SCIN – Self-Canceling Installment Note
This procedure involves an installment sale of property. It has the estate freezing attributes of an installment sale. The seller acquires a fixed value note in exchange for property which is likely to realize future appreciation in value. The note includes a provision which states that the note will be canceled upon the death of the seller.
Mr. Goldberg owns 350 shares (out of 500 issued shares) of Max Goldberg Plumbing. An appraisal report indicates that the value of Mr. Goldberg’s interest in the corporation to be $1,000,000. His income tax basis in the stock is $50,000. Mr. Goldberg sells the stock to his son and daughter, Alex and Irma, in exchange for a SCIN (self-canceling installment note.)
Mr. Goldberg expects to acquire J.M. Plumbing, which could cause the sales and net worth of the corporation to more than double over the next 10 years. Mr. Goldberg presently receives a salary of $50,000 from the corporation and a bonus in addition to other benefits equaling $325,000. .
The note is structured for a payout of 20 years. The note includes the following
provision: "For additional
consideration, the payment obligations of this note, both as to principal and
interest, will terminate upon the death of
Issues: What premium must Alex and Irma pay for the cancellation on death provision? What are the income tax consequences to Mr. Goldberg? Is he entitled to an installment payout of capital gains? Must he realize interest income as ordinary income? What are the income tax consequences to his estate upon his death? What are the tax consequences to Alex and Irma? Can they deduct the investment interest expense? Would the tax results be different if the corporation redeemed all of Mr. Goldberg’s stock and if Mr. Goldberg ceased to be an employee of the company?
Mr. Goldberg dies 10 years thereafter. If the transaction complies with all of the requirements prescribed by law, neither the stock sold to Alex and Irma, nor the promissory note will be an asset taxable in Mr. Goldberg's estate.
What is the precedent for this procedure?
Estate of Moss, 74 T.C. 1239 (1980), acq. in result only. The Tax Court held that the remaining note balance due under a self-canceling installment note was not includible in decedent's gross estate under Section 2033 of the Internal Revenue Code since the cancellation provision was part of the bargained-for consideration. The Installment Sales Revision Act of 1980 amended Section 453(b) to permit a sale of appreciated property to qualify for installment reporting even though some or all of the future payments are contingent in amount. The Internal Revenue Service ruled in Rev. Rul. 86-72, 1986-1 CB 253 that the decedent's estate must recognize the deferred installment gain on the estate's initial income tax return. So, we have recognition of the self-canceling installment note by the Tax Court and the Internal Revenue Service. The estate of a deceased taxpayer contested Rev. Rul. 86-72 in the Frane case. Notably, the Internal Revenue Service did not contest the validity of the cancellation provision in the note or the premium paid for the cancellation privilege. Estate of Robert Frane, 98 T.C. 341 (1992), affd in part, revd in part, 72 AFTR2d 93-5268, 93-2 USTC ¶50386 (8th Cir. 1993).
The Tax Court also recognized the validity of the self-canceling installment note in Cain v. Commissioner, 37 T.C. 185 (1961), acq. 1962-2 C.B. 4. Martha King Disborough sold, without reservation or contingency, stock in a family-owned corporation to the corporation for $150,000. The corporation was to pay $6,000 at the time the stock was transferred and $1,000 per month for 12 years or until decedent's death, whichever occurred first. When decedent died, the balance remaining due under the contract was $44,135. The Tax Court held that no part of the purchase price or the stock should be included in the decedent's gross estate or be taxed to Ruby Louise Cain as the transferee of Mrs. Disborough's estate.
In the Frane case, Mr. Frane issued 20-year installment notes to his four children for the sale of common stock in a newly organized family corporation. Interest was payable at the rate of 12 percent. Each note provided that "Unless sooner paid, all sums due hereunder. . . shall be deemed canceled and extinguished as though paid upon the death of Robert E. Frane." At age 53, Mr. Frane's life expectancy exceeded the 20-year term of each note. Mr. Frane died two years after delivery of the notes and after only two installment payments had been made. The Tax Court held that the gain from the sale, reported in installments, must be recognized upon cancellation of the note - on the final joint return of decedent and his wife. The Eighth Circuit Court of Appeals reversed, recognizing the validity of Rev. Rul. 86-72.
A minority opinion written in the Frane case leaves the door open to the use of this technique. That opinion held that in lieu of an installment note, the sale was a contingent sale (the actual amount that will be paid to Mr. Goldberg is unknown – not unusual in the sale of a professional practice where the buyer pays the seller a percent of revenue generated from the seller's former clients for the next number of years), the capital gains would not be recognized for income tax purposes.