What Is the Maximum Allowable Term of a Self-Canceling Installment Note?

The term of a SCIN should not exceed the seller's actuarial life expectancy. If the term of the note extends beyond the seller's life expectancy, the IRS is likely to re-characterize the note as a private annuity for income tax purposes. In this event, the income portion of the payments is nondeductible as interest, which is likely to have adverse tax consequences to the buyer in cases where investment or trade or business property is involved.

Although the internal revenue code, regulations and case law have set no clear guidelines, if the seller is in normal health for his or her age, the expected return multiples for a single life as presented in Table V of IRC Reg. §1.72-9 have been an acceptable measure of life expectancy.

In the past, standard mortality factors and life expectancies could be used unless death was imminent, which had been interpreted to mean death was expected to occur within one year. In recently released proposed regulations, the IRS has amended and expanded this "mortality test." Under the proposed rules, if the individual who is the measuring life of the interest being transferred is known to be terminally ill, special actuarial factors, rather than the standard factors, must be used in valuing the interest.

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." The proposed regulations would be effective for valuation dates occurring after the date the regulations are published as final regulations.

It is unclear at this time how it is to be determined whether a person has at least a 50 percent probability of dying within a year. However, quite a number of serious diseases and conditions, such as heart disease, diabetes, many cancers, Alzheimer's disease, etc., do not reduce life expectancy to a 50 percent probability of death within one year until they are in quite advanced stages. It would appear, therefore, that under the new proposed "mortality test" many people with serious diseases or deteriorating physical conditions may use standard mortality factors and life expectancies when designing installment sales with a self-cancellation feature.