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Farmers get favorable ruling on price-later contracts.

The Applegates, cash-method farmers, sold grain to grain elevators under price-later contracts. Under these contracts, they received a down payment when they entered into the contract. However, the grain's purchase price was not set in the contract but was to be fixed later.

The Applegates had one year to fix the price by demanding payment. On the Applegates' demand, the buyer had to pay the going price for grain. If the Applegates did not make their demand within one year, the going price as of the end of the year would be the contract price. Obviously, the sellers would exercise their contractual rights only if the market price of grain rose before the year was up.

In this case the Applegates made no demand by the end of the year, so the contract price was neither determined nor paid by that time.

The Applegates claimed these contracts were installment sales and the amounts they received under the contract were reportable under the installment method.

The IRS claimed the installment method did not apply. It argued that because the Applegates had the unrestricted right to demand the entire contract price at any time during the first year, there was in fact full payment during the first year. The IRS deemed the contract price to be the market price at the date the contract was executed.

In an installment sale, at least one payment must be received after the close of the first tax year (IRC section 453(b)(1)). If a seller receives evidence of indebtedness that is payable on demand or readily tradable, the debt instrument is treated as payment (Section 453(f)(4)). If the Applegates' contract was a payable-on-demand debt instrument, the contract was not an installment sale since they were deemed to receive the entire contract price during the first year.

The Tax Court held in the Applegates' favor.

Result: For the Applegates. The contracts were not payable-on-demand evidence of indebtedness. The Seventh Circuit Court of Appeals believed the term payable on demand refers to cases in which the amount is already set and the seller has the right to choose the time of payment. Here, the Applegates had the right to determine the amount of the payment based on changes in the market price. Thus, they can use the installment method to compute the tax on the a payments.
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Article Details
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Publication:Journal of Accountancy
Article Type:Brief Article
Date:Mar 1, 1993
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