Did you sell your business in 2012 and defer any of the purchase price?  This could be the case if you financed part of the purchase price (i.e., you took back the buyer’s note), or there was an earnout whereby you receive more money if you meet certain performance goals or some of your sales proceeds went into an indemnification escrow to secure breaches of the agreement.   Would you like to lock in 2012’s low long-term capital gains tax rate for all of the taxable gain to be reported from the sale?   If the answer is yes, keep reading.

Each of the sales transactions just described is an installment sale for tax purposes because payment of all or part of the purchase price is deferred past 2012.   When you sell property on an installment sale, you report the gain on the sale only as you receive cash payments.  The tax rates in effect when each payment is received determines your taxes payable on the gain reported.  For those sellers who sold capital gain property in 2012 or earlier years and deferred receipt of part of the purchase price past 2012, the portion of the purchase price received after 2012 will, absent Congressional action, be subject to a substantially higher tax rate (15% in 2012 versus upwards of 25% in 2013 and thereafter, before taking into account California’s higher tax rates which are presently in effect).

For sales taking place in 2012, however, sellers can take action to lock in the lower 2012 tax rates.  All they need to do is opt out of the installment method of reporting their gain.  This election need not be made until their 2012 tax return is due (including extensions), which is as late as October 15, 2013.  So, with the benefit of hindsight, sellers can determine the appropriate course of action to take.

The election is not without a cost.  The seller would be required to report all of the gain from the sale on their 2012 tax return and pay the taxes on that gain.  Naturally, no further tax is due as the payments are received in later years.  Hopefully, the seller will have received enough cash from the sale to pay the taxes due.  If not, it is possible to discount the value of the deferred purchase price and report less gain (and pay less tax) in 2012.  However, this is inconsistent with the goal of locking in today’s low tax rates for all of the gain.

To undertake this strategy, the seller would need to make themself penalty proof on estimated taxes and pay the full amount of taxes on April 15, 2013.  So, working with your accounting professional is imperative in implementing this strategy.