In many sales of private companies, the buyer and seller can overcome differences on price by agreeing to an earn-out. An earn-out is an additional amount to be paid to the seller contingent on the achievement of certain financial goals, generally dependent on achieving specified sales or earnings goals.
Many earnouts for private companies are taxed as installment sales, allowing taxpayers to defer the tax on gain until they receive the cash. However, the rules in this area are complex. For example, you can inadvertently trigger the gain when you pledge an installment sale obligation to a lender.
Complications also arise for earnouts that exceed $5M ($10M for married, filing jointly in community property states such as California). This amount can be subject to an imputed interest charge on the amount of the deferred tax.
Jon’s experience includes:
- Advising taxpayers on whether an earnout can be treated as an “open transaction” rather than installment sale.
- Representing multiple taxpayers (shareholders of the same company) in CA state tax audit on an interest charge on an earnout.