Critics — and even some promoters — say that the private annuity trust strategy has downsides and isn’t for everyone. “Contrary to the claims of promoters, it is a very risky transaction and in any event it will likely cause you to pay more tax than had you not done the transaction in the first place,” says Atlanta tax lawyer Kevin McGrath, who recently wrote an article critical of the tactic in the tax journal “Tax Notes.”
For one, a private annuity trust doesn’t eliminate capital-gains taxes; it just defers them. On each annuity payment, you’ll owe taxes on both capital gains as well as ordinary income, which is taxed at a higher rate. And if you outlive your life expectancy, all of the annuity payments beyond that point will be taxed at ordinary income rates, according to tax rules. Also, the trust itself has to pay taxes on its earnings over the years, depending on how the assets inside it are invested.
Another caveat: Because these trusts are irrevocable, once you sell your property, you don’t have any direct control over how the proceeds are invested. Instead, a separate trustee manages the assets. You also can’t simply invade the trust to get more money beyond the annuity payments.
If you get pitched a private annuity trust, it’s smart to have an independent lawyer and tax adviser carefully study the transaction to make sure that it passes legal muster, and to model projections on whether the arrangement works for you, depending on your age and income needs.
As soon as I fully understand how they work, I’ll write a post on PATs myself. If anyone wants the entire article, email me at [email protected] .