OVERVIEW OF ISSUES RELATING TO THE

MODIFICATION OF THE INSTALLMENT SALES RULES 

BY THE TICKET TO WORK AND WORK INCENTIVES

IMPROVEMENT ACT OF 1999

Scheduled for a Hearing

Before the

SUBCOMMITTEE ON OVERSIGHT

of the

HOUSE COMMITTEE ON WAYS AND MEANS

on February 29, 2000

Prepared by the Staff

of the

JOINT COMMITTEE ON TAXATION

February 28, 2000

JCX-15-00
(i)

CONTENTS

Page

INTRODUCTION ................................................. 1

I. BACKGROUND AND PRESENT LAW ............................ 2

A. Methods of Accounting ........................................ 2

B. The Installment Method ........................................ 3

II. CHANGES IN THE INSTALLMENT METHOD ENACTED

IN THE TICKET TO WORK AND WORK INCENTIVES

ACT OF 1999 ................................................. 7

A. Overview . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7

B. Effect of Prohibiting the Use of the Installment Method for

Dispositions That Would Otherwise Be Reported Using an

Accrual Method of Accounting .................................. 7

C. Effect of Modifying the Pledge Rule . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11
1

 This pamphlet may be cited as follows: Joint Committee on Taxation, Overview of

Issues Relating to the Modification of the Installment Sales Rules by the Ticket to Work and Work

Incentives Improvement Act of 1999 (JCX-15-00), February 28, 2000.

-1-

INTRODUCTION

The Ticket to Work and Work Incentives Improvement Act of 1999 (“Ticket to Work

Act”), enacted on December 17, 1999, contains a provision that prohibits the use of the

installment method of accounting for dispositions of property that would otherwise be reported

for Federal income tax purposes using an accrual method of accounting. A related provision

modifies the installment sale pledge rule to provide that entering into any arrangement that gives

the taxpayer the right to satisfy an obligation with an installment note will be treated in the same

manner as the direct pledge of the installment note.

The House Committee on Ways and Means, Subcommittee on Oversight, has scheduled a

public hearing on February 29, 2000, to review the effects of the partial repeal of the installment

method of accounting on small business owners and to discuss possible regulatory and legislative

issues raised by the repeal. This document,1 prepared by the staff of the Joint Committee on

Taxation, describes present law and issues relating to the installment method and the changes to

that method included in the Ticket to Work and Work Incentives Improvement Act of 1999.
2

 Sec. 451(a).

3

 Treas. Regs. sec. 1.451-1(a).

4

 Scharf’s Estate v. Commissioner, 316 F. 2d 625 (7th Cir. 1963), Harris v.

Commissioner, (6th Cir. 1984) 745 F. 2d 378, Jones v. Commissioner, 306 F. 2d 292 (5th Cir.

1962).

5

 Adequate interest must be provided in such a note. If adequate interest in not provided,

interest will be imputed and the note revalued under section 1274. 

6

 Treas. Regs. sec. 1.61-2(d).

7

 Treas. Regs. sec. 1.451-2.

-2-

I. BACKGROUND AND PRESENT LAW

A. Methods of Accounting

The amount of any item of gross income is required to be included in the gross income of 

the taxable year in which it is received by the taxpayer, unless, under the method of accounting

used in computing taxable income, such amount is to be properly accounted for as of a different

period.2

Cash method

Under the cash receipts and disbursements method of accounting, an amount is includible

in gross income when it is actually or constructively received.3

 An amount does not have to be

received in cash in order to be includible in the gross income of a cash method taxpayer. For

example, the receipt of a negotiable note requires the value of the note to be included in gross

income when the note is received,4 even if the note does not require payment in cash until some

future time.5

 Similarly, the receipt of other types of property or benefits may require their value

to be included in income at the time they are received without regard to when, or if, they are

ultimately converted to cash.6

A cash method taxpayer must also include an item in gross income if it is constructively

received, even if the taxpayer has not reduced it to possession. An amount is constructively

received if it is credited to the taxpayer’s account, set apart for the taxpayer, or otherwise made

available so that the taxpayer may draw on it.7

Accrual method
8

 Treas. Regs. sec. 1.451-1(a).

9

 Sec. 453(f).

-3-

Under the accrual method of accounting an amount generally is includible in gross

income when all the events have occurred which fix the right to receive such income and the

amount thereof can be determined with reasonable accuracy.8

 There is no requirement that cash,

a note, or other property be received by the taxpayer. Under the accrual method of accounting,

the item is includible in gross income because the right to receive the income is fixed, not

because the income has actually been received.

