The IRS has proposed regulations (Prop. Reg. §1.6011-13[1]) that would add monetized installment sales as a listed transaction, subject to the reporting provisions found in the regulations under IRC §6011 and the penalty rules of IRC §6707A when such disclosure is not properly and timely made.

Reportable and Listed Transaction Rules

The preamble to the proposed regulations describes the rules related to disclosures of reportable transactions, including the subset of such transactions that represent listed transactions.

Section 1.6011-4(a) provides that every taxpayer that has participated in a reportable transaction within the meaning of §1.6011-4(b) and who is required to file a tax return must file a disclosure statement within the time prescribed in §1.6011-4(e). Reportable transactions are identified in §1.6011-4 and include listed transactions, confidential transactions, transactions with contractual protection, loss transactions, and transactions of interest. See §1.6011-4(b)(2) through (6). Section 1.6011-4(b)(2) defines a listed transaction as a transaction that is the same as or substantially similar to one of the types of transactions that the IRS has determined to be a tax avoidance transaction and identified by notice, regulation, or other form of published guidance as a listed transaction.[2]

A major issue that applies to any analysis of whether a transaction is a listed transaction is whether the transaction the taxpayer engaged in is substantially similar to the listed transaction—in which case, it remains classified as a listed transaction.

Section 1.6011-4(c)(4) provides that a transaction is “substantially similar” if it is expected to obtain the same or similar types of tax consequences and is either factually similar or based on the same or similar tax strategy. Receipt of an opinion regarding the tax consequences of the transaction is not relevant to the determination of whether the transaction is the same as or substantially similar to another transaction. Further, the term substantially similar must be broadly construed in favor of disclosure. For example, a transaction may be substantially similar to a listed transaction even though it may involve different entities or use different Code provisions.[3]

Since reporting is triggered for years in which the taxpayer is deemed to participate in the transaction, the preamble discusses how those years are determined.

Section 1.6011-4(c)(3)(i)(A) provides that a taxpayer has participated in a listed transaction if the taxpayer’s tax return reflects tax consequences or a tax strategy described in the published guidance that lists the transaction under §1.6011-4(b)(2). Published guidance may identify other types or classes of persons that will be treated as participants in a listed transaction. Published guidance may also identify types or classes of persons that will not be treated as participants in a listed transaction.[4]

The preamble continues, providing instructions on how the transaction is to be disclosed, including the disclosure requirements when the transaction becomes a listed transaction after a return has been filed.

Section 1.6011-4(d) and (e) provide that the disclosure statement Form 8886, Reportable Transaction Disclosure Statement (or successor form) must be attached to the taxpayer's tax return for each taxable year for which a taxpayer participates in a reportable transaction. A copy of the disclosure statement must be sent to the IRS's Office of Tax Shelter Analysis (OTSA) at the same time that any disclosure statement is first filed by the taxpayer pertaining to a particular reportable transaction.

Section 1.6011-4(e)(2)(i) provides that if a transaction becomes a listed transaction after the filing of a taxpayer’s tax return reflecting the taxpayer’s participation in the listed transaction and before the end of the period of limitations for assessment for any taxable year in which the taxpayer participated in the listed transaction, then a disclosure statement must be filed with OTSA within 90 calendar days after the date on which the transaction becomes a listed transaction. This requirement extends to an amended return and exists regardless of whether the taxpayer participated in the transaction in the year the transaction became a listed transaction. The Commissioner of Internal Revenue (Commissioner) may also determine the time for disclosure of listed transactions in the published guidance identifying the transaction.[5]

The preamble next discusses the penalties that can apply to such transactions, including the failure to properly disclose them.

Participants required to disclose these transactions under §1.6011-4 who fail to do so are subject to penalties under section 6707A. Section 6707A(b) provides that the amount of the penalty is 75 percent of the decrease in tax shown on the return as a result of the reportable transaction (or which would have resulted from such transaction if such transaction were respected for Federal tax purposes), subject to minimum and maximum penalty amounts. The minimum penalty amount is $5,000 in the case of a natural person and $10,000 in any other case. For a listed transaction, the maximum penalty amount is $100,000 in the case of a natural person and $200,000 in any other case.

