By David Greenberg August 15, 2011 Private Annuities and Self-Canceling Installment Notes Private annuities and self-canceling

installment notes (SCINs) are both effective wealth transfer planning techniques if properly implemented on an arms length basis in full accordance with all IRS rules and regulations. While similar in many respects, each technique has its advantages and disadvantages when compared to the other. Following is a brief description of private annuities and SCINs. Private Annuities. In the typical private annuity transaction, a parent (the annuitant) sells property to a child (the obligor), in exchange for the childs unsecured promise to make periodic payments (the annuity) to the parent for the balance of the parents lifetime. The amount of the annuity is computed using the fair market value of the property sold, the annuitants life expectancy, and the IRSs published interest rate for the month of the sale. As long as the present value of the annuity received is equal to the fair market value of the property sold, there is no taxable gift. Where a hard to value asset is sold (i.e., an interest in a closely held business) an independent appraisal must be obtained. In addition to avoiding gift taxes, a private annuity removes all appreciation on the property sold from the annuitants estate, and even some of the property sold itself, depending on when the annuitant dies. The reason for this is that private annuities are designed to cease making payments at the annuitants death. In general, unless there is a 50% probability that the annuitant will die within one year, the parties are permitted to use the governments actuarial tables to determine the present value of the annuity. For, an annuitant who is not in good health, but likely to live at least one year, the governments mortality tables will may be more advantageous (from an estate planning perspective) than using the annuitants actual life expectancy. Until April 18, 2007, the annuitant was able to report the built in gain on the property sold piecemeal as part of each annuity payment when received. Under current law, the entire amount of the annuitants gain or loss (if any) must be recognized at the time of the sale. To avoid having the annuitant come up with cash to pay the capital gains tax, the sale could be structured with a down payment (to cover the capital gains tax) and the balance in annuity payments (which are divided into tax-free return of capital and ordinary income).

Self-Canceling Installment Notes A SCIN is a promissory note (usually between family members) that by its terms is canceled at the death of the seller-creditor. The advantage of a SCIN over an ordinary promissory note is that if the seller dies before the note is paid, the unpaid balance of the note is not included in his/her estate. In order to avoid a taxable gift at the time of sale, the purchaser must pay a risk premium to the seller for the cancellation feature. The premium can be in the form of a higher purchase price or a higher interest rate. Unfortunately, there is little authority as to how to calculate the premium, but the premium will be a factor of the sellers life expectancy, the term of the note, and the IRSs published interest rate for the month of the sale. Summary The ideal candidate for both private annuities and SCINs is a person with a taxable estate and a life expectancy that is shorter than the IRS published life expectancy for an individual of the same age. The planned objectives for both techniques are three-fold: (1) removing the future appreciation in the assets sold from the annuitants/sellers estate; (2) removing the unpaid balance of the sales price from the annuitants/ sellers estate (in the event of his/her premature death); and (3) avoiding any gift tax on the sale. Each technique, while similar, has downsides and costs that must be understood. Therefore, it is essential to weigh the pros and cons of each alternative.