675 / What is an interest surcharge with respect to outstanding installment obligations?

Generally, an interest surcharge is an interest charge payable by the seller to the IRS with respect to a portion of a tax liability that is deferred as a result of installment reporting. In other words, installment reporting allows the taxpayer to defer the gain realized from the installment over time rather than in the year of sale. The tax on that gain is considered a deferred tax liability. The interest surcharge applies to all installment obligations held by the taxpayer (meaning it applies to multiple installment sales) in which deferred payments for sales during the taxable year exceed $5,000,000. There is an exception to the surcharge with respect to: (1) property used or produced in the trade or business of farming, (2) timeshares and residential lots, and (3) personal use property.¹

The amount of the interest surcharge is determined by multiplying the “applicable percentage” of the deferred tax liability by the underpayment rate in effect at the end of the taxable year (with respect to tax deficiencies). The “applicable percentage” is determined by dividing the portion of the aggregate obligations for the year that exceeds $5,000,000 by the aggregate face amount of such obligations that are outstanding at the end of the taxable year. If an obligation remains outstanding in subsequent taxable years, interest must be paid using the same percentage rate as in the year of the sale.² In addition, if the installment obligation is pledged as security for a loan, the net proceeds of the loan will be treated as a payment received on the installment obligation (up to the total contract price); however, no additional gain is recognized on subsequent payments of such amounts already treated as received. The date of such constructive payment will be (a) the date the proceeds are received or (b) the date the indebtedness is secured, whichever is later.³

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1. IRC § 453A(b).

2. IRC § 453A(c).