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  • Writer's pictureRoger Reed

Watch Out For Schemes Aimed at High-Income Filers

TLDR: The IRS has issued a warning about scams that target Charitable Remainder Annuity Trusts and monetized installment sales, which are often misused by promoters to attract clients. Taxpayers should be aware of potentially abusive arrangements and seek out trusted tax advice instead of being fooled by aggressive advertising and sales pitches.

The Internal Revenue Service (IRS) has cautioned taxpayers to be wary of questionable tax practitioners and independent promoters who are selling abusive tax schemes aimed at high-income filers. As part of its annual Dirty Dozen campaign, the IRS has identified potentially abusive arrangements involving tools such as Charitable Remainder Annuity Trusts and monetized installment sales. Such schemes can be misused by promoters to leave filers vulnerable to potential risks. The IRS urges taxpayers to be vigilant and seek reputable tax advice while avoiding aggressive advertising and sales pitches.

IRS Commissioner Danny Werfel emphasized the importance of taxpayers seeking out trusted and reputable tax advice. The agency remains concerned about abusive tax arrangements, and they are a focal point for the IRS's enforcement efforts. While the Dirty Dozen list is not a legal document or a formal listing of agency enforcement priorities, it is intended to alert taxpayers and the tax professional community about various scams and schemes that put them at risk of losing money, personal information, and data.

The Dirty Dozen campaign highlights the risks associated with 12 scams and schemes that put taxpayers and the tax professional community at risk of losing money and personal information. Some items on the list are new, while others are making a return visit. The IRS aims to raise awareness among taxpayers and the tax professional community about various scams and schemes that are still prevalent. Taxpayers should review the legal requirements underlying these types of arrangements and consult with competent, independent, qualified advisors before engaging or claiming any purported tax benefit.

Schemes aimed at high-income filers

Charitable Remainder Annuity Trust (CRAT) Charitable Remainder Trusts 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 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 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 (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.

The IRS reminds taxpayers that they are legally responsible for what is on their tax return, not the practitioner or promoter who entices them 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 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 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 taxpayers should avoid, 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. Where appropriate, the 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 like those listed 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.”

Report tax fraud As part of the Dirty Dozen awareness effort, the IRS encourages people to report individuals who promote improper and abusive tax schemes as well as tax return preparers who deliberately prepare improper returns.

To report an abusive tax scheme or a tax return preparer, people should mail or fax a completed Form 14242, Report Suspected Abusive Tax Promotions or Preparers and any supporting materials to the IRS Lead Development Center in the Office of Promoter Investigations.

Mail: Internal Revenue Service Lead Development Center Stop MS5040 24000 Avila Road Laguna Niguel, California 92677-3405

Fax: 877-477-9135

Alternatively, taxpayers and tax practitioners may send the information to the IRS Whistleblower Office for possible monetary reward.

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