B. The Installment Method

In general

The installment method provides an exception to the general principles of income

recognition by allowing a taxpayer to defer the inclusion in income of amounts that are to be

received from the disposition of certain types of property until payment in cash or cash

equivalents is received. In general, a taxpayer using the installment method recognizes gain

equal to the amount of payments received during the taxable year times the ratio the profit on the

disposition bears to the total contract price. For this purpose, payments do not include the receipt

of evidences of indebtedness of the person acquiring the property, unless such evidences of

indebtedness are payable on demand, or are issued by a corporation or governmental entity and

are readily tradable.9

For example, in 2000, an individual taxpayer (who is not in the trade or business of

selling real estate) sells non-farm real property with a basis of $100,000 for $1,000,000, realizing

a gain of $900,000 and establishing a profit ratio of 90%. At closing, the taxpayer receives

$200,000 in cash and an $800,000 note bearing adequate interest that is due in 2002. The

taxpayer would recognize gain of $180,000 ($200,000 received times the profit ratio of 90%) in

2000 and an additional gain of $720,000 ($800,000 received on payment of the note times the

profit ratio of 90%) in 2002. The interest on the note would be included in gross income by the

taxpayer according to the taxpayer’s normal method of accounting.

The installment method defers the recognition of income compared to both the cash and

accrual methods. Compared to the cash method, the installment method permits additional

deferral when payment is received in the form of a negotiable note. The deferral is more

pronounced when the installment method is compared to the accrual method, since the accrual

method requires income to be recognized as soon as the taxpayer has a right to the income,

without regard to when payment is received. For most dispositions, the accrual method requires

income to be recognized when title to the property passes, which may substantially precede the

time payment is received.
10 Sec. 453A(a)(1).

11 The net proceeds equal the gross loan proceeds less the direct expenses of obtaining the

loan.

12 Sec. 453A(d)(4).

-4-

Pledge rules

A special pledge rule10 provides that if an installment obligation is pledged as security for

any indebtedness, the net proceeds11 of such indebtedness are treated as a payment on the 

obligation, triggering the recognition of income to the same extent as would the receipt of cash. 

The pledge rule requires the same recognition of income whether the taxpayer receives cash from

the purchaser or uses an installment obligation to secure borrowings from a third party. Actual

payments received on the underlying installment obligation subsequent to the receipt of the loan

proceeds are not taken into account until such subsequent payments exceed the loan proceeds

that were treated as payments. For dispositions occurring on or after December 17, 1999, an

installment obligation is considered to be pledged as security for an indebtedness to the extent an

arrangement allows the taxpayer to satisfy all or a portion of the indebtedness with the

installment obligation.12

For example, in 2000, an individual taxpayer (who is not in the trade or business of

selling real estate) sells non-farm real property with a basis of $100,000 for $1,000,000; realizing

a gain of $900,000 and establishing a profit ratio of 90%. At closing, the taxpayer receives

$200,000 in cash and an $800,000 note bearing adequate interest that is due in 2003. In 2001,

the taxpayer borrows $300,000 pledging the note as collateral. In 2002, the taxpayer receives a

$300,000 prepayment on the note. The remainder of the note is paid when due in 2003.

Under the installment method, the taxpayer reports gain to the extent of proceeds

received. In the year of sale, the taxpayer would recognize gain of $180,000 ($200,000 received

times the profit ration of 90%).

In 2001, the taxpayer is required to report an additional $270,000 of the gain ($300,000 X

.9) because the pledging of the note for the $300,000 loan is treated as a payment of $300,000 on

the installment obligation. Subsequent payments on the loan would not be taken into account

until they exceed the amount ($300,000) that was considered paid as a result of the pledge. Thus,

this taxpayer would not report any gain as a result of the $300,000 prepayment in 2002. The

final payment of $500,000 on the note in 2003 would cause the remaining $450,000 of gain to be

recognized.
13 Sec. 453A(b)(1).

14 Sec. 453(i).

15 Sec. 453(a)(2).

16 Sec. 453A(a)(1).

17 Sec. 453A(c)(2). The underpayment interest rate is the statutory rate under sec.

6621(a)(2) and is equal to the Federal short-term rate plus three percentage points.

