| ||By George! Costanza Provides Additional Certainty To SCIN Transactions |
Daniel W. Matthews*
*Assistant Professor, Thomas M. Cooley Law School, Lansing, Michigan; Michigan State University, B.A. 1993; Detroit College of Law, Michigan State University, J.D. summa cum laude, 1997; New York University, LL.M. (in Taxation) 1998. This article was written and accepted for publication while the author was an associate with Cox, Hodgman, & Giarmarco, P.C., Troy, Michigan. The author would like to express appreciation to Randall A. Denha and George M. Malis for their efforts in the development of this article.
Over two decades have passed since the Tax Court's seminal decision in Estate of Moss v. Commissioner, which held that the value of a bona fide self cancelling installment note (SCIN) is not includible in the gross estate of its holder. Since that time, several commentators have attempted to provide guidance as to when a SCIN will be considered bona fide and will pass potential scrutiny from the Service. Fortunately for estate planners, the Sixth Circuit's reversal of the Tax Court's decision in Estate of Costanza v. Commissioner has provided additional guidance and certainty with respect to the use of the SCIN in estate planning. The Estate of Costanza decision is arguably the most important decision involving the estate and gift tax treatment of a SCIN since Estate of Moss.
In Estate of Costanza, the decedent, Duilio Costanza, sold his restaurant and accompanying real estate to his son, Michael, in exchange for a SCIN payable over a period of 11 years secured by a mortgage on the real estate. At the time of sale, Duilio was 73 years old and had a life expectancy between five and 13.9 years. Five months after execution of the SCIN, Duilio unexpectedly passed away, although he had suffered from heart disease during the final 15 years of his life.
Duilio's estate identified the SCIN on its estate tax return, but claimed that the SCIN had no value due to the cancellation upon death provision. The Service issued a notice of deficiency, contending, among other things, that the SCIN was not a bona fide transaction. As such, the Service contended that Duilio's transfer of the restaurant and real estate to Michael was a taxable gift, as the transfer was not made for adequate and full consideration in money or money's worth. The Tax Court agreed with the Service, holding that the SCIN was not bona fide, and as such, Duilio merely gifted the property to Michael. Accordingly, the value of the property was subject to the estate tax.
The Tax Court pointed to a number of factors indicating that the SCIN was not bona fide. The court noted that the SCIN was dated December 15, 1992, although it probably was not executed before January 6, 1993. Additionally, although the SCIN called for monthly payments beginning in January 1993, Michael did not make the first three monthly payments to Duilio until March 1993. Moreover, between March 1993 and Duilio's death on May 12, 1993, Michael made no more payments. Michael explained that Duilio agreed to accept quarterly payments on the SCIN, despite the clear terms of the SCIN calling for monthly payments. The Tax Court did not find Michael's explanation persuasive and concluded that Duilio had made a gift to Michael equal to the value of the restaurant and accompanying real estate, less the three payments Michael made to Duilio.
On appeal, the Sixth Circuit ruled that intrafamily transfers are presumed to be gifts. Nevertheless, it held that in the context of a SCIN the presumption of a gift may be rebutted if, at the time of the transaction, there is a "real expectation of repayment." Unlike the Tax Court, the appellate court placed less emphasis on the fact that the SCIN was signed after its effective date and that Michael made three monthly payments after their due date. Instead, it focused on the fact that Duilio sought to use the income from the SCIN to retire in his native Italy. Moreover, the SCIN was adequately secured by a mortgage on the real estate sold. More importantly, the Sixth Circuit stated that Duilio's premature death "was clearly not anticipated." Accordingly, the Sixth Circuit reversed the Tax Court and held that the SCIN was bona fide and that the presumption of an intrafamily gift was rebutted.
The Sixth Circuit next considered the Service's alternate position that the transfer from Duilio to Michael was a bargain sale. The Service contended that the true value of the SCIN was considerably less than the value of the property that Duilio transferred to Michael. Accordingly, the Service argued that the difference in value between the SCIN and the properties transferred would constitute a gift from Duilio to Michael. The Sixth Circuit declined to decide the bargain sale issue, deciding instead to remand the case to the Tax Court for further proceedings on the issue.
This article discusses the impact of the Estate of Costanza decision, along with prior authorities, on the use of the SCIN for estate planning purposes. Specifically, the article provides guidelines for when a SCIN will survive scrutiny from the Service in light of the Estate of Costanza decision, especially with respect to an aggressive SCIN transaction involving a seller of advanced age. To help illustrate the type of transactions in which Estate of Costanza may be applicable, the following hypothetical will be used throughout this article.