Magazine article The CPA Journal

Court Rules on Self-Cancelling Installment Notes

Magazine article The CPA Journal

Court Rules on Self-Cancelling Installment Notes

Article excerpt

In Frane v. Commissioner (No. 92-1818, 7/6/93), the Eighth Circuit considered the case of a taxpayer who at the age of 53 sold stock in his company to his four children. Each child signed a note for the appraised value of the stock payable in annual installments over 20 years for a total principal amount of $141,050. The notes provided that in the event of the taxpayer's death, the unpaid principal and interest of the note would be deemed cancelled as though paid upon the death of the taxpayer.

To compensate the taxpayer for assuming the risk that he would die before 20 years passed and thus not receive full payment on the notes, the notes included an above-market interest rate of 12 percent. However, at the time of the sale of the stock, the taxpayer's life expectancy exceeded the 20-year term of the promissory notes.

The taxpayer only lived to receive two of the installments on the notes. He recognized a portion of each installment as income measured by his basis in the stock and the full contract price. After he died, his children made no further payments, and neither his last income tax return nor the estate's income tax return reported any income resulting from the self-cancellation of the notes. …

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