-5-

The pledge rules do not apply to small installment sales, those where the sales price does

not exceed $150,000.13

Limits on the use of the installment method

The installment method may not be used in connection with the sale of certain types of

property. Taxpayers (other than farmers and dealers in timeshares and residential lots who elect

to pay an interest charge on the taxes they defer by using the installment method) are not allowed

to use the installment method for sales to customers in the ordinary course of business or for

sales of property of a type that is normally held for sale to such customers. In addition, the

installment method may not be used with respect to the disposition of property on a revolving

credit plan or the disposition of stocks or securities that are traded on an established securities

market. In the case of sales of personal property, any gain that is attributable to depreciation on

personal property must be included in gross income in the year of sale.14 The installment method

may be used only to defer the portion of the gain that exceeds the accumulated depreciation. For

dispositions occurring on or after December 17, 1999, the installment method may not be used if

the income from the disposition would otherwise be reported under an accrual method of

accounting.15

Limits on tax deferral benefits in large installment sales

The amount of benefit that may be obtained through the use of the installment method is

limited by the imposition of an interest charge on the tax deferral attributable to the portion of the

installment sales that arise during and remain outstanding at the close of the taxable year that

exceeds $5 million.16 Dispositions where the sales price does not exceed $150,000 are not taken

into account for the purpose of determining whether outstanding installment sales arising during

and remaining outstanding at the close of the taxable year exceed $5 million. Interest accrues at

the same rate as applies to underpayments of income tax and is treated as interest expense for

other Federal income tax purposes.17

Assuming that the underpayment rate is an accurate measure of the taxpayer’s cost of

funds, the interest charge should put the taxpayer in an equivalent economic position to that it
18 $1,000,000 X (10/11) = $909,090.

-6-

would have been in had the installment method not been available. However, this is true only to

the extent the interest charge applies. Because the interest charge does not apply to the first $5

million of installment sales that arises during and remains outstanding at the close of the taxable

year, a taxpayer may obtain significant tax deferral benefits without being subject to the interest

charge.

For example, three cash-basis taxpayers own unimproved land worth $11 million with a

basis of $1 million. The first taxpayer sells its land for cash and recognize a gain of $10 million

in the year of sale. The second taxpayer sells its land for $1 million cash and a note for $10

million due in 5 years. The installment method allows the second taxpayer to limit the gain it

recognizes in the year of sale to $909,09018 and defer the tax on the remainder of its $10 million

gain for 5 years. However, the second taxpayer is required to pay an interest charge on one half

of its tax deferral, the portion of the installment sale that arose during and remain outstanding at

the close of the taxable year in excess of $5 million.

The third taxpayer sells an undivided one-half interest in its land for $500,000 down and

a $5 million note due in 5 years, and then sells its remaining interest in the land the following

year on the same terms in an unrelated transaction. The third taxpayer will be able to use the

installment method without being subject to the interest charge, since the amount of installment

sales arising during and remaining outstanding at the close of any taxable year never exceeds $5

million.
-7-

II. CHANGES IN THE INSTALLMENT METHOD ENACTED IN THE TICKET TO

WORK AND WORK INCENTIVES ACT OF 1999

A. Overview

The Ticket to Work and Work Incentives Act of 1999 (“The Ticket to Work Act”) made

two significant changes to prior law with respect to installment sales.

First, a provision in the Ticket to Work Act prohibits the use of the installment method of

accounting for dispositions of property that would otherwise be reported for Federal income tax

purposes using an accrual method of accounting. The provision did not change present law

regarding the availability of the installment method for dispositions of property used or produced

in the trade or business of farming. The provision also did not change present law regarding the

availability of the installment method for dispositions of timeshares or residential lots if the

taxpayer elects to pay interest under section 453(l). The provision did not change the ability of a

cash method taxpayer to use the installment method where the cash method taxpayer is

considered to be the seller of the property.

A second provision in the Ticket to Work Act modifies the pledge rule to provide that

entering into any arrangement that gives the taxpayer the right to satisfy an obligation with an

installment note will be treated in the same manner as the direct pledge of the installment note. 

For example, a taxpayer disposes of property in an installment sale. If the taxpayer pledges the

installment note as security for a loan, or enters into an arrangement that gives it the right to

“put” or repay the loan by transferring the installment note to the taxpayer’s creditor, it would be

required to treat the proceeds of such loan as a payment on the installment note and recognize

the appropriate amount of gain.

