Law Offices - Kenneth D. Sisco, Attorney - Personal Information
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Private AnnuitiesTO TRANSFER PROPERTY AND/OR REDUCE ESTATE TAXESA Private Annuity is an excellent means for funding an offshore strategy; but it may also be of benefit to anyone wishing to transfer property, or whose estate is facing the prospect of high estate taxes. What is a Private Annuity?An annuity is an arrangement whereby the client transfers property to another in return for the other's promise to make periodic payments to the client in fixed amounts for the rest of the Client's life. The typical situation involves an insurance company; but properly established private annuities are fully recognized by the Internal Revenue Service as well. The major difference between a private annuity and a commercial annuity is that the person or entity that assumes the obligation for the private annuity, hereafter referred to as the "Transferee" is not in the business of selling annuities. A second difference, is that commercial annuities are usually funded with cash, whereas private annuities are frequently funded with all sorts of property, such as real estate or corporate stock. Whereas commercial annuity companies determine their payout terms according to standard actuarial tables, a private annuity may determine its payout terms according to many factors, including the Client's desire to make a partial gift to the Transferee. Finally, a private annuity is not subject to the same legal restrictions on permissible investments and maintenance of reserves, to which commercial annuities are subject. Uses for Private AnnuitiesThere are basically two uses for private annuities; the transfer of property and the reduction of taxes by means of the reduction of one's taxable estate. In combining these two broad categories, the uses and benefits of private annuities, are limited only by the imagination of your attorney. 1. Means for Transferring Property Offshore.One of the most commonly asked questions when considering offshore operations is, "How do I legally get my money offshore?" The private annuity can accomplish this legally and completely above board. The Client using cash or even appreciated property, simply purchases a private annuity from the foreign entity. There is no gift, and if there is capital gain, it will be handled similarly to an installment sale contract. With proper planning, this arrangement may also answer the question "How do I legally get my money back?" The foreign entity will agree to make payments to the Client for as long as the Client lives. But in the meantime the Client's estate, otherwise subject to estate taxes and the claims of creditor's, is reduced by the amount of the annuity, and the foreign entity will have the cash and/or property for investment. 2. Estate Tax Savings.Probably the most common motivation for establishing a private annuity is to reduce the Client's gross estate for estate tax purposes. For example, suppose the Client has a large taxable estate, including corporate stock of $400,000. If he dies in that situation, his estate will incur an estate tax, plus administration and attorney fees. If, on the other hand, he had used the stock to purchase a private annuity, the estate's taxes would be reduced, even though the Client would continue to be benefitted by the stock for the rest of his life, and the annuity payments would be made from the stock dividends. Moreover, any further appreciation of the stock would not be in the Client's estate. Of course, the annuity payments received by the Client would go into his estate, requiring further planning. 3. Income Tax Savings.Income tax savings is seldom a motivation for creating an annuity, but for most, tax consequences will be neutral to favorable. Part of each annuity payment will be treated as return of capital, and an additional part may be treated as a capital gain, assuming capital gains will be treated favorably in the future. Income splitting may result in further income tax savings, if the Transferee is in a lower tax bracket than the Client. This, of course, is particularly true where the Transferee is a foreign entity that does not pay U.S. taxes at all. 4. Gift Taxes.Clients frequently desire to make substantial gifts to their children, so that in addition to removing the amount of the gift from their estate, they can see the result of the gift before they pass on. Unfortunately, this will either result in a substantial gift tax (if more than $10,000 per year), or it will result in use of some or all of the Client's $1,000,000 credit. If instead of making a gift, the Client transfers cash or property in exchange for an annuity, the Transferee will have immediate benefit of the cash or property, but without a gift tax or loss of any part of the Client's unified credit. Disadvantages of Private AnnuitiesFor those that can use the benefits of a private annuity at all, the advantages far out weigh the disadvantages. This is especially true for those interested in utilizing the private annuity for funding a foreign entity. However, there are factors that may come into play that will render the annuity less attractive than it would have been otherwise. 1. Early death of Client.When property is transferred pursuant to an annuity, the Transferee's basis is equal to the total amount of payments made to the client. Thus if the client suffers an early death, the Transferee's basis may be considerably lower than it would have been if the property had been inherited. 2. Late death of Client.On the other hand, if the Client lives well beyond the time expected, the payments made by the Transferee may exceed the value of the property and the estate tax savings achieved with the annuity. 3. Early Death of Transferee.In order for the annuity to be effective, the Client must retain absolutely no security interest in the property transferred. This poses an obvious problem if the Transferee predeceases the Client, especially if the Transferee's estate is not sufficient to honor the obligation. In the case of a foreign entity this is not a factor. In the case of an individual, the problem of an early death can be mitigated by means of life insurance; but in the case of a dishonest relative, there may be no acceptable answer. 4. Transferee's Difficulty in Paying.The amount of the annuity payment is determined by the value of the property transferred and the life expectancy of the Client. If the Client is elderly and the property value is high, (especially if the property does not produce income), the Transferee may have difficulty in making the required payments. Of course lower payments can be agreed to, but that could result in a partial gift; and if no payments are made, a total gift. 5. No Interest Deduction.A portion of the annuity payment is the equivalent of interest, but no deduction will be permitted to the Transferee. If the Transferee is a foreign entity that does not pay U. S. taxes, this factor is irrelevant anyway. 6. Income Taxes.The Client will report a portion of each payment received as capital gain. Thus if the Client lives to his/her life expectancy at the time of the transfer, the Client will pay income taxes on the entire realized gain. If the Client had retained the property until death, no income taxes would be paid on the sale of the property, because the heirs would enjoy a stepped up basis. Taxation of Annuity PaymentsTaxation of annuity payments is even more complicated than most tax law, and is therefore well beyond the scope of this article. The following example, however, will give the reader some idea of how payments are taxed. Suppose a Client 65 years old, with a life expectancy of twenty years, according to annuity tables, transfers a capital asset with an adjusted basis of $50,000 and a fair market value of $200,000 to his child in exchange for the child's promise to make annual payments of $29,155, for the life of the Client. Each annual payment would be taxed as follows: a. $2,500 of each payment would be considered a return of capital ($2,500 X 20 yrs. = $50,000) and not taxed at all; b. $7,500 would be considered capital gain (7,500 X 20 yrs. = $150,000) and would be taxed at capital gains rates, whatever those rates are; c. $19,155 would be taxed as ordinary income. ConclusionUnder our system of government, disposing of one's property as we see fit and reducing taxes, is always a challenge. When facing that challenge, a private annuity is one tool that the prudent planner, simply cannot afford to overlook. CLICK HERE For The Cost Of Establishing a Private Annuity Copyright ©1996 |
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