Sale of asset for self-cancelling installment note leads to gift tax liability

Sale of asset for self-cancelling installment note gives leads to gift tax liability in CCA201330033.

Proskauer Rose LLP

USA

October 10 2013

CCA 201330033 asked whether the transfer of stock to a grantor trust in exchange for self-cancelling installment notes constituted gifts by the transferor. A SCIN is a promissory note where the debt is extinguished if the transferor/maker dies during the term of the note.

In general, a transaction where property is exchanged for a note will not be treated as a gift if the value of the property transferred is substantially equal to the value of the note. Treas. Reg. § 25.2512-4 provides that the fair market value of a note is presumed to be the amount of its unpaid principal plus accrued interest. For a gift to exist, the value of the gift must exceed the value of the note or the note must be uncollectible or the property pledged or mortgaged as security is insufficient to satisfy the note.

In analyzing the open issues in this CCA, the Service reviewed a SCIN case from the Sixth Circuit, Estate of Costanza v. Comm'r. In Costanza, the court held that a SCIN signed by family members is presumed to be a gift unless there is an affirmative showing that there existed a real expectation of repayment and intent to collect the debt. In Costanza, the taxpayers showed that the transferor required a steady stream of income to retire and an unwillingness to simply gift the transferred assets. According to the court, these facts showed an intention to actually collect on the debt. In the CCA, however, the SCINs only provided for interest payments each year, which to the Service, indicated that a steady stream of income was not contemplated. Also, according to the Service, the decedent in the CCA had sufficient assets so he did not need to rely on the notes for his living expenses. Together, these facts showed that the notes lacked the indicia of genuine debt. The Service found there was no reasonable expectation that the debt would be repaid.

The Service further held that the value of the notes should be determined using a willing buyer/willing seller standard, which looks at the value an unrelated willing seller would accept for the note and the amount an unrelated willing buyer would pay for the note. The Service also stated that decedent's life expectancy should be taken into consideration, since the notes would be extinguished at the decedent's death. The difference between the notes' fair market value based on the willing buyer/willing seller standard and the fair market value of the property transferred constituted a taxable gift.

There were no estate tax consequences associated with the cancellation of the notes.