IRS Limits Agents' Use of Constructive Receipt with Collateralized Letters of Credit

By Maples, Larry | The CPA Journal, June 2002 | Go to article overview

IRS Limits Agents' Use of Constructive Receipt with Collateralized Letters of Credit


Maples, Larry, The CPA Journal


IT IS CRUCIAL TO UNDERSTAND WHAT THE IRS MEANS by "standby letter of credit," the type of property securing the letter of credit, and the effect of changes in the underlying security.

In two recent instances, IRS field offices attempted to treat a note collateralized by a letter of credit as immediate income under the doctrine of constructive receipt, only to be rebuffed by the IRS's national office. The relevant technical advice memoranda (TAM) herald an important development for taxpayers that receive amounts in an installment sale collateralized by a letter of credit.

Background

Accrual taxpayers normally cannot defer income with a letter of credit since the receipt of a note is taxable regardless of the collateral arrangement. Cash basis taxpayers or installment sellers, on the other hand, can claim that a letter of credit is merely security and thus not taxable until either the note or the letter of credit is collected. The IRS has often taken the position, however, that a letter of credit is a cash equivalent under IRC section 451.

There is, however, judicial conflict over the meaning of this doctrine of cash equivalency. Taxpayers have often cited the Fifth Circuit's decision in Cowden [61-- 1USTC 9382, 289 F.2d 20 (CA-5, 1961) rev'g 20 TCM 1635 (1961)] to establish that the fair market value of an item does not necessarily determine its cash equivalency. The Fifth Circuit believed that lack of transferability or a market where the instrument would trade at a substantial discount would argue against cash equivalency. The Ninth Circuit, however, held in Warren Jones [75-2 USTC 9732, 524 F.2d 788 (CA-9, 1975) rev'g 60 TC 663 (1973)] that the market value of the instruments should be included in income even if they could only be sold at substantial discounts. The Ninth Circuit observed that the availability of installment reporting would cushion taxpayer hardship in this situation. Such a cushion becomes moot, however, if the IRS treats the security for the note as "payment" under the installment sale rules.

The specific question of whether a letter of credit triggers income has never been clearly answered by the courts. In Watson [80-1 USTC 9302 (CA-5, 1980) aff'g 69 TC 544)], the Tax Court taxed a letter of credit received by a seller. The Tenth Circuit thought that a standby letter of credit avoids this fate because it is nontransferable [Sprague, 80-2 USTC 9631, 627 Fd 1044 (CA-10, 1986) rev'g DC 76-2 USTC 9566], but the Tax Court disagreed [Griffith 73 TC 933 (1979)].

Installment Sales

This judicial conflict was in the background as Congress amended the installment sales rules in 1980 by redefining payment as follows: "Payment does not include the receipt of evidences of indebtedness of the person acquiring the property (whether or not payment of such indebtedness is guaranteed by another person)" [IRC section 453 (f)(3)]. Thus, a third-party guarantee is not payment. IRC section 453 does not define thirdparty guarantees, but it invited the Treasury Department to issue regulations to carry out congressional intent. Temporary Regulations 15 a.453-1(b)(e) said that a standby letter of credit is not payment under IRC section 453. The Treasury Department's position is very solid because it rests on a statement in the committee report that a standby letter of credit is an example of the type of third-party guarantee envisioned by Congress.

Although these temporary regulations mention no qualifying third-party guarantee other than the standby letter of credit, they give examples which dearly indicate that escrow accounts will not be considered third-party guarantees. Thus, it is crucial to understand what the IRS means by "standby letter of credit," the type of property securing the letter of credit, and the effect, if any, of changes in the underlying security. IRS district offices have attempted to characterize letter of credit arrangements as payment under the installment sale rules.

The rest of this article is only available to active members of Questia

Sign up now for a free, 1-day trial and receive full access to:

  • Questia's entire collection
  • Automatic bibliography creation
  • More helpful research tools like notes, citations, and highlights
  • Ad-free environment

Already a member? Log in now.

Notes for this article

Add a new note
If you are trying to select text to create highlights or citations, remember that you must now click or tap on the first word, and then click or tap on the last word.
One moment ...
Project items

Items saved from this article

This article has been saved
Highlights (0)
Some of your highlights are legacy items.

Highlights saved before July 30, 2012 will not be displayed on their respective source pages.

You can easily re-create the highlights by opening the book page or article, selecting the text, and clicking “Highlight.”

Citations (0)
Some of your citations are legacy items.

Any citation created before July 30, 2012 will labeled as a “Cited page.” New citations will be saved as cited passages, pages or articles.

We also added the ability to view new citations from your projects or the book or article where you created them.

Notes (0)
Bookmarks (0)

You have no saved items from this article

Project items include:
  • Saved book/article
  • Highlights
  • Quotes/citations
  • Notes
  • Bookmarks
Notes
Cite this article

Cited article

Style
Citations are available only to our active members.
Sign up now to cite pages or passages in MLA, APA and Chicago citation styles.

(Einhorn, 1992, p. 25)

(Einhorn 25)

1

1. Lois J. Einhorn, Abraham Lincoln, the Orator: Penetrating the Lincoln Legend (Westport, CT: Greenwood Press, 1992), 25, http://www.questia.com/read/27419298.

Cited article

IRS Limits Agents' Use of Constructive Receipt with Collateralized Letters of Credit
Settings

Settings

Typeface
Text size Smaller Larger
Search within

Search within this article

Look up

Look up a word

  • Dictionary
  • Thesaurus
Please submit a word or phrase above.
Print this page

Print this page

Why can't I print more than one page at a time?

Full screen

matching results for page

Cited passage

Style
Citations are available only to our active members.
Sign up now to cite pages or passages in MLA, APA and Chicago citation styles.

"Portraying himself as an honest, ordinary person helped Lincoln identify with his audiences." (Einhorn, 1992, p. 25).

"Portraying himself as an honest, ordinary person helped Lincoln identify with his audiences." (Einhorn 25)

"Portraying himself as an honest, ordinary person helped Lincoln identify with his audiences."1

1. Lois J. Einhorn, Abraham Lincoln, the Orator: Penetrating the Lincoln Legend (Westport, CT: Greenwood Press, 1992), 25, http://www.questia.com/read/27419298.

Cited passage

Welcome to the new Questia Reader

The Questia Reader has been updated to provide you with an even better online reading experience.  It is now 100% Responsive, which means you can read our books and articles on any sized device you wish.  All of your favorite tools like notes, highlights, and citations are still here, but the way you select text has been updated to be easier to use, especially on touchscreen devices.  Here's how:

1. Click or tap the first word you want to select.
2. Click or tap the last word you want to select.

OK, got it!

Thanks for trying Questia!

Please continue trying out our research tools, but please note, full functionality is available only to our active members.

Your work will be lost once you leave this Web page.

For full access in an ad-free environment, sign up now for a FREE, 1-day trial.

Already a member? Log in now.