establish that the loan was to fund his business interest and could therefore take the interest expense as a UPE on his Schedule E. Mike should be able to take the gain over 3 years, while still receiving P&I from Bill for the 3 separate loans over a longer period.

Does this work for you? I think it does for me.

Answers are easy. Questions are hard!

TAXOHAuthor

Level 10

Thanks! That definitely works for me and makes it easier. It was just throwing me off and getting me confused since the seller is personally financing the 3 notes.

IRonMaN

Level 15

But George had me thinking we were working on a word problem and I was getting ready to try and figure what time Mike's and Bill's trains were going to meet in Chicago. 😅

Slava Ukraini!

BobKamman

Level 15

I didn't wade through this but you probably should:

In Revenue Rulings 99-5 and 99-6 the Internal Revenue Service ("IRS") discusses the federal income tax consequences of a single-member, disregarded LLC acquiring a second member and of a two-member LLC becoming a single-member LLC. In addition, in Notice 99-6 the IRS provides two temporary safe harbors regarding employment tax reporting and payment compliance by certain disregarded entities, including single-member LLCs, and invites comment on various aspects of application of the federal employment tax regime to these entities.

http://pmstax.com/part/disllc9901.shtml

TAXOHAuthor

Level 10

Thanks Bob. I'll check it out.

joshuabarksatlcs

Level 9

I had a minor in physics (technically a double minor - physics and bourbon) and would need to know the coefficient of air resistance to determine the time for the trains to meet the fly...

Not that I care about flies.

I also wonder how the number of years (15) was picked in the tax problem. Did it have to do with George's Level 15? My clients would have a colossal disadvantage - I'm only Level 4.

(A never-announced Lacerte community rule: After you marked a response as the solution, the comments that followed are game.)

Joking aside, my 2 cents:

For the 3-year installment sale idea to fly (nothing to do with the aforementioned fly), I would need to see three cancelled checked from the Seller to the Buyer, and three (each of equal amount to the purported installment amounts) from Buyer to Seller for the so-called (refinancing) loans. Otherwise, substance-over-form rules and the installment sale is really for15 years.

Even if my clients had the cancelled checks, I would still need to consider whether the deal could be collapsible transactions.

But then, why would the IRS care? The tax payments for the sale transaction were accelerated. Which brings me to my curiosity as to why pay the tax in three when you could pay in 15 years? Because the capital gain rate may go up? On the flip side of that, even today, a dollar definitely feels like it's worth a lot less than a dollar last year.... But then, it's me.

I come here for kudos and IRonMaN's jokes.

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