Self-canceling installment notes (SCINs) are often discussed, but rarely used by our clients, until now. A SCIN involves the sale of an asset (for example, a business interest or stock), typically to the seller's family members, in exchange for an installment note with a term shorter than the seller's life expectancy. It's structured so that all indebtedness is forgiven upon the death of the seller (the note holder). While the SCIN is a great estate-planning vehicle, clients often use the short or mid-term applicable federal rate (AFR) for intra-family sales structured with a loan, to avoid the SCIN mortality risk premium. (The Internal Revenue Code requires that a mortality risk premium be added to the AFR.) But, given the current sustained long-term low interest rate environment and its effect on reducing the mortality risk premium, choosing the AFR rate may be short-sighted. The SCIN has many other advantages that outweigh the small difference between the AFR and the SCIN interest rates. We'll discuss why high-net-worth families should execute SCINs — now more than ever.

How it Works

Besides direct gifting, no other planning strategy provides the immediate removal of an asset from an estate as does the SCIN. Three U.S. Tax Court cases have clarified the tax effect of the SCIN: Estate of Moss v. Commissioner,1Estate of Frane v. Comm'r,2 and Estate of Costanza v. Comm'r.3 Further, Congress approved the basic rule under IRC Section 2512: The value of the property transferred must equal the consideration, and any excess value will be deemed a gift.4. Due to the potential for substantial wealth transfer, the IRS requires a mortality risk premium be added to the AFR. This premium is calculated using a formula that considers the life expectancy of the seller (the older the seller, the higher the premium).

The estate benefits of the SCIN are easy to identify if the seller dies before life expectancy. The asset sold is immediately removed from the seller's estate. The note then terminates at the seller's death, making all future interest and principal payments disappear. This termination isn't considered a gift. In contrast, a seller using a traditional installment method must include whatever remaining principal exists at the time of death in his estate. With a SCIN, even if the seller lives to life expectancy, the asset that's sold grows outside the seller's estate.

Calculating Annual Payment

The annual payment for a SCIN is calculated in one of three ways:

  1. Amortized note with mortality risk premium added to the principal amount;
  2. Interest-only note with mortality risk premium added to the principal amount; or
  3. Amortized note with mortality risk premium added to the interest rate (SCIN rate).

In all cases, the interest rate is fixed for the life of the note at the calculated SCIN rate for the month in which the note is created.

Interest rate trends have created an unexpected efficiency of the mortality risk premium relative to the AFR, so the difference between the AFR and SCIN rate is greatly reduced. This current trend (what we call the “SCIN premium contraction”) presents a unique, low-cost opportunity to capitalize on the tremendous benefits a SCIN provides. As interest rates decrease, so do the mortality premiums that are part of the SCIN equation, lowering those rates. “Risk Premium Contraction” (below), illustrates the difference in percentages between the SCIN rate and long-term AFR, at ages 55 and 70, between January 2000 and March 2012. As the lines approach zero, the SCIN rate is reduced relative to the long-term AFR.

For a male, age 55, there's been no difference between the SCIN rate and the long-term AFR only twice in history — in December 2010 and again in August 2011. The largest spread between the SCIN rate and AFR since January 2010 was only .58 percent. The highest spread from January 2000 through December 2011 was in June 2000 when the premium was 3.31 percent, creating a SCIN rate of 9.7 percent. The SCIN rate as of March 2012 is 3.07 percent, less than one-third of the rates a decade ago!

For a male, age 70, the lowest SCIN premiums over the AFR have been 2.39 percent and 2.49 percent in December 2010 and August 2011, respectively. Contrast these premiums with those of June 2000, when a 70-year-old male would have had to pay a premium of 6.09 percent over the AFR of 6.39 percent or a SCIN rate of 12.48 percent.

