The Latest Installment

The "Overview" document about collateralized installment sale (or "C453") transactions—see the "Publications" link above—says, "(W)e will introduce to you a lender which is willing to lend to you (as to all of our sellers) an amount that is equal to an agreed high percentage of the amount that S.Crow Collateral Corp. receives from the final buyer when we re-sell the asset to the final buyer."

We’ve been asked why lenders are willing to do this, when normally a lender would either not lend against an installment contract or would do so only at a steep discount.

We’re glad to answer, but first it’s important to note that the lender to a C453 seller to S.Crow Collateral Corp. does not lend "against" the installment contract by which S.Crow Collateral Corp. buys the asset. In fact, the lender does not obtain a lien of any kind on the installment contract. Further, the amount that the lender loans is not credited against the unpaid balance on the installment contract, or vice-versa.

Instead, what the installment contract does is provide the money—assuredly so—with which our seller makes the payments on the loan.

So why is that enough for the lender, to be willing to lend "an agreed high percentage" of the amount which S.Crow Collateral Corp. receives on the resale? Here are some reasons why:

1. Access to new investors.

When the lender lends money to someone who sells to S.Crow Collateral Corp., the money being loaned must then be invested somewhere—and the lender may be very pleased to have a timely opportunity to present to our seller information about how those loan proceeds could be invested with the lender, to the advantage of both our seller and the lender. This opportunity is especially timely, because the loan is made at a time when our seller must make an investment decision anyway.

2. More money from existing investors.

When the lender already has existing investors, C453 presents an occasion and rationale for the lender to communicate with those investors again, about the advantages of selling capital assets in C453 transactions, receiving a loan from the lender, and then investing the non-taxable loan proceeds with the lender.

3. Loan-fee income.

Lending to S.Crow Collateral Corp.’s C453 sellers provides the lender with the opportunity for additional cash flow through loan fees.

4. Access to the best borrowers, with C453-enhanced credit.

At a time when credit is tight and banks are turning down many very capable borrowers, it doesn’t mean that no one wants to lend. It does mean, though, that everything about a proposed loan transaction has to be just right, or the lender likely won’t go forward with it. In the case of lending to sellers to S.Crow Collateral Corp., everything is indeed just right, for reasons such as these:

A. The borrower is someone who has just sold a capital asset and is now free of the risks that went with it;

B. The borrower is someone who has an assured steady cash flow (through the C453 contract with S.Crow Collateral Corp.) with which to make all of the required payments on the loan;

C. S.Crow Collateral Corp. has just received cash for the sale and can satisfy the lender’s investment criteria for that cash;

D. S.Crow Collateral Corp. is highly experienced in such transactions and has never defaulted; and

E. An automatic payment system is put into place for the loan’s repayment, to assure follow-through.

All of this makes for an ideal lending situation for the lender.

Furthermore, it makes for an ideal borrowing situation for someone who sells to S.Crow Collateral Corp.—but that’s a subject for another time.—Stan Crow

Last week I wrote about one way to illustrate the common error of conflating one form of sale transaction with another, simply because the tax cost of one of them is greater. As applied to what S.Crow Collateral Corp. does, this error arises when some tax advisers say that an installment sale to S.Crow Collateral Corp. is "really" a cash sale, just because our seller can borrow other cash.

This week I have another way to illustrate the error.

Let’s suppose that you are considering driving by car from New York City to Boston, and you are considering alternate routes. You could take I-95 through New Haven and Providence and on to Boston. Or, you could take the Hutchinson River Parkway, then the Merritt Parkway, then the Wilbur Cross Parkway, then I-91 to Hartford, I-84 to Sturbridge, MA (what a great place to visit!), and then I-90 (the Mass Pike) on into Boston by Worcester and Cambridge. Or, you could take I-684 from near White Plains northward to I-84, then I-84 through Danbury, Waterbury and Hartford and on to Sturbridge, and then the Mass Pike from there on.

All of these routes, and some variations on them, will take you from the same starting point to the same ending point. The places, sights and sounds along the way will differ substantially, however.

Let’s suppose that you decide on the I-95 route, with one reason being to avoid the tolls on the Mass Pike.

Now, then, do you suppose that you could be required by the Commonwealth of Massachusetts to pay tolls as though you had taken the Mass Pike, because your travel on I-95 was "really" travel on the Mass Pike? The Massachusetts authorities might say that you started your trip from the same place at which you would have started if you had taken the Mass Pike, and you ended your trip at the same place as you would have ended it if you had taken the Mass Pike. They might say that you traveled on the same day as you would have traveled if you had decided to take the Mass Pike. They might say that you used the same car, and that your reason for the trip was the same either way. So, they might say, your travel on I-95 was "really" travel on the Mass Pike, and you owe them the amount which you would have paid in tolls on the Mass Pike.

I think you’d think that the Massachusetts officials who made that argument were nuts. After all, you didn’t drive on the Mass Pike. How can not driving on the Mass Pike be the same as driving on the Mass Pike?

Yet that’s the same argument that many tax advisers make (are they "really" working for the IRS?), when they contend that even though an installment sale is not legally a cash sale it is nonetheless a cash sale for tax purposes, because it could have been a cash sale and the seller accomplished with other means much of what a cash sale would have accomplished.

They’re wrong, though. The tax code treats installment sales and cash sales as being two different ways of selling the same thing, but with Congressionally mandated different tax results. The tax code even goes further (in Section 453A(d)) and specifies the precise circumstances in which borrowed money can count as a cash paid under an installment contract. (It’s when the loan is "directly secured by an interest in such installment obligation" and if the "installment obligation" itself satisfies all or part of the debt.) Some advisers ignore (or haven’t read) the precise limitations of Section 453A(d) and contend that the IRS can effectively remove those limitations that Congress adopted and treat any loan as being "really" a cash payment of sale proceeds.

