Academic journal article Journal of Accountancy

Notes That Cancel at Death Mean Estate Owes Income Tax

Academic journal article Journal of Accountancy

Notes That Cancel at Death Mean Estate Owes Income Tax

Article excerpt

Frane sold stock in his company to each of his four adult children. Each block of stock was worth $140,000. The children signed promissory notes, agreeing to pay the $140,000 principal amount in 20 annual installments at an interest rate of 12%. The notes provided they would be "canceled and extinguished as though paid" on Frane's death.

Although Frane's life expectancy at the time of the sale exceeded 20 years, he died less than 3 years later, after only two payments had been made on the notes.

Frane used the installment method to report gain on the stock sale attributable to the two payments while he was alive. No income from the canceled notes was reported on the decedent's final return or the estate's income tax return.

The IRS claimed the notes' cancellation resulted in the recognition of income that had to be reported either on the estate's income tax return or on the decedent's final return.

IRC section 453B(a) provides: "If an installment obligation is ... distributed, transmitted ... or otherwise disposed of, gain or loss shall result ...... Section 453B(f) treats an installment obligation that is canceled as if it was "disposed of" Section 453B(c) provides that section 453B does not apply to the transmission of installment notes at death, "except as provided in section 691 (relating to . …

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