The modification of the pledge rule applies only to installment sales where the pledge

rule of prior law applied. Accordingly, the new rule does not apply to (1) installment method

sales made by a dealer in timeshares and residential lots where the taxpayer elects to pay interest

under section 453(l)(2)(B), (2) sales of property used or produced in the trade or business of

farming, or (3) dispositions where the sales price does not exceed $150,000, since such sales

were not subject to the pledge rule under prior law.

B. Effect of Prohibiting the Use of the Installment Method for Dispositions That Would

Otherwise Be Reported Using an Accrual Method of Accounting

Sales by accrual method taxpayers

The change made by the Ticket to Work Act to prohibit the use of the installment method

for dispositions that would otherwise be reported using an accrual method of accounting

effectively prevents such taxpayers from using the installment method. Accrual method

taxpayers are now required to report income from all sales under an accrual method, i.e., when all
19 Report 106-201, Report by the Committee on Finance to Accompany S. 1792, the Tax

Relief Extension Act of 1999, at p. 38.

-8-

the events have occurred that fix the taxpayer’s right to receive the income and the amount of the

income can be determined with reasonable accuracy.

Prior to enactment of The Ticket to Work Act, an accrual basis corporation was allowed

to use the installment method for the sale of any item that was not of a type held for sale to

customers in the ordinary course of business or a publicly traded security. If the installment sales

for the year exceeded $5 million, an interest charge might have applied to a portion of the tax

deferred by using the installment method, but the method was available.

The provision was included in Tax Relief Extension Act of 1999, as reported by the

Senate Finance Committee. The legislative history indicates that the Senate Finance Committee

believed that the installment method is inconsistent with the use of the accrual method of

accounting and that the continued use of the installment method in such situations would allow a

deferral of gain that is inconsistent with the requirement of the accrual method that income be

reported in the period it is earned, rather than the period it is received.19

Sales of accrual method S corporations by cash method owners

The change made by the Ticket to Work Act to prohibit the use of the installment method

for dispositions that would otherwise be reported using an accrual method of accounting is

expected to affect the availability of the installment method in certain transactions involving the

sale of S corporation shares. In particular, this is expected to be the case where the owners of an

S corporation sell their stock and an election is made to deem the S corporation to have sold its

assets in order to provide, among other benefits, a step-up in the basis of the assets of the S

corporation to the purchaser.

The consequences resulting from the change made by the Ticket to Work Act depend

upon whether the disposition in question is a sale by the S corporation of its assets or a sale by

the shareholder of the S corporation stock. An S corporation is a corporation whose taxable

income or loss is passed through and taken into account by the corporation’s shareholders, rather

than by the corporation itself, whether or not the income is distributed. An S corporation can

have a method of accounting that is different from the methods used by its shareholders.

The change made by the Ticket to Work Act does not affect the ability of a cash method 

S corporation shareholder to use the installment method to sell its shares. In that case, the sale is

made by a cash method taxpayer and the installment method remains available. The change

made by the Ticket to Work Act does prevent an accrual method S corporation from selling its

assets using the installment method, whether the S corporation is the actual seller or is deemed to

have sold its assets as a result of a section 338 election.
20 Sec. 338.

21 Sec. 453(h), Prop. Regs. sec. 1.338(h)(10)-1.

22 See Rev. Rul. 68-13, 1968-1 C.B. 195, Rev. Rul. 57-434, 1957-2 C.B. 300.

-9-

This potentially affects a common method of selling an S corporation to an outside buyer. 

Such buyers generally prefer to acquire the assets of the company and not its stock. This allows

the new owners to use their cost as the basis of the assets and recover the purchase price through

depreciation and amortization. This also limits the legal liabilities associated with the old

company that the purchasers may be responsible for. On the other hand, most sellers prefer to

sell their stock.

The Federal tax law allows a corporation to elect to be treated as having sold its assets.20

This allows the shareholders to sell stock and the purchasers to purchase assets, maximizing the

amount of basis allowed for future cost recovery. Prior to the publication of proposed

regulations in 1999, it was not clear that the election could be made by an S corporation. 

However, prior to the effective date of the Ticket to Work Act, the IRS addressed the availability

of this election and held that it did not significantly affect the ability of the shareholders to use

the installment method for the sale of their S corporation stock. The effect of the election was to

treat the company as having taken an installment note in exchange for its assets and then to have

distributed the note to the shareholders. The installment note retained its status and did not

trigger an acceleration of income in the hands of the former S corporation shareholders.21

As a result of the enactment of the Ticket to Work Act, the installment method is no

longer available to the accrual method corporation for dispositions occurring on or after

December 17, 1999. In that case, the section 338 election to treat the S corporation as having

sold its assets triggers gain at the S corporation level where the installment method is no longer

available. Since an S corporation is required to pass corporate level gain through to its

shareholders, the benefits of the installment method are lost to the shareholders if a section 338

election is made.

