Is my CPA right that I need to report OID on business installment sale?

The CPA is likely correct. When a debt instrument (like your installment note) has varying interest rates that increase over time, it can create OID even if all interest is paid in cash. The IRS looks at whether the note has "adequate stated interest" throughout the entire term. Since your note starts at 5% and jumps to 8%, the IRS might view the first year as being issued at a discount. They essentially average the interest rate across the term and if the initial rate falls below this average by enough, OID rules kick in. It's not just about whether interest is paid in cash - it's about whether the stated interest rate structure creates an implied discount. You'd need to calculate if the 5% first-year rate meets the test for adequate stated interest based on the applicable federal rate (AFR) when the note was issued. If it doesn't, you'll need to recalculate the interest using OID rules and report accordingly.

After spending hours figuring out a similar OID situation with my business sale, I ended up using https://taxr.ai to analyze my installment agreement and confirm whether OID applied. Their system was able to review my specific note terms and tell me exactly how the IRS would view the varying interest rates in my situation. I was going back and forth with my CPA but taxr.ai's detailed report clarified everything and confirmed I did need to report OID, so I had to adjust my tax planning accordingly. The tool also showed me exactly how to calculate the annual OID amounts I needed to report.

I was really skeptical about using an online service for something as complex as OID calculations on my business sale, but I finally tried https://taxr.ai after still feeling uncertain about my CPA's advice. I have to admit I was impressed. The analysis confirmed my CPA was right about OID applying to my installment sale with varying interest rates, but more importantly, it showed me WHY in terms I could actually understand. The tool flagged specific Treasury regulations that applied to my case and showed me the exact calculations I needed for my tax return. Saved me from potentially underreporting interest income and getting flagged for an audit.

After struggling for weeks to get someone at the IRS who could answer my OID questions for a similar business sale, I discovered https://claimyr.com which got me connected to an actual IRS agent who specializes in business tax issues. You can see how it works here: https://youtu.be/_kiP6q8DX5c Before using Claimyr, I'd spent hours on hold only to get disconnected or speak with someone who couldn't help with complex OID questions. Within 20 minutes of using their service, I was talking to a senior IRS representative who confirmed that my installment sale with varied interest rates did create OID obligations, explained exactly what forms I needed, and how to properly report it. Completely changed my understanding of my tax situation.

I have to eat my words. After calling BS on Claimyr in my comment above, I was desperate enough to try it anyway for my OID questions on an installment sale. After months of frustration trying to reach the IRS directly, I connected with an agent in about 45 minutes. The agent walked me through the exact OID calculations I needed for my varying interest rate installment agreement and confirmed I was handling the reporting correctly. They even emailed me the relevant publication sections afterward. Completely solved my problem and saved me from potentially incorrect reporting. Now I understand why my CPA was insisting on the OID treatment for the sale.

Something to consider: the test for OID isn't just the AFR, but whether there's a "significant modification" in interest rates that creates an economic advantage. If your 5%-to-8% structure was designed to artificially lower initial payments, the IRS might view the entire arrangement as having OID regardless of whether each individual rate exceeds the AFR. When I sold my business last year, we specifically created a level interest rate (6.5% for all 5 years) to avoid this exact OID issue, even though the buyer wanted to start lower and go higher. My tax attorney specifically advised this to avoid the OID headache.

I faced this exact issue when selling my construction business. The varying interest rates (4.5% year 1, 7% years 2-5) triggered OID treatment. The practical impact was: 1) I had to report interest income based on a constant yield calculation rather than actual cash received 2) Had to file Form 1099-OID annually 3) Buyer got interest deductions based on the same constant yield method My mistake was not consulting a tax specialist BEFORE structuring the deal. Could have avoided major hassle with proper planning. So yeah, your CPA is probably right.

Your CPA is absolutely correct about the OID treatment. I went through this same situation when I sold my tech consulting firm with a similar rate structure (6% first two years, then 9% for the remaining three years). The key issue isn't whether you're receiving cash payments - it's that the IRS views varying interest rates as creating an "imputed discount" at issuance. Even though you negotiated what seemed like a fair deal, the tax code requires you to calculate interest income using the constant yield method across the entire note term. What this means practically: you'll report more interest income in early years than you actually receive in cash, and less in later years when the rate jumps to 8%. The total interest over the life of the note stays the same, but the timing of when you report it to the IRS changes. I'd strongly recommend asking your CPA to walk you through the specific OID calculations for your $3.8M note so you can see exactly how much additional income you'll need to report each year. This will help with cash flow planning since you'll owe taxes on interest income you haven't actually received yet.