Additional penalties may also apply. In general, section 6662A imposes a 20 percent accuracy-related penalty on any understatement (as defined in section 6662A(b)(1)) attributable to an adequately disclosed reportable transaction. If the taxpayer had a requirement to disclose participation in the reportable transaction but did not adequately disclose the transaction in accordance with the regulations under section 6011, the taxpayer is subject to an increased penalty rate equal to 30 percent of the understatement. See section 6662A(c). Section 6662A(b)(2) provides that section 6662A applies to any item which is attributable to any listed transaction and any reportable transaction (other than a listed transaction) if a significant purpose of such transaction is the avoidance or evasion of Federal income tax.[6]

Taxpayers also face an extended statute of limitations if they do not file the required disclosures in a timely manner.

Participants required to disclose listed transactions who fail to do so are also subject to an extended period of limitations under section 6501(c)(10). That section provides that the time for assessment of any tax with respect to the transaction shall not expire before the date that is one year after the earlier of the date the participant discloses the transaction or the date a material advisor discloses the participation pursuant to a written request under section 6112(b)(1)(A).[7]

As well, the preamble describes the issues that apply to material advisers, but in this article we are concentrating on the impact on those who enter into the arrangements so we won’t cover that discussion.

The Transaction – Delay Payment of Taxes on Gains But Still Have Cash in the Taxpayer’s Hands (Too Good to be True? Yes, per the IRS.)

The preamble describes the transaction of interest in these regulations.

The Treasury Department and the IRS are aware that promoters are marketing transactions that purport to convert a cash sale of appreciated property by a taxpayer (seller) to an identified buyer (buyer) into an installment sale to an intermediary (who may be the promoter) followed by a sale from the intermediary to the buyer.[8]

The transaction begins with a purported installment sale by the taxpayer to the intermediary of the property in question.

In a typical transaction, the intermediary issues a note or other evidence of indebtedness to the seller requiring annual interest payments and a balloon payment of principal at the maturity of the note, and then immediately or shortly thereafter, the intermediary transfers the seller’s property to the buyer in a purported sale of the property for cash, completing the prearranged sale of the property by seller to buyer.[9]

So now we have what looks like a traditional installment sale between the buyer and the intermediary. However, the intermediary has no intention of holding the property, instead transferring the property to the ultimate buyer for cash. Now the cash is sitting in the hands of the intermediary and not in the hands of the buyer. Those promoting the structure have a solution to that problem.

In connection with the transaction, the promoter refers the seller to a third party that enters into a purported loan agreement with the seller.

Now the seller has cash but also has a debt owed to a third party. Meanwhile, the intermediary is stuck with cash and a liability to repay the debt. This situation is likely to introduce risk and costs into the mix that both the intermediary and the seller would prefer to avoid. Therefore, the solution looks to use the liquidity that the intermediary has to provide the third party with the funds to make this loan.

The intermediary generally transfers the amount it has received from the buyer, less certain fees, to an account held by or for the benefit of this third party (the account).[10]

And then we move to eliminate any risk for both the third party and the seller.

The third party provides a purported non-recourse loan to the seller in an amount equal to the amount the seller would have received from the buyer for the sale of the property, less certain fees. The “loan” is either funded or collateralized by the amount deposited into the account. The seller’s obligation to make payments on the purported loan is typically limited to the amount to be received by the seller from the intermediary pursuant to the purported installment obligation. Upon maturity of the purported installment obligation, the purported loan, and the funding note, the offsetting instruments each terminate, giving rise to a deemed payment on the purported installment obligation and triggering taxable gain to the seller purportedly deferred until that time.[11]

And now, the promotional materials explain the “tax magic” the promoter claims to have achieved with this structure.

The promotional materials for these transactions assert that engaging in the transaction will allow the seller to defer the gain on the sale of the property under section 453 until the taxpayer receives the balloon principal payment in the year the note matures, even though the seller receives cash from the purported lender in an amount that approximates the amount paid by the buyer to the intermediary.[12]

Not surprisingly, the IRS has announced its intention to challenge these arrangements.

The IRS intends to use multiple arguments to challenge the reported treatment of these transactions as installment sales to which section 453 purportedly applies, including the arguments described below.[13]

The IRS’s first argument is that there is no bona fide sale to the intermediary.