Yes, and I-95 is "really" the Mass Pike. Sure.—Stan Crow

I’ve struggled to find a way to explain clearly why it is that I believe that so many tax advisers lose their way when they’re considering a transaction that is unfamiliar to them. I think that now I have found at least part of the answer.

I’ve previously mentioned the comment which I often hear, which goes something like this: "Although this transaction is set up as a tax-deferred installment sale of a capital asset, I think that the IRS will say that the transaction is really a cash sale/sale of non-capital assets/sale of the assets of a corporation/whatever, and collect the tax now or collect a higher tax accordingly."

The underlying (but mistaken) rationale for this comment is that the transaction could be structured in a more tax-costly way, so the IRS is likely to say that the transaction form is a disguise which must be cast aside so that the transaction can be re-cast in the more tax-costly way in accord with what the transaction "really" is.

Do you see the error in that rationale? It’s equating what the transaction "could" be to what the transaction "really" is. Or, one can put it in the form of a logical statement:

1. The transaction can be either an "A" transaction or a "B" transaction.

2. The tax cost of the transaction will come sooner and be higher, or either of them, if the transaction is a "B" transaction.

3. Therefore, the transaction is a "B" transaction.

It should be obvious to us all that the conclusion does not follow from the premises.

Let’s illustrate this another way, with the tax code itself. Let’s suppose the following:

1. Congress decides to reverse the tax treatment of cash sales and installment sales, so that the capital-gains tax is deferred on cash transactions but is immediately due on installment sales;

2. John Doe sells a capital asset for cash, with a gain, and he plans to report it as a tax-deferred cash sale;

3. He places the cash proceeds with his investment adviser for management and investment; and

4. His tax adviser says to him, "Because the money is not in your hands right now, I think the IRS will say that this is really an installment sale and require you to pay the tax immediately."

That may sound silly, but I think that many tax advisers would do exactly that: they would reverse their present advice, and tell their clients to pay the tax now, or to pay more tax, because, in their view, whatever is the more tax-costly way is the real way. The facts of the transaction itself could be unchanged, but those advisers would say that the same transaction which they previously said was really "B" is now really "A", for no reason other than the change in the tax cost of "A" vs. "B".

So, let’s get rid of that confusion and instead state the real rule, which is this: The IRS must take the transaction as it finds it, as the parties (at arms’ length from each other) structured it, if in fact the parties’ actions accord with the transaction documents. The IRS taxes the transactions that occur; it cannot freely not change them into transactions of its own liking and then tax them accordingly.—Stan Crow

I can’t begin to guess how many times I’ve heard people say, when they hear about what collateralized installment sales can achieve for them, "If only I had known then what I know now".

The person will often then go on to say something like one of these:

"Just a few months ago I sold _____________ and had to pay a substantial sum in capital-gains taxes."

"Recently my buyer paid in full his note to me, and I had to pay $___________ in capital-gains taxes."

"Last Fall I sold the assets of my business. We faced a huge tax at the entity level, and then we incurred a tax again when the money was distributed to the shareholders."

"In October I sold my professional practice and incurred a large tax liability on the sale."

"Along with others, a while back I invested in a commercial property which we lost to the bank when we couldn’t keep up with our loan payments. According to the bank’s IRS Form 1099, we have a large tax liability for "forgiveness of debt" income, even though we lost the property!"

When I hear statements such as these, they almost burst out as expressions of strong regret, that the speaker didn’t know then what the speaker knows now: that a collateralized installment sale (or "C453") transaction could have mitigated or even avoided the problem. Usually the person next says, "Why didn’t my CPA/attorney/broker/financial planner/investment adviser or whoever tell me?"

I can’t help you with what you wish you had known then, but I can help you to know now what you will be glad you knew when now becomes then for some future transaction. A good place to start is with the new brochures which are now on the S.Crow Collateral Corp. Website, in the "Publications" list. Click on the "Publications" link above and read, or download and read, the publications which interest you. Share with friends who may benefit.

That way, you will know what you need to know when you need to know it, and you won’t be left with just your regrets because no one told you.—Stan Crow

This is the primary-source-vs-secondary-source question—and I have observed on a number of occasions that many tax advisers never, or only rarely, turn to the primary source: the tax law itself. Consequently, they give advice to their clients on the basis of what the tax adviser has heard about the law, rather than on the basis of the law itself.

A classic example of that occurred last week, when a tax adviser told his clients that their business, which used the accrual method of accounting, could not use installment reporting on the gain on the sale of the business’ assets.

The problem is that he was wrong, and the reason why he was wrong was that he was relying on out-of-date commentaries rather than on the statute itself. If he had checked the statute—the primary source—he would have learned that the statutory bar to installment reporting by accrual-basis taxpayers which was adopted in 1999 was repealed retroactively in 2000. In 2011, he was still advising his clients otherwise, no doubt relying on old articles about the 1999 enactment that has since been repealed.

It can happen to anyone. I know, because I, too, find it to be an enticing temptation, to take others’ word for it, about some arcane provision in the tax code. More than once, when I’ve actually gone to the effort to read the law for myself, I’ve found that it wasn’t quite the way it was represented to be.

I’ve learned from this that the law has a reputation just as people do; if enough people say that the law says such and such, more or less everyone will believe that it really says that. In that way, their mistaken belief about the law can become almost self-fulfilling, as people shape what they do to fit with the law’s reputation rather than with the law itself.

America has a whole industry of tax advisers who never actually read the law. It would be very healthy for them, if they would learn to read the tax law itself, for themselves. How about a self-discipline program, of reading even one section of the tax law every week?

The quality of their tax advice would markedly improve.—Stan Crow