Cummings & Lockwood Estate Planning FAQs

A self-cancelling installment note (SCIN) is a debt instrument that contains a provision which calls for the cancellation of the liability upon the death of the holder during the term of the promissory note.  If you, as the holder of the SCIN, die prior to the expiration of the term of the SCIN, the automatic cancellation feature may operate to remove from your estate a significant amount of assets from what would otherwise be includible.

This technique is beneficial if you believe that you will not survive your actuarially determined life expectancy.  Using the SCIN transaction any portion of the sales price for your interest(s) that is not paid before your death, together with any post-sale appreciation, will be excluded from your estate (and avoid estate tax) at your death.  Although your estate may be subject to income tax at your death (based upon the unpaid sales price) the applicable federal rate will be the capital gains tax rate (currently 20%), rather than the federal estate tax rate (currently 40%); furthermore, your estate will be in the position to argue that this capital gains tax should be deductible for estate tax purposes.

If you believe you will survive to or beyond your actuarial life expectancy a SCIN may not be the ideal solution, as you may end up with more value in your estate (to be subjected to estate tax) than if you did not engage in the transaction at all.  In that case, a traditional installment sale would be preferable.

The key elements of the transaction closely resemble a traditional installment sale, with some key differences:

• The term of the SCIN should be a period of years less than your life expectancy, otherwise it might be deemed a private annuity.
• The terms of the Note must take into account the possibility of your death before the Note is paid off by including an increased interest rate or an increased principal amount.  This is known as a “risk premium.”  The sales price would be determined based upon (a) the fair market value of the interests being sold (b) plus the “risk premium” for the possibility that you may die before receiving all of the payments (i.e., the full purchase price).  If the sales price includes these two values, then no gift tax consequences will result from the transfer.  The risk premium is incorporated by either utilizing a higher interest rate (i.e., an “interest rate premium”) or by increasing the purchase price (i.e., a “principal premium”).  What constitutes an adequate risk premium is a fact-specific question.  Since your life expectancy is a critical component of the risk premium, it must be considered.  If the seller has a “terminal illness,” such actuarial tables may not be used.  A terminal illness means that the seller has “an incurable illness or other deteriorating physical condition” which results in at least a 50% probability that the individual will die within one year.
• The SCIN can be arranged to be self-amortizing, interest-only with a “balloon” payment of principal at the end of the term, or to require level principal payments, or something in the middle like a traditional installment note.  Generally, an interest-only SCIN (whether using an interest rate premium or principal premium) will likely result in the most estate tax savings.

In addition to the benefits outlined under the traditional installment sale discussion, the SCIN offers the following additional benefits:

Potentially greater estate tax savings.

Unlike a traditional installment sale, with a SCIN, the remaining principal balance would not be included in your estate at your death because, by the terms of the promissory note, it cancels at your death.  The estate tax savings can be substantial if the seller dies materially prior to her life expectancy.  The private annuity, also shares this benefit.

Lower interest rate.

Although the issue is not settled, most estate planners agree that the applicable base interest rate (excluding a risk premium component) to use for the promissory note is the AFR in effect for the month of sale.  However, a conservative approach would be to use the higher section 7520 rate, which is 120% of the mid-term AFR for the month in which the sale occurs.

Backloading of payments.

If you use an interest-only SCIN that defers the payment of principal, at least initially, the purchasing trust would have a greater opportunity to convert its illiquid interest into liquid assets (i.e., cash or marketable securities), which would leverage the proceeds, allowing you to more easily shift value to younger generations.  More importantly, a SCIN offers a major advantage if you were to die prior to the end of the term because of the possibility for a sizeable principal balance payment never being made back to you or your estate.  As previously explained, the estate tax savings could be substantial.

In addition to the disadvantages outlined under the traditional installment sale discussion, the SCIN has the following disadvantages:

Substantially greater seed funding.

If the principal premium approach is taken, the initial seed funding of the trust would accordingly increase, i.e., to maintain 10% of the principal obligation, at a minimum.

Risk of lengthy life.

If you outlive your life expectancy, the assets included in your estate will be substantially greater than had the property been sold in a traditional installment sale.  Because of the risk premium, the SCIN payments will be significantly higher.  A similar risk, although less substantial, exists with a private annuity.

Uncertainty of calculations.

The calculation of payments under a SCIN can be uncertain, including the determination of the risk premium and your life expectancy.  By comparison, private annuity calculations are relatively straightforward.