The IRS has again this year issued a warning about questionable tax practitioners and promoters of schemes aimed specifically at wealthy taxpayers.
Part of the agency’s latest annual "Dirty Dozen" scams, these potentially “abusive arrangements” involve charitable remainder annuity trusts and monetized installment sales.
“It’s difficult to determine the level of awareness wealthy clients have regarding these scams. It can vary widely,” said Deysi Monti, associate director of tax services at EP Wealth Advisors in Torrance, Calif.
“Occasionally a client will forward a suspect email to me to ask if the idea is legitimate. I typically suggest that if something seems too good to be true, it usually is,” added David Handler, a Chicago-based partner in the trusts and estates practice group of Kirkland & Ellis.
Charitable remainder trusts are irrevocable trusts that let individuals donate assets to charity and draw annual income for life or for a specific period. A charitable remainder annuity trust (CRAT) pays a dollar amount each year. The IRS examines such trusts to ensure they correctly report trust income and distributions to beneficiaries and file required tax documents.
The IRS says that such trusts are sometimes used by promoters, advisors and taxpayers to try to eliminate ordinary income or capital gain on the sale of property.
“Property with a fair market value in excess of its basis is transferred to a CRAT,” the IRS said. “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 tax rules, the taxpayer or beneficiary treats the remaining payment as an excluded portion representing a return of investment for which no tax is due. In potentially abusive monetized installment sales, another scam, promoters find taxpayers seeking to defer the recognition of gain at the sale of appreciated property. They facilitate a purported monetized installment sale for the taxpayer for a fee.
These sales occur when an intermediary purchases appreciated property from a seller in exchange for an installment note, which typically provides for payments of interest only, the IRS warns, with principal being paid at the end of the term. The seller gets the lion’s share of the proceeds but improperly delays recognition of gain on the appreciated property until the final payment on the installment note, often years later.
Monti and her firm said these are some of the tactics that schemers may use:
• Guarantees of high returns or tax-free income and offers to “double your money” or eliminate taxes using installment sales, trusts or other means.
• Pressure to invest quickly and unsolicited calls or emails.
• Claims that the transaction is legal and approved by the IRS but without providing any supporting documentation.
• Complicated legal and financial jargon that may obscure the nature of the investment.
• Use of LLCs, S corps, trusts or charities that promise to shield taxable income from taxes.
The best steps wealthy clients can take to protect themselves against this and other scams is to “contact [your] tax advisor before clicking on or responding to any solicitation involving supposed tax saving strategies, investments or products,' Handler said.