Bay
Financial Newsletter
The Self-Canceling Installment Note
(SCN)
There are many tools and techniques to assist you in
meeting your tax and non-tax objectives. The Self-Canceling Installment
Note (SCIN) is a cross between a private annuity and an installment
sale and has many of the advantages and best features of both.
A SCIN involves the sale of a business interest, stock,
or an interest in real estate or other asset, typically to one or
more family members of the owner/seller, or entity that represents
them, in exchange for an installment note with a term shorter than
the seller's life expectancy.
In essence, the seller (usually a senior family member)
serves as a "friendly banker" by financing the sale of a
family business or other asset through a loan payable by a junior
family members or a trust in installments (annual, semiannual, quarterly,
or monthly) over a specified period of years.
But unlike the classic installment sale, the note in
a SCIN includes provisions for automatic cancellation of the unpaid
balance at the death of the seller. In other words the SCIN is a promissory
note (evidence of debt), given by a buyer to a seller, with a provision
under which the obligation to make any future payments ends at the
seller's death. If the seller lives beyond the period over which installment
payments are to be made, the "cancel at death" provision
is ignored. If the seller dies during the term of the note, the buyer's
obligation to make payments ends on the date of death.
The hoped for objectives are two-fold: (1) the exclusion
of the unpaid balance of the note from the seller's estate and (2)
the avoidance of any gift tax on the transfer.
The ideal candidate for a SCIN has a shorter actual
life span than would be indicated by his/her actuarially projected
life expectancy. The earlier into the specified term the seller dies,
the more advantageous the SCIN is. This is because the property transferred
plus all the appreciation and any income it has produced is removed
from the transferor's estate. Only after-tax loan repayments received
and remaining at the transferor's death are included in the transferor's
estate.
WHY SET UP A SCIN?
Prorate capital gains. You can sell an asset with a
low tax basis and spread the gain over the term of the note rather
than bunching that gain all into one year. Prorating the taxable gain
over the payment period may enable a shift of income from high bracket
to lower bracket (or higher deduction) years so that you net more
of the income.
Estate tax savings on asset appreciation. If the stock
purchased by the younger family member(s) appreciates more rapidly
than the investment purchased by senior family members (with the annual
after-tax proceeds of the installment sale, or if you consume or give
away the after-income tax proceeds), the effect you have created an
"estate freeze" since your estate will either remain the
same or decrease.
So the SCIN enables an asset to be retained within
the family unit while its value is frozen for death tax purposes.
This is particularly appealing during economic conditions in which
asset values are depressed at the same time interest rates are relatively
low.
Estate tax savings on principal. Unlike the classic
installment sale (but similar to a private annuity), the SCIN will
remove the unpaid balance from the seller's estate since there is
a risk premium (or mortality charge) built into the agreement, therefore,
the present value of any remaining payments should be excluded from
the seller's estate.
Create cash flow. If you own non-income -producing
assets (such as undeveloped land, by selling it to a family member,
the asset (such as a family vacation home) can be kept within the
family unit yet the seller's income can be increased significantly.
Children who currently (or anticipate to) support aging parents may
want to consider this "graceful and dignified" approach to provide
income for their parents who might otherwise be financially handicapped.
A fixed stream of income for the term of the note is secured (assuming
the buyer-child remains both financially able and willing to make
payments).
The SCIN, of course, also has downsides and costs which
must be understood. So when planning, it is always essential to weigh
the pros and cons of all your viable alternatives.
As always, please feel free to call to discuss these
or any other items of importance to you!
The opinions voiced in this material are for general
information only and are not intended to provide specific advice or
recommendations for any individual. To determine which investment(s)
may be appropriate for you, consult your financial advisor prior to
investing.