The AFR and IRC Section 7520 rates were added to the IRC with the enactment of the Deficit Reduction Act of 1984.5 The IRC interest rates (which are based on the AFRs) have never been lower than they are now. With this historical perspective, SCINs should become part of every planning discussion. “Rates for Age 55 Male” (p. 24) and “Rates for Age 70 Male” (p. 24), show the steady decline of the AFR, along with a steady decline in the SCIN rate, since January 2000.

If a client has difficulty justifying the payment of a mortality premium for a SCIN, consider that the SCIN rates for both ages 55 and 70 are now lower than the average 30-year mortgage loan rates over the last 20 years. The average 30-year fixed mortgage since 1990 is 6.97 percent, according to the Freddie Mac Primary Mortgage Market Survey of 30-year fixed rate mortgages.6 A SCIN structured in March 2012 for a male age 55 would have a lifetime fixed rate of 3.07 percent. The SCIN rate for a male age 70 for March 2012 is 5.52 percent for life.

The SCIN Advantage

The overriding benefit of using a SCIN in wealth transfer planning is that the principal amount outstanding to the seller is forgiven at his death. With forgiveness of the note, the asset is removed from the estate. There's a major shortcoming to the IRC methodology in that it doesn't take specific health conditions into consideration, but this shortcoming works to the taxpayer's advantage. The IRC requires disclosure of poor health or terminal illness, but otherwise bases the SCIN risk premium on only the age of the seller. Terminal illness is defined as an “incurable illness or other deteriorating physical condition that would substantially reduce a person's life expectancy to the extent that there is at least a 50 percent probability that the individual will not survive for more than one year from the valuation date.”7 This works in favor of the taxpayer, because the risk premium could understate the risk that the seller will die during the SCIN term in certain circumstances. Quite a number of serious diseases and conditions, such as heart diseases, diabetes, Alzheimer's and many cancers don't reduce life expectancy to a 50 percent probability of death within one year.

When the seller is reluctant to give up the cash flow or income from an asset, a SCIN may provide lifetime cash flow payments. These payments may be customized to the seller's objectives. Though counter-intuitive, a taxpayer may either overvalue an asset being sold or increase the interest rate charged in a SCIN to increase the income paid from the note. It seems illogical that the IRS would challenge an asset being sold for more than its appraised value or at a rate higher than the minimum prescribed by the IRC. Later, we provide a fact pattern, “Natural Gas Leases,” in which this technique might be used.

As with any intergenerational sale, all appreciation after the SCIN is created is removed from the estate. The asset that's sold grows outside the estate of the seller. “Why Do a SCIN?” (p. 25), shows the factors to consider in determining if a SCIN is the right strategy for your client.

Combining SCIN and IDIT

A common concern among advisors pertaining to a sale to an intentionally defective irrevocable trust (IDIT) is the incomplete nature of the transfer if a seller dies during the term of the note. Arguably, a SCIN sale to a defective trust is a completed transfer at the moment the grantor dies. There's no note to include in the estate of the decedent and, perhaps, less risk of IRS scrutiny.

SCINs may be structured with an IDIT. This freezes the value of the asset and leverages the trust growth based on the seller-financed, minimum interest rate. If the asset being sold can support the SCIN payment, and the risk premium has been mitigated with the interest rate, a SCIN immediately reduces the seller's estate.

The tax consequence to the seller remains neutral as the seller/grantor reports offsetting income tax and interest deduction for the interest portion of the payments received.8 Principal repayment is received tax free.9 The major considerations include the seller's health and cash flow needs, as well as the cash flow attributes of the asset to be sold.

SCIN With Real Estate

Consider the example of John Martin, who has a net worth in excess of $20 million and a $5 million real estate portfolio that he's ready to transfer to his children. He has already used his gift tax exemption, so selling the property is the only way to transfer it to the next generation without gift tax. Furthermore, John has had several health setbacks in the last five years, most certainly shortening his life expectancy, evidenced by recent unsuccessful attempts to be underwritten for life insurance. The real estate generates an annual net income of $500,000, which he uses to maintain his standard of living. John is 70 years old and has an emotional, perhaps irrational desire, given the size of his estate, to maintain the real estate cash flow for the rest of his life.

