April 21, 2023

Hey there, just thought I’d share some important tax info with you all! The IRS recently sent out a warning (IR 2023-64) to high-income folks about some sketchy arrangements involving charitable remainder annuity trusts (CRATs) and monetized installment sales. Basically, some promoters are advertising these strategies to lure clients in, but they’re not following the rules. The problem is, taxpayers are the ones responsible for their tax returns, not the promoters who got them into the mess.

So, what’s up with CRATs? These are irrevocable trusts that let you donate assets to a charity and then get an annual income either for life or for a set period of time. In the IRS warning, they mentioned that they’re keeping an eye on these trusts to make sure everything is above board. Some people try to misuse them to avoid paying taxes on ordinary income and capital gains from selling property. They might wrongly claim that transferring property to a CRAT bumps up its value as if it had been sold to the trust. The CRAT then sells the property but doesn’t recognize the gain because of this supposed step-up in value. Finally, the CRAT buys a single premium immediate annuity with the money from the property sale.

The issue here is that taxpayers, or beneficiaries, might misuse some tax code sections to treat the remaining payment as tax-free, which isn’t right.

Now, let’s talk about monetized installment sales. Some promoters target people looking to delay recognizing gains on the sale of appreciated property. They set up a so-called monetized installment sale, usually for a fee. In this setup, an intermediary buys the property from the seller and pays them with an installment note. The notes are typically interest-only, with the principal paid at the end of the term. The sneaky part is that the seller gets most of the money from the sale, but they don’t recognize the gain on the appreciated property until the final payment, which could be years later.

The IRS isn’t messing around with this stuff. They might hit you with penalties ranging from 20% to 40% of the tax you didn’t pay, or even a 75% civil fraud penalty if things get really serious.

So, family office clients, watch out for these red flags and make sure you’re playing by the rules! It’s always better to be safe than sorry when it comes to taxes.