The Self-Canceling Installment Note in Estate Planning (SCIN)

Self-Canceling Installment Note

When it comes to planning a person’s estate, it can range from the relatively straightforward, such as preparing a revocable trust all the way to the very complex – such as irrevocable trusts, foreign trusts, etc. Aside from trusts being used for estate planning, there are various other types of tools and techniques that can be used to help manage a person’s estate planning goals — and one type of planning procedure that may be beneficial for some taxpayers is the self-canceling installment note. The crux of the self-canceling installment note is that it includes a provision that allows for the cancellation of the buyer’s obligation to pay. This is important in certain situations in which a family business or other type of entity may be passed from one generation to the next. Let’s look at some of the basics of the self-canceling installment note.

Defining the Self-Canceling Installment Note

Installment contracts are used to require periodic payments for the acquisition of various assets. For example, a person can have an installment contract to purchase a high-dollar item so that they can pay it off monthly or quarterly, along with interest payments. With a self-canceling installment note, the idea is the recipient or the holder of the note includes a self-cancellation provision within the terms of the note. As a result, when a person who holds the note passes away, the person making payments no longer has to make payments and thus the estate of the decedent will not include that asset — which has been self-canceled. If instead for example a jumbo payment triggers at death, then it would require the remainder of the note to be paid if the holder were to pass away.

Is a Self-Canceling Installment Note Legal?

Yes, and a good case that illustrates the concept is the U.S. Tax Court case in the case of Moss in which the court came to the following conclusion:

Estate of Moss

• • • The parties have stipulated that decedent’s sale of stock for which the notes were issued was a bona fide sale for adequate and full consideration. The cancellation provision was part of the bargained for consideration provided by decedent for the purchase price of the stock.

    • As such, it was an integral provision of the note. We do not have a situation, therefore, where the payee provided in his will or endorses or attaches a statement to a note stating that the payor is to be given a gift by the cancellation of his obligation on the payee’s death.

    • We believe there are significant differences between the situation in which a note contains a cancellation provision as part of the terms agreed upon for its issue and where a debt is canceled in a will.

    • The most significant difference for purposes of the estate tax is, as petitioner points out, that a person can unilaterally revoke a will during his lifetime, and, therefore, direct the transfer of his property, at his death. All interest that decedent had in the notes lapsed at his death.

    • We agree, therefore, with the statement in Austin that the situation here is analogous to that of an annuity or an interest or estate limited for decedent’s life.8Since there is not interest remaining in decedent at his death, we hold that the notes are not includable in his gross estate.”

The Self-Cancelling Installment Note in Estate Planning

The most common type of scenario in which a self-canceling installment note is beneficial is when the holder of the note does not believe they will live long enough to receive all the payments to the term of the note when that is their intended goal — with the ultimate goal of the asset passing to family members such their children, without bolstering the value of the decedent’s estate. Noting, there are some technicalities involving life expectancy tables and risks costs/payments to consider as well to make sure the sale is considered a proper and good-faith.

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Golding & Golding specializes exclusively in international tax, and specifically IRS offshore disclosure. 

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