Legal Blog
The Weekly Scenario: Private Annuity and Estate or Gift Taxes
Question: What is a private annuity and does it save estate or gift taxes?
Answer: There are occasions when it may be beneficial from an economic and tax point of view for a parent to sell all or part of his or her business or other income-producing investments to the children. One way to structure such a sale is through a private annuity.
With a private annuity, a seller, usually the parent(s), sells an asset to a child(ren) in exchange for the child’s unsecured promise to pay an amount for life to the parent who sold the asset. Structured properly, a private annuity can be an effective method to convey income-producing assets from one generation to the next without gift or estate tax exposure.
The main benefit of a private annuity is that it removes the property’s future appreciation from the seller’s estate in an arm’s length transaction (e.g., commercially reasonable terms, fair market value) and it enables the seller to receive an income stream. Some of the annuity payment is considered a return of the seller’s original investment (return of principal) and is not taxable. Upon the seller’s death, the annuity ends and none of its value (or the value of the original assets sold) is included in the seller’s estate.
Comment: A private annuity does have some downsides. If the seller lives longer than his life expectancy, the ‘cost’ may be particularly expensive for the children in terms of an ongoing payment obligation. Another issue is that the seller may not be in much better a position (from an estate tax standpoint) if she does not spend the payments received via the annuity. In fact, private annuity works best when the seller is not expected to live for his or her life expectancy.
One more point – A grantor trust is a great vehicle to use in conjunction with a private annuity. The annuity payments can be structured to be received tax-free by the sellers because of the rules governing grantor trusts.
As always, if you have any questions or would like to learn more, please contact Steve Shane at sshane@offitkurman.com or .
ABOUT STEVE SHANE
Steve Shane provides strategic counseling to clients in need of estate administration, charitable giving and business continuity planning while minimizing estate, gift, and generation-skipping transfer tax exposure. He offers legal guidance to clients on asset protection and the proper disposition of assets in accordance with the client’s objectives, while employing tax planning techniques such as the use of irrevocable trusts, life insurance planning, lifetime gifts, and charitable trust. He is also experienced with drafting documents for business planning, the incorporation, and application for exemption for Private Foundations and the administration of decedents’ estates.
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