Many taxpayers are aware that, if property is sold so that payments are received over a period of years, tax reporting can be done under the installment method. Under this method, taxes are deferred until payments are actually received.
Few, however, seem to be aware that a similar concept applies to sales of a company's own inventory to its regular customers. Basically, if you can restructure your terms of payment to require two or more installments, then any uncollected part of the sales price will not be taxed in the current year--it will be taxed in the year it is actually collected. (Under the Installment Sales Revision Act of 1980, two payments are no longer technically required, but they will avoid a lot of arguments with the IRS, so we strongly recommend that your sales terms reflect the multiple payments.)
While the installment method is obviously appropriate for such big-ticket items as computer systems, heavy machinery, and the like, it can also bring substantial benefits to companies selling more routine products. And you don't have to offer the installment sales terms across the board--you can carve out a segment of your customers to maximize the benefits while minimizing the problems.
One of our clients, for example, manufactures and sells electronic equipment to a customer base which generally takes several months to pay its invoices. The company changed its sales terms from net 30 days to one-half in 30 days, one-half in 60 days. Even though the terms of sale were seemingly changed for the worse, collections either remained the same or improved. More importantly, however, the company elected the installment sales method of reporting for Federal Income Tax purposes, and, as a result, defers hundreds of thousands of tax dollars each year.
The installment sales method works best for companies which earn a relatively high gross profit on sales, and which do a large amount of sales during one season of the year.
Incidentally, don't be misled by the word "deferral." Since the amount of your sales is likely to increase (or at least remain the same) next year, you will again have an opportunity to defer taxes on your installment sales. Deferred taxes effectively become permanent tax savings until the business starts to contract and you collect your receivables without replacing them. And given today's interest rates, any tax deferral you can find is worth exploring.
Milgrom, Galuskin, Rosner & Company, CPAs and Advisors to Management New Jersey: 2025 Lincoln Highway, Edison, NJ 08817 / 908-287-9000 New York: 2 Pennsylvania Plaza, #1910, New York, NY 10121 / 212-643-8015
Milgrom, Galuskin, Rosner & Co