Installment Sales of Startup Equity
Founders and early investors often choose to sell their startup equity through an installment sale deferring recognition of capital gains over time. While this strategy can help with cash flow and tax planning, many forget one important twist: California may charge interest on the deferred income, even if the IRS doesn’t.
If you’re planning a partial exit or liquidity event , and your equity is sold on installment terms, this blog explains why the California Personal Income Tax (PIT) interest charge could apply and what steps you need to take to avoid surprises.
What Is an Installment Sale?
An installment sale occurs when you sell property including stock or equity and receive at least one payment after the tax year of the sale. Under IRC §453, you can spread the gain across the years when payments are received.
Example:
You sell shares for $1M , but receive $250K and the rest in later years. You recognize a portion of the gain each year, based on the gross profit ratio.
While this works well for federal tax deferral, California imposes a special rule when you sell California-source assets and defer tax across years.
California’s Rule: Interest Charge on Deferred Tax
Under California Revenue & Taxation Code §17591.1, if you:
- Sell stock through an installment sale
- Have over $5 million in total installment obligations
- And are deferring California taxable income
Then you may owe an interest charge on the deferred tax calculated similarly to IRS interest on tax-deferral strategies like Section 453A.
Even if the IRS does not impose interest (e.g. for QSBS or below-threshold sales), California might.
When the CA Interest Charge Applies
- The sale involves California-source income (e.g. equity in a California-based company)
- The installment obligation exceeds $5 million
- You’re deferring more than one year of tax liability
- The buyer is unrelated and paying over time
The interest is calculated by the Franchise Tax Board (FTB) and must be paid in addition to the regular PIT when installment payments are reported.
Example: Installment Sale Triggers PIT Interest
Scenario:
A founder sells her shares in a California-based AI startup for $8 million, structured as an installment sale over 4 years.
- 2025: Receives $2 million
- 2026–2028: Receives $2 million/year
She reports capital gains proportionately using Form 540 Schedule D, but California adds an interest charge starting in 2026 for the deferred income based on the remaining installment balance.
Step-by-Step: How to Comply with CA Installment Sale Rules
- Calculate Gross Profit Ratio
Determine the ratio of gain to total contract price, per IRS Form 6252. - Track California-Source Income
If your business is California-based, gains from its equity are CA-sourced. - File Form 6252 (Federal) and Report on CA Schedule D
File annually as payments are received. - Watch for Interest Charge Notices from FTB
If your total installment obligations exceed $5M, expect an interest calculation from the state. - Remit Additional PIT Interest
The FTB may send a notice, or you can calculate and include it proactively to avoid penalties.
Key Forms to Know
| Form | Purpose |
|---|---|
| IRS Form 6252 | Federal installment sale reporting |
| CA Schedule D (540) | Report California capital gains |
| Form 540 | CA individual income tax return |
| FTB Interest Notice | Calculated deferred tax interest on installment sales |
Conclusion: Plan for PIT Interest on Deferred Gains
Installment sales can help smooth out tax liabilities but California adds a layer of complexity. If your installment balance exceeds $5M, the FTB may charge interest even if the IRS doesn’t.
Whether you’re selling stock, SAFE instruments, or earnouts tied to future performance, be sure to:
- Run a state-level review of sourcing and tax exposure
- Check if interest applies under CA law
- Adjust your cash flow planning for PIT interest in future years
Need Expert Review?
Anshul Goyal, CPA EA FCA is a U.S.-licensed CPA and California tax expert, helping founders, investors, and startup employees manage:
- Installment sales
- FTB interest charges
- Capital gains optimization
- Multiyear tax projections
Book a Tax Planning Session Now
Disclaimer
This blog is for general educational purposes only and does not constitute legal or tax advice. Consult a licensed CPA before making installment sale or tax deferral decisions. Rules are based on 2025 tax law and may change.
FAQs: Installment Sale & CA Interest
- Do all installment sales trigger CA interest?
No only those with over $5 million in installment obligations may trigger the charge. - Is California’s interest rule the same as federal?
It’s similar but applied separately under R&TC §17591.1. - Can I exclude QSBS from this rule?
Not automatically even if your stock is QSBS under IRC §1202, CA may still assess interest if the thresholds apply. - How do I know if income is California-sourced?
If your business is registered, operating, or headquartered in CA, the equity is generally CA-source. - Do I pay the interest with Form 540?
Yes, or wait for an FTB notice showing the amount and payment instructions.
About Our CPA
Anshul Goyal, CPA EA FCA is a U.S.-licensed Certified Public Accountant, IRS Enrolled Agent, and Fellow Chartered Accountant who helps founders structure tax-efficient exits. He advises on installment sales, CA PIT interest, and IRS/FTB audits for multi-year capital gain plans.