Timing of income from purchase money note

Timing of income from purchase money note

October 07, 2019 | By Keith Martin in Washington, DC

A solar equipment manufacturer lost an attempt in court to spread its taxable income from equipment sales over time.

King Solarman makes mobile LED lighting platforms that are powered by solar panels. Each mobile platform is a two- or four-wheel cart with a battery pack inside, solar panel and extendable tower with LED lights. The solar panel generates electricity during the day that is stored in the battery. The lights draw on the battery at night for power. The devices are used to light parking lots, construction sites and other remote locations

The company sold and leased back 162 units in a single transaction in 2014 presumably to transfer the tax benefits to passive investors. It sold the 162 units to a “fund” that was owned 99% by the passive investors, and 1% by it, for $7,938,000. The fund paid $2,268,814 in cash for the 162 units and gave a note for the balance of $5,794,740. The note required fixed monthly payments over 31 months. The fund immediately leased the units to an intermediary company that subleased them back to King Solarman.

King Solarman reported the cash payment as income in 2014, but did not report the rest of the purchase price to be paid over time under the note.

The IRS said the company should have reported the full purchase price as income in 2014, and the US Tax Court agreed in a decision released in August.

King Solarman was an accrual taxpayer rather than cash taxpayer. Manufacturers selling inventory are generally required to use the accrual method.

Usually someone selling property for payments over time is allowed to use the “installment sale method” and report its gain on sale over the period the installment payments are received. However, the installment method cannot be used by vendors selling inventory.

The company had more than $12 million in sales revenue, which was too much to be able to qualify for relief as a small business.

It argued that it should be able to deduct future expenses — for example, future rent under the related leaseback — as an offset against the sales income. The court said no.

The case is King Solarman, Inc. v. Commissioner.