The SCIN: An Attractive Estate Planning Opportunity In 2012

2012 presents unique opportunities to do estate planning.  The reasons may be familiar to you by now:   lifetime gift and estate tax exemptions are $5 million (without Congressional action, it will go to $1 million in 2013), valuation discounts for family owned entities remain viable, and property values and interest rates at all time lows.  The catch:   There’s a limited time to capitalize on these opportunities.

This article will focus on one estate planning tool, the Self Canceling Installment Note (“SCIN”) whose benefit is magnified under 2012’s low interest rate environment. 

What is a SCIN?

SCINs are a planning technique used in a sale of an asset to either a trust or directly from an older family member to members of a younger generation.  Basically, the older generation sells the asset in exchange for an installment note with a term shorter than the seller’s life expectancy.  Life expectancies are found in IRS tables.   The installment note contains a provision by which the remaining balance is completely canceled upon the seller’s death.

What is the benefit of the SCIN?

What makes a SCIN a valuable tool is the fact that if the seller dies before the term of the note, the remaining balance is completely canceled and this canceled amount is not included in the seller’s taxable estate.   

The SCIN is especially beneficial if only annual interest payments are made until the end of the term, when a balloon principal payment is due.  By deferring the principal payment until the end of the term, the amount cancelled upon death can include the entire principal amount of the promissory note.

To illustrate, assume a client sells a small business worth $10 million to a trust for her children in return for a promissory note with annual interest payments and a balloon payment at the end of the term.  This simple sale would itself be beneficial for estate tax purposes.  If the business  appreciated to $20 million before client’s death, all $10 million of appreciation would be outside the client’s taxable estate, perhaps saving $3.5 million in estate taxes.    However, $10 million remaining principal balance on the note would remain in the taxpayer’s taxable estate, subject to a 35% tax rate.  If the client had used a SCIN rather than a simple promissory note,   the $10 million principal payment would cancel, leaving the trust with a windfall.  For estate tax purposes, this means that the entire $20 million asset escapes estate tax.

Is there any downside to a SCIN?

The IRS would not allow this transaction unless it is equivalent to an arms-length transaction between unrelated parties.   So in return for the self cancelling feature of the note,  a “mortality risk premium” is charged to the payor – typically an increased interest rate.  The older the seller is, the greater the mortality risk premium will be.    

This mortality risk premium is the downside of the SCIN transaction.  If the seller outlives the term of the SCIN, the trust will have paid the mortality risk premium interest rate to the seller for absolutely no benefit.[1] 

What makes 2012 an unusually good time to use a SCIN?

What makes the SCIN extremely attractive now is the historically low interest rate environment.  The SCIN interest rate is the base AFR rate which the IRS requires for all promissory notes, plus the mortality risk premium.  

Today, both the AFR rates and mortality risk premiums are very low.   Long term AFR rates for 2012 have hovered around 2.75%.  The largest the mortality rate premium has been for a 55-year-old male since January 2010 was only .58 percent.  The SCIN rate for a 70 year old in March 2012 was only 3.07 percent.    Thus, a 55 year old can do a SCIN at an interest rate of around 3.47%.  A 70 year old can do a SCIN for a rate of around 5.96%.  In both cases, the SCIN interest rates are below historical average prime rate of interest for third party loans.    Under these circumstances the downside risk of a SCIN is very small when compared to the huge estate tax benefit that could result. 

If you need help with your estate plan or want additional information, please contact us at (404) 255-7400.