Gain Adjustment and Recognition

Technical topics regarding tax preparation.
#1
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My client sold his business in 2021 for 650k, part of the deal was that both he and his partner would stay on as employees for three years and part of the sales price was tied to that commitment. For 2021 my client recognized all gain as it relates to the sale which he elected to do for tax purposes even though 250k of the sales price was to be received over a three-year period going forward. My client's partner decided he does not want to work for the company any longer and part of the deal was that if such action occurred that the receivable would be adjusted downward by 125k, thus effectively reducing the sales price from 650k down to 525k. All gain was recognized in 2021, the question is should 2021 be amended to reflect that sales price of 525k what should be done in 2022 to reflect that the gain previously recognized has been reduced? I have not filed the 2021 1120s as it has been on extension.
 

#2
Wiles  
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Amend, but it has not been filed yet?? I'm confused.
 

#3
Nilodop  
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Three ways to report such a sale. Which is yours? Each has its rules.
https://www.cpajournal.com/2020/06/16/a ... ligations/
And I'd have to think a bit about whether this sentence is accurate.
Because the method of accounting for a transaction is usually irrevocable, once a taxpayer makes a method election, that method will likely govern regardless of the eventual outcome of the contingent consideration.
 

#4
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I have not filed the return for 2021 yet. From the responses, I will adjust the sales price and file the return for 2021.
 

#5
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I have not filed the return for 2021 yet. From the responses, I will adjust the sales price and file the return for 2021.

I’m not sure if everyone caught on to the nuance of your situation. You’re saying that the sale took place in 2021. And I “think” you are implying that the decision to terminate employment took place in 2022. You didn’t say. But if that’s the case, then the issue becomes: Are we required to report in 2021 based on what we knew as of 12/31/21? Or, are we allowed to report, in 2021, based on events that took place subsequent to 2021 (i.e., termination of employment)?
 

#6
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this is exactly what I was asking. I indicated that the sale took place in 2021 and a subsequent event in 2022 changed the sales price, but when should I recognize the change? Can we explore Jeff's observation and answer if 2021 should be filed recognizing the full sales price? if so, what about 2022?
 

#7
Nilodop  
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I definitely missed that nuance.

The reg. itself does not say when to value the consideration. In OP's facts, we'd probably want to know as much as possible about the likelihood that existed, at the date of the sale, that the price would end up being reduced. And maybe that's separate for each seller, as in did the one partner know pretty much that he would not stay on as an employee? And as I read the facts, it'd the 2021 1120S that's not yet filed, but (maybe) based on wording in OP, one owner filed with the higher amount assumed. Hard to say. And certainly, even if the rule is to value as of sale date, w/o regard to subsequent events, a large amount of judgment goes into valuation, and how, at this late date, can either selelr know for sure what he was expecting/intending at the sale date.
 

#8
Nilodop  
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It's interesting that the decision of one owner affected the overall sale price/proceeds of both owners.

In the Lombardi TCM case in 1994, there is this language:
Here, the gross selling price is the total $488,000 purchase price agreed to between the parties as it appeared on the contract of sale. The subsequent renegotiation between the parties and the reduction in this price occurred in 1986, which was 2 years following the year of sale and subsequent to the years in issue. Petitioners cannot retroactively seek a recalculation of their selling price and the gross profit based on events which occurred following the year of sale. See Cox v. Commissioner [Dec. 32,601], 62 T.C. 247, 255 (1974). The selling price on this installment sale remains at respondent's figure of $488,000.


But the reliance on Cox may be misplaced. That case was about changing the contract in a later year to meet the 30% rule for installment sales (old law).

My bottom line - yes, you should value at date of sale, but there is enough room for judgment call to be made taking into accout later events that may have been anticipated at that date.
 

#9
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I don’t know whether this helps or not, but here’s a quote from Goetze Gasket & Packing Co., Inc. v. Commissioner, 24 T.C. 249 (1955):

A taxpayer on an accrual basis is not required to include in the "amount realized" (as property other than money) the value of the right to receive property in a future year where there is a substantial contingency as to the amount ultimately to be received.

https://scholar.google.com/scholar_case?case=2814750129065230733&hl=en&as_sdt=6&as_vis=1&oi=scholarr
 

#10
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Based on the responses I am reading, I think that the best way to handle this transaction is to value the sale in 2021 at the contract sales price and calculate the taxable gain for 2021 under the installment method and not to elect treat or recognize all of the sales in the year of the disposition. The reduction is part of the contract, whereas the owners who sold their business were required to stay on, and if not, then the future receivable would be reduced. This reduction was contemplated but not anticipated otherwise they would have negotiated the deal differently. The contract sales were for 650k in 2021, 250k of it receivable in future years. The 250k was to be reduced if an owner now employee quit; this is what happened one of the guys quit. My issue was when to recognize this event (the quit and reduction to the sales price); was it all recognized in 2021 and the subsequent event recognized in 2022 or go back to a return (not filed yet, on extension till 9/15) and reduce the sales price?
 

#11
Nilodop  
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To me, this is fascinating. Is it true? It's interesting that the decision of one owner affected the overall sale price/proceeds of both owners.
 


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