IRS Targets Abusive CRAT Schemes With New Final Regs
As if charitable remainder annuity trusts weren’t complicated enough, now there’s another reason to be careful when implementing one as part of a client’s estate plan. Done properly, CRATs can be powerful tools to provide income streams to individuals before distributing assets to charity. Taxpayers receive an immediate income tax deduction equal to the future value of the gift that the charity ultimately receives, and taxpayers can preserve the value of highly appreciated assets. Sometimes, however, taxpayers try to take tax benefits too far and end up on the wrong side of the rules.
How CRATs work
Basically, a funded CRAT temporarily distributes payments in fixed annuities to the donor or other non-charitable beneficiary over the term of the trust, and then at the end of the term the remaining interest is distributed to one or more charities. The term can be a fixed number of years (no more than 20 years) or one or more lifetimes. CRATs do not pay any income tax. The fixed percentage payment to the beneficiary should be less than 5% and not more than 50% and the value of the actually calculated charitable balance interest should be at least 10%. CRATs are often suited to high-interest environments. A higher Internal Revenue Code Section 7520 rate means that the annuity is discounted more. This results in a large residual interest transfer to charity and a large charitable deduction.
The ‘dirty dozen’ list
In 2023, the Internal Revenue Service included abusive CRATs on its “Dirty Dozen” list. In these abusive transactions, taxpayers transfer the appreciated property to the CRAT and misrepresent that the basis has been increased to fair market value as if the property had been sold to the trust. When the CRAT later sells the property, it does not recognize a gain due to the stepped-up basis. The CRAT then uses the proceeds to purchase a premium instant annuity. The taxpayer claims that the remaining payment is an excluded portion representing an investment return, which is not taxable. In doing so, the taxpayer abuses the rules under IRC Sections 72 and 664.
The proposed Regs
A year after the program appeared on the “Dirty Dozen” list, the IRS released the proposed rigs. These rules sought new consequences for irrevocable trustees to whom the donor had paid an annuity, with the charity receiving the remaining assets upon the grantor’s death or expiration. The last rules They entered into force on July 9, 2026. They identify certain CRAT transactions and similar transactions with listed transactions.
Listed transaction
According to the IRS website, a “listed transaction” is a structure that is the same or very similar to the types of transactions that the IRS determines to be tax avoidance transactions and that are identified as listed transactions by notice, regulation or other published guidance. The IRS considers a taxpayer to have entered into a listed transaction if the taxpayer’s return reflects the tax consequences or tax strategy described in Treasury Regulation section 1.6011-4(c)(3)(i)(A).
Specifically with respect to CRATs, a transaction is a listed transaction if: (1) the issuer creates a belief that it is a CRAT; (2) property to be covered by the grantor’s appreciation of the trust; (iii) the trustee sells that property; (4) The trustee uses some or all of the proceeds to purchase an annuity. (5) The trustee treats each payment of the annuity as a tax-free investment of the original investment and taxable ordinary income distributed to the beneficiaries instead of using the funds at ordinary income and capital gains levels. Any taxpayer who uses such a structure during the tax year can still be audited within 90 days to file the return. Failure to do so can result in fines of up to $100,000 for individuals in bad faith. The IRS may call the transaction into question unless the taxpayer notifies it. At that point, the IRS has 1 year after the disclosure to contest the transaction.
The consequences of the face of ‘material consultants’
Taxpayers are not the only ones who face consequences if they engage in listed transactions. Material advisors and other participants must file certain disclosures with the IRS detailing any gift tax consequences. If they fail to disclose, they face penalties. IRS Web Site Material Consultant means a person who provides material assistance, assistance or advice in arranging, promoting, selling, implementing, guaranteeing or otherwise providing any reportable transaction and receives, directly or indirectly, gross income in excess of the threshold amount for such assistance, assistance or advice. The limit for listed transactions is $10,000 for natural persons and $25,000 for all other entities. The limit for unlisted transactions is $50,000 for natural persons and $250,000 for all other entities. Material counsel may be required to file Form 8918, a disclosure statement. Generally, a material adviser must maintain a list identifying each entity or individual that the adviser acted as a material adviser on a reportable transaction.
Most importantly, the regulations clarify that an organization designated as a charitable remainder entity is not treated as a participant and is exempt from any reporting requirements. The proposed rigs requested comment on whether the charitable remainder beneficiary could be a material advisor. While charitable remainder beneficiaries may provide the taxpayer with general information about CRATs, that information does not extend to material aid, assistance or advice. Additionally, the charitable remainder usually does not have a gross income equal to the threshold for providing the information.
The taxpayer from these rigs must strictly follow the rules governing CRATs and avoid listed transactions. Implementing this type of listed transaction is not only at the expense of the taxpayer, but also the material advisor. When used properly, CRATs can be a great option for individuals and charities, but taxpayers should remember that they are responsible for what’s on their tax returns.
