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GETTING PERSONAL: Private Annuity Trusts Await IRS Rule January 8, 2007

Posted by notapundit in Economic News.

NEW YORK (Dow Jones)–Estate planners have largely stopped creating new private annuity trusts as they await a ruling next month that could limit the tax benefits of the trusts dramatically.

Private annuity trusts had been an increasingly popular vehicle for deferring taxes on the sale of property and other assets. But the Internal Revenue Service and U.S. Treasury Department issued a proposal in October that could make them much less attractive.

The IRS plans to hold a hearing on its proposal on Feb. 16.

At least one of the major firms in the business of packaging private annuity trusts to the public has permanently abandoned them. Another big provider is hoping to convince the IRS not to disallow the trusts.

“We are still the National Association for Private Annuity Trusts, but depending on what the IRS does, we may merge it into another of our companies,” said Kevin McBarron, president of Napat, a privately held, for-profit organization.

Private annuity trusts have been used to lessen the tax bite on assets ranging from stocks to art, but their popularity really boomed as the real estate market heated up in the 1990s and property owners looked to preserve profits.

The trusts allow the owner of an asset to defer all tax due on its sale by removing it from the owner’s estate in exchange for an income stream. An agreement is signed that requires one party to transfer ownership to another party. In return, the buyer makes periodic payments to the seller for a specified time, usually the lifetime of the seller or the seller’s spouse.

For example, parents who own a piece of property might set up a trust that names their children as beneficiaries. The parents sell the property to the trust in return for a private annuity trust that provides them with a fixed income for life.

Capital-gains tax on the sale of the asset is spread out over the period of the annuity payments.

The IRS proposal would disallow the tax deferral.

“Instead of paying the tax as you go, they’re going to take the present value of the annuity payments and tax you on it up front,” said Steven B. Gorin, a partner at Thompson Coburn LLP, a law firm in St. Louis, Mo., and a member of the Real Property, Probate and Trust Law Section of the American Bar Association.

The ABA section is readying comments for the IRS on its proposal, according to Gorin.

The Treasury Department and the IRS said in the proposal that they had learned some taxpayers are inappropriately avoiding or deferring gain on the exchange of highly appreciated property for the issuance of annuity contracts.

“Many of these transactions involve private annuity contracts issued by family members or by business entities that are owned, directly or indirectly, by the annuitants themselves or by their family members,” the agencies said.

The IRS dislikes deferral because it postpones tax payments and may reduce or virtually eliminate them, according to Jerry J. McCoy, an attorney in Washington, D.C. It views a private annuity as something that should be taxed as a commercial annuity through a commercial issuer.

The proposed regulations wouldn’t apply to money received after Oct. 18, 2006, under annuity contracts received in exchange for property before that date.

It isn’t certain if the IRS will adopt the proposal as is, but many in the industry are expecting the agency to say “that private annuity trusts aren’t dead, but they’re going to take a lot of power out of it, in our opinion,” said Anthony W. March, president, executive director and chief financial advisor at NISS Foundation Inc., a public non-profit organization.

The NISS Foundation sprang from the ashes of the National Private Annuity Trust in Kitty Hawk, N.C., which closed down in the wake of the IRS proposal. This month, it started marketing its NISS Asset Exchange, which provides an income stream in exchange for assets including real estate, investment accounts, business holdings and collectables, among other assets, according to March. NISS wouldn’t go back to using private annuity trusts, even if the IRS were to drop its proposal altogether, he added.

The IRS, McBarron of Napat said, could adopt the proposal “as it is, strike it down, or somewhere in between.” He said, “Depending on its stance, we’re going to be prepared to adapt our business to the rulings.”

Napat hasn’t set up any new private annuity trusts since the IRS proposal, McBarron said.

The company is talking to attorneys and certified public accountants about writing a group letter to the IRS urging it to issue more detailed guidance on private annuity trusts, rather than passing the proposal as it is.

Private annuity trusts have a number of gray areas that could be addressed in guidance. A basic question is whether income can be deferred in a trust, for example, and for how long. Another is who can qualify as a trustee.

Even the issue of when a private annuity trust can be created isn’t spelled out clearly, according to McBarron.

By Arden Dale, Dow Jones Newswires


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