Capital Gains Pain

Entrepreneur, June, 2000 by Stephen Barlas

New legislation hurts both buyers and sellers of businesses.

Entrepreneurs trying to sell businesses are running into problems, thanks to legislation passed by Congress in 1999 at the Clinton administration's behest. Now, because of heated protests about the bedeviling bill, Congress has uttered an "oops" in the form of a House bill reinstituting use of the installment method for accounting for the income earned from the sale of a business.

Last year's Ticket to Work and Work Incentives Improvement Act requires S and C corporation owners to pay a capital gains tax upfront when they sell their business, if they're accrual-basis taxpayers and regardless of when they received proceeds from the sale. Bank lending is typically unavailable to a buyer, who generally takes a loan from the seller. The installment method allows the seller to record those loan repayments as he or she receives them over a period of years.

Eliminating the installment method forces the seller to record the entire sale upfront. Because the tax load is greater, the seller must demand a bigger down payment from the buyer--which limits the pool of buyers and thereby decreases the value of the business for sale.

Neither Congress nor the Clinton administration anticipated the severe adverse consequences of eliminating the use of the installment method for accrual taxpayers. "That provision is causing real pain," says Giovanni Coratolo, director of small-business policy at the U.S. Chamber of Commerce. He figures that 200,000 small businesses are sold each year.

In March, the House passed H.R. 3081 (Small Business Tax Fairness Act), which includes H.R. 3594, a bill from Rep. Wally Herger (R-CA) that restores the installment method. But Clinton has threatened to veto the bill due to other provisions it includes. Because H.R. 3081 passed on an essentially party-line vote of 257-169, Congress would have trouble overriding the veto.

Meanwhile, there's effort in the Senate to pass a narrow installment method bill, which contains just one provision, similar to H.R. 3594. If it passes, it could be "conferenced" with the House-passed H.R. 3594 and sent to the president.

Even though there'd be substantial bipartisan support for it, Clinton isn't likely to sign a bill reinstituting the installment method for all accrual taxpayers. But compromise is possible, notes Joseph Mikrut, tax legislative counsel at the U.S. Treasury. He thinks the installment method might be allowed for a select segment of small businesses, like those with less than $5 million in sales. Insists Mikrut, "We understand legislation has imposed financial burdens on small businesses."

Stephen Barlas is a freelance business reporter who covers the Washington beat for 15 magazines.