Do you own a business but have significant estate planning tax considerations? Do you need to generate income from the business to fund retirement? A SCIN might be right for you.
A SCIN is a variation of the installment sale. Recall an installment sale spreads out the capital gain of a business over multiple annual payments rather than recognizing it all at once. SCINs add a little twist to the usual installment sale. With a SCIN, when the seller dies, the remaining payments are cancelled. Yes, that’s right… cancelled! Hence why a SCIN stands for “Self-cancelling installment note”. A SCIN is best for the business seller in 3 circumstances.
1) A seller doesn’t need income payments past their death.
2) A seller wants to remove their business from their estate.
3) A seller wants higher income payments during life.
From the buyer’s perspective, they might prefer a SCIN over a typical installment sale because:
1) The payments might be cancelled early.
2) The buyer can deduct the portion of payments attributable to the interest expense.
The buyer does pay a premium for this in the form of higher interest charges on the sale.
Let’s look at Brent, age 53, who sells a business worth $2,000,000 in exchange for a 20-year self-cancelling installment note. The likelihood of Brent dying before reaching age 73 adds 31.2996% (a calculation based on IRS tables). Brent effectively sells the business at $2,625,992 (rather than $2,000,000) and the buyer makes payments accordingly.
At death, there is no estate tax because the property has been sold. However, the cancellation of the payments will trigger recognition of the entire remaining gain on the descendant’s estate income tax return as capital gain. Thankfully, this remaining gain is only taxed at capital gain rates (maximum 20%) rather than federal estate tax rate (40%).
Typically, business owners agree to a SCIN if they have potential estate tax issues, and they need to remove the business from their estate. If you have questions about potential business exit strategies, or you are a small business owner looking for financial planning or investment management advice, give us a call at 571-969-1459 or email us at ryan@ifpinvest.com. We’d be happy to learn more about your situation.
