Amending Returns After Reinstatement of Installment Method for Accrual-Basis Taxpayers

In Dec. 28, 2000, the Installment Tax Correction Act of 2000 repealed (retroactively) the 1999 repeal of the installment method of accounting for accrual-basis taxpayers; see Tax Clinic, "Congress Reinstates Installment Method for Accrual-Basis Taxpayers," TTA, March 2001, p. 151. The legislation failed, however, to provide any guidance for taxpayers that fully reported, under an accrual method, income from installment-sale transactions while the prohibition was in place. The IRS filled this void with Notice 2001-22. Generally, the notice allows taxpayers to elect the installment method by filing an amended return(s) before the expiration of the statute of limitations for the applicable tax year(s), to report income from an installment sale under the installment method.

Effect of Retroactive Repeal of Sec. 453(a)(2)

Prior to its repeal, Sec. 453(a)(2) prevented an accrual-method taxpayer from using the installment method for installment sales. It generally provided that "the installment method shall not apply to income from an installment sale if such income would be reported under an accrual method of accounting without regard to this section." The effective date of the amendment made by Sec. 453(a)(2) was generally Dec. 17, 1999.

The Installment Tax Correction Act of 2000 repealed Sec. 453(a)(2), thereby permitting an accrual-method taxpayer to again use the installment method for installment sales. Specifically, the legislation provides that Sec. 453 "shall be applied and administered as if" the 1999 change in law "had not been enacted."

Sec. 453(a) requires income from an installment sale to be reported under the installment method unless the taxpayer elects to have such method not apply to a particular disposition. Under Sec. 453(d) and Regs. Sec. 15A.453-1(d), a taxpayer must elect out of the installment method by the due date (including extensions) for filing the tax return for the year of disposition. The taxpayer makes the election by reporting the full amount of the installment-sale income on Schedule D of Form 1040 or on Form 4797, Sales of Business Property (Also Involuntary Conversions and Recapture Amounts Under Sections 179 and 280F(b)(2)). The Service grants a taxpayer that files a return timely without electing out an automatic extension to elect out by filing an amended return within six months of the return's due date (excluding extensions) (Regs. Sec. 301.9100-2(b)). A revocation of the election out of the installment method for any disposition may be made only with IRS consent (Sec. 453(d)(3)).

Because Sec. 453(a)(2) was repealed as if the 1999 amendment never took effect, taxpayers that fully reported income under an accrual method from an installment-sale transaction entered into from Dec. 17, 1999–Dec. 28, 2000 have effectively elected out of the installment-sale method, under Regs. Sec. 15A.453-1(d)(3)(i).

Notice 2001-22

Apparently recognizing the inequity of this situation, on Feb. 6, 2001, the Service issued Notice 2001-22, which gave IRS consent to revoke an effective election out of the installment method to an accrual-method taxpayer that filed a return by April 16, 2001, reporting income from an installment-sale transaction entered into on or after Dec. 17, 1999. Under the notice, a taxpayer may revoke its effective election out by filing (within the applicable limitations period) an amended return for the tax year of the installment sale (and for any other affected tax year), reporting the gain on the installment method. The IRS has informally confirmed that the notice was intended to address only those taxpayers that reported installment-sale transactions under Sec. 453(a)(2) (i.e., under an accrual method).

Thus, a taxpayer who had an installment-sale transaction after Dec. 16, 1999 and filed a return by April 16, 2001, reporting the transaction on the accrual method (i.e., reporting an amount realized equal to the selling price), can retroactively apply the installment-sale method to that transaction by filing an amended return(s) using the installment method for the transaction. If an amended return using the installment method is not filed, the election out of the installment method will not be revoked. Therefore, any returns for the year of sale and any subsequent years in which payments were received must be amended for the revocation to be effective. The taxpayer retains the opportunity to revoke the election out of the installment method as long as all tax years in which payments are received remain open.

Notice 2001-22 addresses only taxpayers who reported installment-sale transactions under Sec. 453(a)(2) (i.e., under the accrual method). Consequently, the notice does not provide direction to taxpayers who entered into an installment sale after Dec. 16, 1999 and before Dec. 28, 2000, but did not report an amount realized equal to the selling price on the return filed for the tax year in which such sale occurred (e.g., a disposition treated as an open transaction). Amendment under the notice is not applicable to such situations, as it affects only taxpayers that filed a return "reporting the sale on an accrual method of accounting (and, thus, an amount realized equal to the selling price)." If an accrual-basis taxpayer wishes to use the installment method to report a transaction not fully reported earlier under an accrual method, he may need to consider the implications of Rev. Rul. 90-38 and other accounting method issues.

From Alexa Mortenson, J.D., and Lynn Afeman, CPA, Washington, DC