Tax Tactics – February 2013
Betting on a SCIN – This Tool May Help You Transfer Assets at Little or No Tax Cost
Estate planning can be a gamble. Tax and estate tax laws change. Family members pass away before their time. But a gamble that can pay off in certain circumstances is the self-canceling installment note — or SCIN. It may allow you to transfer a business or other assets to family members at little or no tax cost.
How it works
You sell your business or other assets to your children or other family members (or to a trust for their benefit) in exchange for an interest-bearing installment note. The “self-canceling” feature means that if you die during the note’s term — which must be no longer than your actuarial life expectancy at the time of the transaction — the buyers (that is, your children or other family members) are relieved of any future payment obligations.
A SCIN offers a variety of valuable tax benefits. First and foremost, if you die before the note matures, the outstanding principal is excluded from your taxable estate. And any appreciation in the assets’ value after the sale is also excluded from your estate. This may allow you to transfer a significant amount of wealth tax-free.
You also can defer capital gains on the sale by spreading the gain over the note term. If you die before the note matures, however, the remaining capital gain will be taxed to your estate even though no more payments will be received.
Finally, the buyers may be able to deduct the interest they pay on the note.
The risk premium
To compensate you for the risk that the note will be canceled and the full purchase price won’t be paid, the buyers must pay a premium — in the form of a higher purchase price or interest rate. There’s no magic number for this premium; the appropriate premium is a function of your age and the note’s duration. If the premium is too low, the IRS may treat the transaction as a partial gift and assess gift taxes.
Both types of premium can work, but they involve different tax considerations. If you add a premium to the purchase price, for example, a greater portion of each installment will be taxed to you at the more favorable long-term capital gains rate, and the buyers’ basis will be larger. On the other hand, an interest-rate premium can increase the buyers’ income tax deductions.
The premium catch also comes with risk. SCINs present the opposite of mortality risk: The tax benefits are lost if you live longer than expected. If you survive the note’s term, the buyers will have paid a premium for the assets, and your estate may end up larger rather than smaller than before.
Is it worth the gamble?
Under the right circumstances, a SCIN can be a good bet. But it’s critical that you — and your family — understand the risks and rewards. If it pays off, your family will reap a bounty in the form of income, gift and estate tax savings. Make sure you work closely with your estate planning and tax advisors for the best results. •
This material is generic in nature. Before relying on the material in any important matter, users should note date of publication and carefully evaluate its accuracy, currency, completeness, and relevance for their purposes, and should obtain any appropriate professional advice relevant to their particular circumstances.
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