First, the intermediary is not a bona fide purchaser of the gain property that is the subject of the purported installment sale. In these transactions, the intermediary is interposed between the seller and the buyer for no purpose other than Federal income tax avoidance, and the intermediary neither enjoys the benefits nor bears the burdens of ownership of the gain property. The interposition of the intermediary typically takes place after the seller has decided to sell the gain property to a specific buyer at a specific negotiated purchase price, and the purported resale by the intermediary to such buyer generally takes place almost simultaneously with the purported sale to the intermediary for approximately the same negotiated purchase price, less certain fees. The seller’s only purpose for entering into an agreement with the intermediary is to defer recognition of the gain on the sale of the gain property to the buyer. Other than the Federal income tax deferral benefits provided by the installment method provisions of section 453, the sole economic effect of entering the monetized installment sale transaction from the perspective of the seller is to pay direct and indirect fees to the intermediary and the purported lender in an amount that is substantially less than the Federal tax savings purportedly achieved from using section 453 to defer the realized gain on the sale.

When an intermediate transaction with a third party is interposed and lacks independent substantive (non-tax) purpose, such transaction is not respected for Federal income tax purposes and the transaction is appropriately treated as a sale of the property by the seller directly to the buyer in the taxable year in which the gain property is transferred by the seller. See Commissioner v. Court Holding Co., 324 U.S. 331, 334 (1945) (“A sale by one person cannot be transformed for tax purposes into a sale by another by using the latter as a conduit through which to pass title. To permit the true nature of a transaction to be disguised by mere formalisms, which exist solely to alter tax liabilities, would seriously impair the effective administration of the tax policies of Congress” (footnote omitted)); Wrenn v. Commissioner, 67 T.C. 576 (1976), (holding that a taxpayer did not engage in a bona fide installment sale when the taxpayer transferred stock to his spouse under a purported installment sale contract, followed by the spouse immediately selling the stock to a third party for a negligible gain); Blueberry Land Co. v. Commissioner, 361 F.2d 93, 100 (5th Cir. 1966), (holding that a corporation’s transaction with an unrelated intermediary entered into solely to avoid Federal income taxes on the sale should be disregarded for Federal income tax purposes and the corporation should be taxed as if it sold the property directly to the ultimate buyer); Enbridge Energy Co. Inc. v. United States, 354 F. App’x 15 (5th Cir. 2009) (holding that an intermediate sale was a sham, the intermediary lacked a “bona fide role in the transaction,” as its only purpose for being a party in the transaction, and indeed for existing, was to mitigate the Federal tax bill arising from the transaction, and that the transaction should be treated, for Federal tax purposes, as a sale directly from the seller to the taxpayer).[14]

The agency also argues that the intermediary never takes true ownership of the transferred property.

In addition, it is inappropriate to treat the intermediary in the monetized installment sale transaction described in this NPRM as the acquirer of the gain property that is the subject of the purported installment sale because the intermediary neither enjoys the benefits nor bears the burdens of ownership of the gain property that a person must possess to be considered the owner of property for Federal income tax purposes. See Grodt & McKay Realty Inc. v. Commissioner, 77 T.C. 1221 (1981). See also Derr v. Commissioner, 77 T.C. 708 (1981) and Baird v. Commissioner, 68 T.C. 115 (1977).[15]

The IRS also argues that the seller should be treated as having received payment at the time of the sale, given these facts.

Second, in these transactions the seller is appropriately treated as having already received the full payment at the time of the sale to the buyer because (1) the purported installment obligation received by the seller is treated as the receipt of a payment by the seller under §15a.453-1(b)(3) since it is indirectly secured by the sales proceeds, or (2) the proceeds of the purported loan are appropriately treated as a payment to the seller because the purported loan is not a bona fide loan for Federal income tax purposes, or (3) the pledging rule of section 453A(d) deems the seller to receive full payment on the purported installment obligation in the year the seller receives the loan proceeds.[16]

Finally, the IRS argues that this transaction runs afoul of the economic substance requirement found in IRC §7701(o).

Third, the transaction may be disregarded or recharacterized under the economic substance rules codified under section 7701(o) or the substance over form doctrine. The step transaction doctrine and conduit theory may also apply to recharacterize monetized installment sale transactions described in this NPRM.[17]

The Proposed Regulation

Proposed Reg. §1.6011-13 is found at the end of the document. The regulation begins by stating that the described transaction will be treated as a listed transaction.

Transactions that are the same as, or substantially similar to, a transaction described in paragraph (b) of this section are identified as listed transactions for purposes of §1.6011-4(b)(2).[18]

Reg. §1.6011-13(b) provides the definition of the listed transaction, which is a monetized installment sale transaction.

