By mauch | April 26, 2007
As you already know, the Private Annuity Trust or PAT is no longer a viable capital gains tax deferral tool. Why is this??
To cut to the chase… because the IRS saw through the PAT and realized that it was nothing more than a tool to allow the seller to take an asset from one pocket and put it in another. The PAT didn’t address many of the important IRS guidelines, which led to its demise. In addition, all of the “PAT experts” that sprouted up over the years that began to sell PAT packages like the next big craze.
Quick analysis of the PAT:
A PAT (Private Annuity Trust) is basically a transaction where a trust is set up to house the asset, which if it is a business or real estate, the asset is usually sold to convert the asset into cash. The cash is usually invested in an annuity to provide the seller with a stream of income over time. That is a very simplified version.
Now, there are many problems with the PAT that led to the IRS decision to shut it down. I’ll go over some of them here.
- Did not address the constructive receipt doctrine - When looking at a PAT for what it is (or was), you can easily see that if push comes to shove the seller truly could get at the funds in the trust if they really wanted to. They technically could go to the trustee (which is often a family member) and ask for “a bit more money this month”. Just having this ability triggers the constructive receipt doctrine which also triggers the realization of capital gains.
- Did not address the economic benefit doctrine - Once again, by having “access” to the funds and possible control over how the funds are handled, the PAT tramples over the economic benefit doctrine which triggers capital gains.
- Was just a trade of one asset for another - If you break down the PAT to its simplest form, you see that it is really nothing more than trading one asset for another. The seller started with an asset worth $x (property or business) and ends up with an annuity worth $x.
In contrast, the Structured Sale is a completely different animal. The Structured Sale is not an exchange in any shape or form. It is merely an installment sale where the buyer (an actual buyer… not a trust set up for the sellers benefit) simply transfers their obligation to pay to a 3rd party (backed by the annuity issuer) who in turn uses the buyers funds to purchase a fixed annuity to fund the future installment payments.
It has long been a fact that the IRS allows for installment sales and for substitution of obligors. That is all the Structured Sale is… an installment sale with a substitute obligor to make the installment payments.
The fact that the Structured Sale and PAT both use annuities is the only similarity that they share. PAT’s were a trade of an asset for an asset, while the Structured Sale is the sale of an asset by installment sale.
Of course, the Structured Sale offers the seller huge benefits such as the comfort of having their payments 100% fully backed by the large Fortune 50 annuity issuer, tax deferral, customized payment streams (truly almost anything you can think of), and more.
So… next time someone tries to say that the IRS is cracking down on “things” like the Structured Sale, be rest assured that they ARE NOT. The Structured Sale is an installment sale with a substitute obligor… and that is all it is in it’s simplest form.
If you have any questions on the Structured Sale or would like additional resources on the Structured Sale, be sure to give us a call @ 1-800-666-5584 anytime.