Got Premium? Costanza v. Commissioner and the Tax Treatment of Intrafamily SCINs Cancelled by Death

by Gadi Zohar
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This article hopes to accomplish one goal for the practitioner who is essentially unfamiliar with self canceling installment notes and another for the seasoned practitioner who is more versed in their use. In the first instance, the article seeks to introduce a practitioner to the basics of the self canceling installment note (SCIN) along with some general considerations regarding their use in practice. The primary purpose of a SCIN is to get property (typically a closely held business) out of the donor’s estate without incurring transfer taxes. A SCIN, usually executed between family members, is different from other notes in that a person’s death immediately terminates any obligations to pay on the note. To account for this feature, a SCIN must first be a bona fide transaction where the parties manifest the subjective intention of creating a debtor-creditor relationship; and the SCIN must be an exchange for full and adequate consideration in order to avoid gift tax treatment. Whether analyzing for a bona fide transaction or for full and adequate consideration, the author argues that the crux of the SCIN is the risk premium: an enhancement in either interest or principal accounting for the fact that a person’s death may cancel the obligation to pay on the note before its maturity date. For the seasoned practitioner, this article cautions against the lure of reliance upon a pro-taxpayer case, Costanza v. Commissioner of Internal Revenue, as a guide to one’s execution of SCINs. Thus, this article may be bifurcated into 1) a primer on self canceling installment notes, and 2) a comment on a case that the author feels is bad law despite the allure of its taxpayer-friendly holding.

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DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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