A transaction is a monetized installment sale transaction if, in connection with the transaction, and regardless of the order of the steps, or the presence of additional steps or parties--

(1) A taxpayer (seller), or a person acting on the seller’s behalf, identifies a potential buyer for appreciated property (gain property), who is willing to purchase the gain property for cash or other property (buyer cash);

(2) The seller enters into an agreement to sell the gain property to a person other than the buyer (intermediary), in exchange for an installment obligation;

(3) The seller purportedly transfers the gain property to the intermediary, although the intermediary either never takes title to the gain property or takes title only briefly before transferring it to the buyer;

(4) The intermediary purportedly transfers the gain property to the buyer in a sale of the gain property in exchange for the buyer cash;

(5) The seller obtains a loan, the terms of which are such that the amount of the intermediary’s purported interest payments on the installment obligation correspond to the amount of the seller’s purported interest payments on the loan during the period. On each of the installment obligation and loan, only interest is due over identical periods, with balloon payments of all or a substantial portion of principal due at or near the end of the instruments’ terms;

(6) The sales proceeds from the buyer received by the intermediary, reduced by certain fees (including an amount set aside to fund purported interest payments on the purported installment obligation), are provided to the purported lender to fund the purported loan to the seller or transferred to an escrow or investment account of which the purported lender is a beneficiary. The lender agrees to repay these amounts to the intermediary over the course of the term of the installment obligation; and

(7) On the seller’s Federal income tax return for the taxable year of the purported installment sale, the seller treats the purported installment sale as an installment sale under section 453.[19]

Reg. §1.6011-13(c) gives details on what would constitute substantially similar transactions in this case.

A transaction may be substantially similar to a transaction described in paragraph (b) of this section if the transaction does not include all of the elements described in that paragraph. For example, a transaction would be substantially similar to a monetized installment sale described in paragraph (b) of this section if a seller transfers property to an intermediary for an installment obligation, the intermediary simultaneously or after a brief period transfers the property to a previously identified buyer for cash or other property, and in connection with the transaction, the seller receives a loan for which the cash or property from the buyer serves indirectly as collateral.[20]

Reg. §1.6011-13(d) defines who will be treated as a participant in such a transaction.

Participants in a monetized installment sale transaction described in paragraph (b) of this section include sellers, intermediaries and purported lenders described in paragraph (b) of this section and any other taxpayer whose Federal income tax return reflects tax consequences or the tax strategy described in paragraph (b) of this section or a substantially similar transaction. Buyers of gain property described in paragraph (b) of this section are not treated as participants.[21]

These are only proposed regulations, so they are not yet effective. The proposed regulations provide for the following proposed effective dates.

This section’s identification of transactions that are the same as, or substantially similar to, the transaction described in paragraph (b) of this section as listed transactions for purposes of §1.6011-4(b)(2) and sections 6111 and 6112 of the Code is effective the date that these regulations are published as final regulations in the Federal Register. Notwithstanding section 301.6111-3(b)(4)(i) and (iii) of this chapter, material advisors are required to disclose only if they have made a tax statement on or after the date that is 6 years before the date that these regulations are published as final regulations in the Federal Register.[22]

[1] REG-109348-22, August 4, 2023, https://public-inspection.federalregister.gov/2023-16650.pdf (retrieved August 4, 2023)

[2] REG-109348-22, August 4, 2023

[3] REG-109348-22, August 4, 2023

[4] REG-109348-22, August 4, 2023

[5] REG-109348-22, August 4, 2023

[6] REG-109348-22, August 4, 2023

[7] REG-109348-22, August 4, 2023

[8] REG-109348-22, August 4, 2023

[9] REG-109348-22, August 4, 2023

[10] REG-109348-22, August 4, 2023

[11] REG-109348-22, August 4, 2023

[12] REG-109348-22, August 4, 2023

[13] REG-109348-22, August 4, 2023

[14] REG-109348-22, August 4, 2023

[15] REG-109348-22, August 4, 2023

[16] REG-109348-22, August 4, 2023

[17] REG-109348-22, August 4, 2023

[18] Proposed Reg. 1.6011-13(a), August 4, 2023

[19] Proposed Reg. 1.6011-13(a), August 4, 2023

[20] Proposed Reg. 1.6011-13(a), August 4, 2023

[21] Proposed Reg. 1.6011-13(a), August 4, 2023

[22] Proposed Reg. 1.6011-13(a), August 4, 2023