Private Annuities: Proposed Regulations Issued

October 17, 2006 —Treasury and IRS update tax rules on exchanges for private annuities

A private annuity is an unsecured promise to make periodic payments for a specified length of time in return for cash or property.

Individuals who exchange appreciated property (such as a business, a piece of real estate, or an investment portfolio) for a private annuity have been allowed to defer the recognition of capital gains. Effectively, rather than recognizing capital gain and paying the resulting capital gains tax at the time of the exchange, individuals have been able to spread out the capital gain and resulting tax over the life of the annuity.

The IRS has suggested that private annuities have been used inappropriately to avoid federal income tax, pointing out that mechanisms have been put in place to secure the payment of amounts due under the annuity contract.

The Treasury Department and the IRS have issued proposed regulations that would significantly change the way the exchange of appreciated property for a private annuity is taxed. The proposed regulations are not restricted to those perceived to have used private annuities inappropriately; they will affect any client considering a private annuity.

The proposed regulations would put the transferor in the same position that he or she would have been in if the property transferred was sold for cash and the cash was used to purchase the annuity. The entire amount of any gain or loss must be recognized at the time of the exchange. This makes the tax rules consistent with those that currently apply to commercial annuities. The proposed regulations do not apply to exchanges of annuity contracts under Section 1035, or to charitable gift annuities.

Effective date:

The proposed regulations will generally be effective for exchanges made after October 18, 2006. The regulations would not be effective for annuity payments received after October 18, 2006 under an exchange made prior to that date. The effective date is April 18, 2007 for exchanges that meet certain conditions (in general, where the exchange involves an unsecured annuity contract issued by an individual, and the property that is exchanged is not sold or disposed of for a two year period).

About Bay Colony Partners
Bay Colony Partners provides employers with employee benefit services and products, including 401(k) retirement plans, executive benefits, group health care plans, and human resources services. Principals Bob Auditore, Gary Cowles, and Jeff Kagy, are experts in their respective practice area and directly service clients with strategic direction, customized solutions and benefits plan design, as well as the implementation and administration of the plans and initiatives.

As a consulting firm with brokerage services, Bay Colony Partners is a source for the latest knowledge that employers need to plan and shape their benefits programs, and a resource for having insurance companies compete on price and service. They work with company leadership to ensure regulatory compliance, fiduciary responsibility, and comprehensive programs for senior executives and all staff alike. The company delivers a full range of human resources services, as well, ranging from organizational consulting to recruitment and staffing support.

Located in Woburn, MA, the company services employers throughout the New England region.
 
Contact: Gary Cowles, gcowles@baycolonypartners.com
Bay Colony Partners
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