Am I eligible for an installment sale?

March 28, 2003

Subject:   ISO installment sale
Date:   Sun, 16 Mar 2003
From:   Walter

In tax year 2002 I exercised a large number of ISO’s in a privately held company. I then left the company. The company sold my stock and gave me a promissory note. They reported as income on my W-2 the gain on shares held less than one year. Am I eligible for an installment sale? My tax advisor (CPA) does not think I can back off income from the W-2 without triggering an IRS inquiry. Please help.

Thank you.



Date:   Mon, 24 Mar 2003

Hello Walter,

It appears to me that this is not a transaction that qualifies for installment sale reporting, because the income is compensation instead of income from “a disposition of property.” I know this is pretty technical and doesn’t seem to make sense. Since there is a recharacterization of the income from capital gain to compensation, it doesn’t qualify for installment sale reporting.

An alternative question is whether the transaction qualifies for deferred compensation treatment. Since you received “property” – a note – instead of an unsecured promise contract, I don’t think it qualifies as deferred compensation, either.

I think your best bet is to have the note appraised. Private party notes typically have a fair market value far below the face amount. You could then redetermine your ordinary income based on the fair market value of the property received. The excess collected over the fair market value would be reported as interest income as the payments are collected.

Yes, changing the amount reported on Form W-2 can result in IRS scrutiny, so you should include full disclosure with your income tax return. Look at the amount of tax you postpone from following this method to decide if it’s worth the expense involved.

Good luck!

Mike Gray

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