Selling the real estate over the maximum term SCIN would require a payment of $485,333 per year. In a sale scenario without a SCIN, the trustees would be encouraged to accelerate principal repayment to repay the debt. Instead, the trustees would be better advised to enter into a SCIN transaction, and use any excess cash flow to compound in the trust, outside of the estate. The relatively low risk premium, better alternative use of excess cash and the comfort of lifetime payments, make a SCIN the clear best option for wealth transfer for John.

Natural Gas Leases

Let's assume that David Jones, a 55-year-old male, has an estate of less than $5 million in real estate, but expects a very high volume of payments from future natural gas royalties. At the moment, a professional appraiser values the royalties at $500,000, due to the risks that the natural gas will never be extracted from the property. However, anecdotal evidence from neighboring properties indicates a potential cash flow in excess of $1 million per year for the foreseeable future. David faces a conundrum in that he's cash poor, but possibly about to encounter a huge increase in the value of his estate and estate tax exposure. David has expressed that if he could maintain $350,000 of annual cash flow for life (three times his current income), he would like to remove the future appreciation from his estate to a trust for his descendants. A SCIN for the appraised value of $500,000 at the lowest SCIN rate in March 2012 provides annual cash flow of $26,861. If instead, the sale was for $6,515,100, the annual trust payments would satisfy the $350,000 cash flow requirement expressed by David. All royalty payments in excess of what's paid to David and appreciation of the real estate are removed from the estate, thus avoiding the potential for estate tax.

If natural gas isn't produced from the property, the trust will be forced to default on the SCIN payments, and the property will be returned to the estate.

As customary with sale-to-trust methodology, the trust entering into the SCIN should be seeded with at least 10 percent of the purchase price and stay current on SCIN payments to elude IRS scrutiny.

Refinancing Opportunity

As indicated by the orange horizontal line in “Rates for Age 55 Male,” and “Rates for Age 70 Male,” there's a great opportunity for a trust that has previously structured a purchase from its grantor to restructure and refinance to a SCIN. The orange horizontal line shows the current SCIN rate at each age. The SCIN rate in March 2012 for a 70-year-old male, including the mortality risk premium, was 5.52 percent, lower than the mid-term rate for all notes created before January 2001, when the mid-term AFR was 5.61 percent. The SCIN rate for a 55-year-old male in March 2012 is 3.07 percent, lower than the mid-term rate for almost all notes created before October 2008.


  1. Estate of Moss v. Commissioner, 74 T.C. 1239 (1980), acq. 1981-2 C.B. 1, 1981 WL 383629 (IRS ACQ Dec. 31, 1981).
  2. Frane v. Comm'r, 998 F.2d 567 (8th Cir. 1993).
  3. Costanza v. Comm'r, 320 F.3d 595 (6th Cir. 2003), rev. F Costanza v. Comm'r, T.C. Memo. 2001-128.
  4. “Where property is transferred for less than an adequate and full consideration in money or money transfer then the amount by which the value of the property exceeded the value of the consideration shall be deemed a gift, and shall be included in computing the amount of gifts made during the calendar year.” Internal Revenue Code Section 2512.
  5. The Deficit Reduction Act of 1984 (H.R. 4170, 98th Congress, Public Law 98-369).
  6. Primary Mortgage Market Survey 2011 by Freddie Mac,
  7. Treasury Regulations Section 25.7520-3(b)(3).
  8. Revenue Ruling 85-13, 1985-1 C.B. 184.
  9. Ibid.

Sean Maher, far left, is the CEO of Valley Forge Financial Group Inc. in King of Prussia, Pa. and Tim Laffey is head of its Wealth Transfer Operations

Sean Maher and Tim Laffey