On October 17, 2006, the IRS introduced Proposed Regulations which, if ultimately enacted in the same or similar form, would significantly affect the taxation of some limited types of transactions involving private annuities entered after October 18, 2006, and some other limited types of transactions involving private annuities entered after April 18, 2007.

Importantly, the Proposed Regulations do not eliminate private annuities or even the most common types of transactions involving private annuities. Instead, the IRS sought to address a certain type of transaction that the IRS considered to be particularly abusive, which was the so-called "Private Annuity Trust" ("PAT") transaction. In a PAT, sellers essentially exchange appreciated assets (such as Real Estate) for fixed annuity payments, which spread out their capital-gains taxes over many years. The idea had been to avoid paying the upfront capital gains that would have otherwise been owed if the seller simply had sold the asset outright. Instead, the seller had been taxed on the annuity payments when they came out of the trust, effectively spreading out the taxes over a longer period.

The transactions that the Proposed Regulations identify as abusive generally contain one or more of the following features:

(1) The Trust or other entity that purchased the property by way of a private annuity transaction was owned or controlled either by the annuitant or by the close family of the annuitant;

(2) The Private Annuity payments were secured (either directly or indirectly);

(3) The property had already been agreed to be sold or placed in escrow to a true third-party buyer prior to the time that the Private Annuity Trust was implemented, and the Private Annuity Trust was only inserted in the middle of the transaction to attempt to avoid or defer taxes.

It should be noted that not all transactions involving private annuities and trusts are either considered to be abusive, or are impermissible after the release of the new Proposed Regulations. Indeed, many of the most useful private annuity transactions were not significantly affected by the Proposed Regulations (i.e., transactions entered into for valid non-tax reasons such as estate planning and passing down a closely-held business). For instance, private annuity transactions to trusts that are taxed as grantor trusts are largely unaffected and those private annuities remain permissible.

In any event, there should be no concern for anyone who entered into a Private Annuity Trust already as long as it was funded before October 18th. However, if you are now contemplating entering into a private annuity transaction, it might be a good time to have the transaction reviewed to determine whether there are issues that should be addressed in light of the Proposed Regulations.