IRS finalizes rules labeling CRATs as listed transactions

The Internal Revenue Service and the Treasury Department released final regulations Wednesday identifying certain arrangements claiming to be charitable remainder annuity trusts as “listed transactions,” akin to tax shelters, requiring participants and their advisors to file disclosures about them or face penalties if they fail to disclose.

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The final regulations describe a transaction in which taxpayers purport to eliminate ordinary income and/or capital gain on the sale of property.

In abusive transactions of this type, the IRS noted, property with a fair market value in excess of its basis, for example, interests in a closely-held business, and/or assets used or produced in a trade or business, is transferred to a purported CRAT, which then sells the property and uses some or all of the net proceeds to purchase a single premium immediate annuity, or SPIA. 

By misapplying the rules under Sections 72 and 664 of the Internal Revenue Code, the taxpayer, or beneficiary, claims the CRAT annuity is taxable to the recipient only to the extent of the income portion of the SPIA annuity payment. The IRS included CRATs on its list of the Dirty Dozen Tax Scams in 2024.

The final regulations basically follow the previously proposed regulations from the Treasury and the IRS identifying certain CRAT transactions and substantially similar transactions as “listed transactions” for tax reporting purposes.

The Treasury and the IRS have been moving away from issuing notices about tax shelters after running afoul of the Administrative Procedures Act during court challenges over conservation easements. Instead they are following the more established procedure of issuing proposed regulations and then giving the public time to comment before issuing final regulations. However, now that the final regulations are out, the IRS will be on the lookout for taxpayers and tax professionals who fail to disclose CRAT arrangements.

“As a matter of risk mitigation, practitioners must immediately identify any client structures matching these criteria,” wrote Ed Zollars of Thomas, Zollars & Lynch in his Current Federal Tax Developments blog. “Given the severity of Sec. 6707A penalties and the extended statute of limitations, proactive disclosure is the only viable method for managing this significant financial and legal exposure unless the taxpayers wishes to gamble that they will be able to show the regulations are invalid in a court proceeding if the IRS comes calling.”

He noted that the “listed transaction” designation serves as a “high-powered monitoring tool” for the IRS’s Office of Tax Shelter Analysis, mandating transparency for both participants and advisors.