On 3/31/23, the IRS continued the release of its 2023 annual “Dirty Dozen” List – this time geared towards high income filers by presenting abusive arrangements that involve Charitable Remainder Annuity Trusts and Monetized Installment Sales. These tools can be misused by promoters, who can advertise these schemes to attract high income filers. “The IRS remains concerned about abusive tax arrangements, and they remain a focal point for our enforcement efforts,” said IRS Commissioner Danny Werfel. “Taxpayers should beware of potentially abusive arrangements and promoters pushing them. People should seek out trusted, reputable tax advice and not be fooled by aggressive advertising and sales pitches.” The Dirty Dozen campaign is a list of 12 scams and schemes that put taxpayers and the tax professional community at risk of losing money, personal information, data and more. The IRS reminds all taxpayers that they are legally responsible for what is on their tax return, not only the practitioner or promoter who entices them to sign on to an abusive transaction.
Taxpayers be wary
Charitable Remainder Annuity Trusts and Monetized Installment Sales are examples of potentially abusive arrangements that all taxpayers should avoid (particularly high-income filers), many of which are now advertised online. The IRS “recommends that taxpayers considering these types of arrangements, carefully review the legal requirements underlying them and consult with competent, independent, qualified advisors before engaging or claiming any purported tax benefit.”
Taxpayers ought to keep in mind that if appropriate, IRS may assert accuracy-related penalties ranging from 20% to 40% of an underpayment of tax, or a civil fraud penalty of 75% of any underpayment of tax related to transactions that are “too good to be true”.
Charitable Remainder Annuity Trust (CRAT)
CRATS are irrevocable trusts that let individuals donate assets to charity and draw annual income for life or for a specific time period. The IRS examines CRATS to ensure they correctly report trust income and distributions to beneficiaries, file required tax documents and follow applicable laws and rules. A CRAT pays a specific dollar amount each year.
CRATS are sometimes misused by promoters, advisors, and taxpayers to try to eliminate ordinary income and/or capital gain on the sale of property. In abusive transactions of this type, property with a fair market value in excess of its basis is transferred to a CRAT. Taxpayers may wrongly claim the transfer of the property to the CRAT results in an increase in basis to fair market value as if the property had been sold to the trust. The CRAT then sells the property but does not recognize gain due to the claimed step-up in basis. Next, the CRAT purchases a single premium immediate annuity with the proceeds from the sale of the property. By misapplying the rules under Internal Revenue Code sections 72 and 664, the taxpayer, or beneficiary, treats the remaining payment as an excluded portion representing a return of investment for which no tax is due.
Monetized Installment Sales
In a Monetized Investment Sale, a promoter finds taxpayers seeking to defer the recognition of gain upon the sale of appreciated property. They facilitate a purported monetized installment sale for the taxpayer in exchange for a fee. These installment sales occur when an intermediary purchases appreciated property from a seller in exchange for an installment note. The notes typically provide for payments of interest only, with the principal being paid at the end of the term. In these arrangements, the seller gets the lion’s share of the proceeds, but improperly delays the recognition of gain on the appreciated property until the final payment on the installment note, often years later.
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