Our installment note will exceed five million dollars, and our tax advisor mentioned a potential IRS interest charge under Section 453A on deferred tax. How do we structure the transaction across legal entities to mitigate or avoid this interest charge?

Question

Tyler Smith · Accepted Answer

Under Internal Revenue Code Section 453A, if the face amount of your installment obligations outstanding at the close of the taxable year exceeds five million dollars, you must pay an annual interest charge to the IRS on the deferred tax liability associated with that excess amount. This interest charge can significantly erode the financial benefits of your tax deferral. If you are expecting an installment note larger than five million dollars, you must plan ahead to legally mitigate this cost.

The five-million-dollar threshold applies on a per-taxpayer basis, not per-transaction. If your business is structured as a pass-through entity, such as an S-corporation or an LLC, and you have multiple owners, the threshold is evaluated individually for each partner or shareholder. For example, if you have three partners with equal shares, you can collectively accept up to fifteen million dollars in installment notes without triggering the Section 453A interest charge, as long as no single partner's share exceeds five million dollars.

If you are a sole owner, you might consider gifting fractional ownership interests to family members or placing shares into irrevocable trusts well in advance of the transaction, though this must be done with careful legal guidance to avoid step-transaction doctrines. Work with your leadership team and tax professionals during your long term strategic planning. Make sure your tax strategy is aligned with your exit goals, using your V/TO to track your transition timeline and corporate structure years before you sign a letter of intent.