The buyer wants to structure our transaction with a contingent earnout but our CPA is pushing for a Section 453 installment sale to defer taxes. How do these two mechanisms clash, and how do we structure the deal so we do not pay taxes on money we might never receive?

Question

Tyler Smith · Accepted Answer

The conflict between a Section 453 installment sale and a contingent earnout comes down to taxation timing and risk. If your transaction includes an earnout, tax regulations generally treat it as a contingent payment sale. This means the IRS assumes you will receive the maximum possible payout and structures your basis recovery accordingly. If you fail to hit those metrics, you are left trying to claw back taxes paid on money you never actually touched. To solve this, you need to negotiate a clear distinction in your purchase agreement between a fixed seller note and contingent earnout payments.

Under the Section 453 rules, a fixed-term installment note allows you to pay capital gains tax proportionally as you receive the cash, which is a massive win for your liquidity. For the contingent earnout portion, your legal team must structure the agreement using the temporary regulations for contingent sales, pushing for a payment-by-payment basis recovery or a maximum transaction price method that protects your cash flow.

Within your EOS leadership team, this structural challenge should be raised as an issue in your weekly Level 10 Meeting. Use the IDS process to align your finance seat and your transaction advisory team on this strategy before you finalize the letter of intent. Do not let a buyer bundle these two distinct structures together. Make sure your fixed installment note is legally and operationally isolated from any performance-based earnout mechanisms.