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    • Kathleen Reynolds
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      Calculates the annual payment for a private annuity measured by one or two lives. It then calculates the tax-free, capital gain, and ordinary income portions of each payment.

      When a private annuity agreement is arranged, one party (the transferor-annuitant) signs over complete ownership of property to another party (the transferee-payor). In return, the transferee makes periodic payments to the transferor for a specified period of time (usually the lifetime of the transferor).

      The private annuity is a useful tool for an individual who wants to spread out over his lifetime payments from selling a highly appreciated asset.

      The private annuity is also as a useful federal estate tax saving tool because payments end when the transferor dies and the entire value of the asset sold is immediately removed from the transferor’s gross estate. The private annuity allows someone who owns non-income-producing property to make that property productive.

      The ideal transferor/payor situation is one that meets the following criteria:

      • The transferor is in a high estate tax bracket or has no marital deduction.
      • The property is capable of producing income and/or is appreciating rapidly.
      • The payor is capable of paying the promised amounts.
      • The parties trust each other (the private annuity must be unsecured).
      • The transferor has other assets and sources of income.

      Private Annuity Inputs Screenshot

      Entering Data

      1. Transfer Date Enter the month and year (dd/yyyy). See Transition Period Notes.
      2. §7520 Rate The program automatically enters the correct §7520 discount rate if you have kept the AFR Rates Manager up-to-date. If the AFR Rates Manager is not up-to-date, the program shows a 30% value for the selected transfer date. The program automatically rounds the rate to the nearest 2/10 of 1% as required under §7520.
      3. FMV of Property Enter the fair market value of the property.
      4. Client’s Basis Enter the transferor’s adjusted basis (cost).
      5. Payment Period Select the number of payments that will be made each year to the beneficiary (Annual, Semiannual, Quarterly, Monthly, Quarterly, and Weekly).
      6. Growth of Payments Enter the percentage (if any) by which the annual payments should grow each year after the first payment is made.
      7. Payment Timing Select Begin or End to indicate when the payment should be made for the selected payment period. A Begin case is assumed to be the same as an End case with an additional payment made at the beginning of the period.
      8. Deferral Period Enter the number of years (if any) by which the payments should also be deferred.
      9. Number of Annuitants Enter the number of annuitants (1 or 2).
      10. Ages Enter the age of the annuitant(s). Valid age inputs are 5 to 109.
      11. Apply Proposed Regulations (REG-141901-05)? In 2006, the Treasury proposed new regulations, under which the full amount of any gain or loss in a private annuity transaction will be realized immediately, instead of ratably over the life expectancy of the annuitant. If adopted, the regulations may be applied to transactions after the date they were proposed (10/18/2006). Choose “Yes” to apply those regulations, or “No” to show how the gain is realized under prior law.
      12. Annuity Payments from a Trust Select “Yes” if the annuity will be payable from a trust or other limited fund.
      13. PV of Limited Fund Enter the value of the trust or other limited fund before the transfer is made in exchange for the annuity agreement.
      14. Exhaustion Method Select either the IRS Method or the Illustrated Method to be used in calculating when the annuity might exhaust the trust or other limited fund. The IRS Annuity Factor Method This is the method which appears to have been used by the IRS in §25.7520-3(b)(2)(v), Example 5. It uses published annuity factors to determine when the trust exhausts, and what the payment is in the last period of the trust.

        The Illustrated Method This method creates the schedule of payments based on the assumption that the trust will grow at a rate equal to the §7520 rate. You can use this method to illustrate when the annuity is expected to exhaust.

      Private Annuity Results Screenshot

      Private Annuity Table Screenshot

      Private Annuity Graph Screenshot


      The program calculates an annuity factor and adjusts it with payout frequency factors. It then divides the resulting factor into the fair market value to arrive at an annual payout. Basis is then divided by joint life expectancy to arrive at the tax-free portion of each annual payment. If ‘Apply Proposed Regulations’ is checked, then the life expectancy is also used to arrive at the capital gain portion. Subtracting the tax-free and capital gain portions from the total payment computes the ordinary income portion.

      When the annuity is deferred, the life expectancy used to calculate the tax-free portion (and capital gain portion) of the annual payments is the life expectancy based on the age of the annuitant(s) at the end of the deferral period.

      When the annuity payments grow by a percentage each year, that growth is taken into account in calculating the “Expected Return Multiple,” which is no longer the life expectancy of the annuitant(s) but the total amount that is expected to be received over the lifetime(s) of the annuitant(s), measured as a multiple of the initial payment. The Tax-Free Portion, Capital Gain Portion, and Ordinary Income Portion will also increase in proportion to the increase in the total annual payments.

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