Sales of accrual method sole proprietorships by cash method owners

The effect of the change made by the Ticket to Work Act to prohibit the use of the

installment method for dispositions that would otherwise be reported using an accrual method of

accounting on the sale of an accrual method sole proprietorship by a cash basis owner is not

clear.

The IRS has traditionally taken the position that a sale of a business that is operated as a

sole proprietorship is to be considered as a sale of the individual assets that make up the

business.22 Accordingly, the IRS denies the availability of the installment method with respect to

the disposition of inventory or marketable securities of a sole proprietorship, and will require the
-10-

immediate recapture of accumulated depreciation on personalty before the installment method is

applied to any remaining gain. It has been suggested that this approach requires the sale to be

considered to be made by the business, and not by the owner in his or her capacity as an owner. 

If this is the case, it would appear that an accrual method sole proprietorship could not be sold

using the installment method.

A reading of the above cited Revenue Rulings suggests that the IRS approach was

developed to limit the use of the installment method with respect to the sale of inventory. It does

not follow that the sale also must be considered to be made by the accrual method business rather

than the cash method owner. To the extent the installment sale is not in the ordinary course of

the business, as would be the case if all or a substantial portion of the assets of the business were

being sold and the owner does not intend to continue in the business, it may not be appropriate to

assign the sale to the accrual method business rather than the cash method owner. An

interpretation that treats the cash method owner as the seller, while retaining the concept of the

sale of individual assets stated in the Revenue Rulings, could allow the continued access to the

installment method for sales of sole proprietorships without extending it beyond the reach of

prior law and allowing it to apply to the sales of inventory and marketable securities.

Requiring the sale of the assets of an accrual method sole proprietorship to be treated as a

sale by the business and not by the owner is of particular concern because the sole proprietorship

form does not provide an alternative for the transfer of ownership. A sole proprietor can only

transfer the assets of the business, while a partner can transfer his or her partnership interest and

a shareholder can transfer his or her stock. In either of these cases, assuming the owner did not

elect to treat the sale as being made by the business, a cash method owner would retain access to

the installment method.

Sales of accrual method partnerships by cash method partners

The change made by the Ticket to Work Act to prohibit the use of the installment method

for dispositions that would otherwise be reported using an accrual method of accounting is not

expected to have a significant effect on the sale of an interest in an accrual method partnership by

a cash method partner. Typically, such transactions involves the sale of the partnership interest

to the new partner by the old partner. Alternatively, they may involve the redemption of the old

partner by the partnership in connection with a contribution to the partnership by the new partner. 

In either case, the sale is made by the cash method partner, and access to the installment method

is not affected by the change in the Ticket to Work Act.

Following the transfer of a partnership interest, a partnership may elect to adjust the basis

of partnership property to reflect the purchase price of the partnership interest. This election is

made by the partnership under section 754 and does not affect the tax treatment of the selling

partner.
-11-

C. Effect of Modifying the Pledge Rule

The change made by the Ticket to Work Act that modifies the pledge rule provides that

entering into any arrangement that gives the taxpayer the right to satisfy an obligation with an

installment note is treated in the same manner as a direct pledge of the installment note.

For example, a taxpayer disposes of property for an installment note and the disposition is

properly reported using the installment method. The taxpayer normally only recognizes gain as

it receives the deferred payment but, if the taxpayer pledges the installment note as security for a

loan, the taxpayer is required to treat the proceeds of such loan as a payment on the installment

note and to recognize the appropriate amount of gain. As a result of the change made by the

Ticket to Work Act, the taxpayer also is required to treat the proceeds of a loan as payment on

the installment note to the extent the taxpayer has the right to “put” or repay the loan by

transferring the installment note to the taxpayer’s creditor. Other arrangements that have a

similar effect are treated in the same manner.

This modification of the pledge rule applies only to installment sales where the pledge

rule of present law applies. Accordingly, the provision does not apply to (1) installment method

sales made by a dealer in timeshares and residential lots where the taxpayer elects to pay interest

under section 453(l)(2)(B), (2) sales of property used or produced in the trade or business of

farming, or (3) dispositions where the sales price does not exceed $150,000, since such sales are

not subject to the pledge rule under present law.