IRS Warns of Schemes Aimed at Wealthy Taxpayers

Apr 6, 2023 | GTM Blog, Tax & Wage Laws, Tax Season

Questionable tax practitioners and independent promoters selling schemes like CRATs and monetized installment sales can leave wealthy taxpayers vulnerable to underpayment tax penalties or civil fraud penalties.

The Internal Revenue Service (IRS) recently cautioned taxpayers to resist questionable tax practitioners and independent promoters selling schemes aimed at wealthy taxpayers.

As part of the IRS annual Dirty Dozen, these potentially abusive arrangements involve things like Charitable Remainder Annuity Trusts and monetized installment sales. These tools can be misused by promoters, who can advertise these schemes to attract clients. The promoters misapply the rules and can leave you vulnerable.

“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 IRS annual Dirty Dozen campaign highlights 12 scams and schemes that put taxpayers and the tax professional community at risk of losing money, personal information, data, and more.

Schemes aimed at high-income filers

Charitable Remainder Annuity Trust (CRAT)

Charitable Remainder Trusts are irrevocable trusts that let you donate assets to charity and draw annual income for life or for a specific time period.

The IRS examines charitable remainder trusts to ensure they correctly report trust income and distributions to beneficiaries, file required tax documents, and follow applicable laws and rules. A charitable remainder annuity trust (CRAT) pays a specific dollar amount each year.

Unfortunately, these trusts 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 of more than 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 (SPIA) with the proceeds from the sale of the property.

By misapplying the rules under 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.

You are legally responsible for what is on your tax return, not the practitioner or promoter who may try to entice you to sign on to an abusive transaction.

Monetized installment sales

In these potentially abusive transactions, promoters find taxpayers seeking to defer the recognition of gain upon the sale of appreciated property. They facilitate a purported monetized installment sale for you 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.

These are examples of potentially abusive arrangements that you should avoid, many of which are now advertised online.

If you are 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.

You may also be subject to accuracy-related penalties ranging from 20 to 40 percent of an underpayment of tax, or a civil fraud penalty of 75 percent of any underpayment of tax related to transactions like those mentioned here.

However, this is not an exclusive list of transactions the IRS is scrutinizing, and taxpayers and practitioners should always be wary of participating in transactions that seem “too good to be true.”