Personal Trust Corner - A J.D.’s Perspective

Smart Legacy Moves: How Business Owners Can Minimize Taxes with SCINs and Grantor Trusts

By Amy Piedmont, J.D., LLM, Vice President, Sr. Trust Relationship Manager and
Katherine “Kate” Gambill, J.D., Vice President, Sr. Trust Relationship Manager

In our series, “The Personal Trust Corner: A J.D.’s Perspective,” we aim to spotlight one planning strategy each month in response to the ever-changing Estate Tax Laws. This month, we turn the spotlight on Self-Canceling Installment Notes, and Installment Sales to Grantor Trusts.

Self-Canceling Installment Notes (SCINs)

When it comes to estate tax planning strategies, Self-Canceling Installment Notes (SCINs) offer a powerful tool for transferring assets to family members while minimizing tax liabilities. Unlike traditional installment sales, SCINs come with a unique feature that cancels the outstanding note balance upon the Payee's death, providing a tailored approach for estate planning.

Structuring SCINs for Optimal Benefits

To ensure the forgiveness feature of the note is excluded from gift tax assessment, a risk premium is typically added to either the interest rate or principal of the note. This adjustment accounts for the possibility of the note being canceled before full repayment, thereby avoiding any gift implications. The Applicable Federal Rate (AFR), compounded semi-annually, serves as the minimum interest rate benchmark for SCINs between related parties.

In the event of the Payee's death before full repayment, the Payor's outstanding balance is forgiven, effectively excluding it from the Payee's taxable estate. The longevity of the SCIN note plays a crucial role in determining the interest rate premium, balancing potential estate tax savings with the risk of premature death before payment completion.

The IRS places importance on the health status of the Payee when structuring a SCIN. To avoid triggering significant gift tax implications, it is essential that the Payee is in reasonable health at the time of entering into the SCIN. Deviations from this standard, such as entering into a SCIN with an individual in poor health or with a shorter life expectancy, may lead to unwanted tax consequences.

Key Design Considerations and Risk Management

Timely payments are paramount in maintaining the integrity of a SCIN. Failure to meet payment deadlines could jeopardize the legitimacy of the indebtedness in the eyes of the IRS, potentially exposing it to gift or estate tax liabilities. Additionally, securing the note with collateral or other guarantors is a widespread practice to mitigate risks associated with non-payment.

Strategic Planning for Optimal Results

Your attorney will carefully weigh the trade-offs associated with paying a higher interest rate or principal premium in SCINs. Balancing the potential increase in the Payee's estate if payments continue beyond life expectancy against the benefits of early cancellation requires a nuanced approach to maximize estate planning advantages.

By leveraging the unique benefits of Self-Canceling Installment Notes, individuals can craft tailored estate planning strategies that align with their long-term financial goals while minimizing tax implications. Understanding the intricacies of SCINs and navigating IRS compliance ensures a robust foundation for effective estate tax planning.

Part 2: Maximizing Estate Planning Benefits with Installment Sales to Grantor Trusts

Combining Tax Benefits and Estate Planning Strategies

An installment sale to a Grantor Trust offers a strategic blend of tax advantages and estate planning benefits. By transferring assets to a Grantor Trust in exchange for an installment obligation, individuals can defer capital gains tax on appreciated property while leveraging the estate planning advantages of an Irrevocable Trust.

Some properties can be sold at a discount to a Grantor Trust, especially those with marketability or control restrictions. This reduces the property's value for capital gains tax purposes. Discounted assets include partial interests in closely held businesses or non-voting shares, optimizing tax efficiency in the transfer process.

The Trust will make periodic payments to the Grantor over a specified term, comprising principal and interest components. Simultaneously, Trust Assets continue to appreciate within the Trust, fostering growth and financial flexibility for both parties involved.

Tax Implications

Operating as a Grantor Trust, the Grantor retains ownership for federal income tax purposes, though not for gift and estate tax considerations. All Trust income, whether derived from asset sales or dividends, is reported on the Grantor's federal income tax return and taxed accordingly.

By assuming responsibility for the Trust's income tax obligations, the Grantor can further reduce their taxable estate while enabling tax-efficient growth within the Trust. Selling assets at a discount to the Trust helps mitigate capital gains tax burdens, with only the interest portion of installment payments being taxable income.

Self-Canceling Installment Notes (SCINs) for Enhanced Estate Planning

If structured as a SCIN, the installment note can offer additional benefits upon the Grantor's death. The debt balance is forgiven, allowing the Trust to grow significantly without incurring gift or estate tax implications. SCINs provide a powerful mechanism for estate planning, ensuring that assets flow seamlessly to beneficiaries according to the Grantor's wishes.

Tax Efficiency and Legacy Preservation

In scenarios where the installment note lacks a self-canceling provision, payments are directed to the Grantor's estate, potentially subjecting them to estate tax. These payments can utilize the Grantor's remaining estate tax exemption and are distributed in accordance with the Grantor's testamentary plan, safeguarding their legacy and financial intentions.

By strategically navigating installment sales to Grantor Trusts, individuals can optimize tax efficiencies, foster estate planning goals, and create a lasting financial legacy for future generations. Understanding the nuances of these transactions and their impact on tax liabilities is crucial for maximizing estate planning benefits and securing a robust financial future.

Please reach out to our Senior Trust Relationship Managers: Amy Piedmont, J.D., LLM, Vice President, in Pensacola, Florida and Katherine Gambill, J.D., Vice President, in Atlanta with any questions or to start a conversation regarding estate planning. We welcome the opportunity to introduce you to how Synovus Trust Company can serve your needs.