On March 19, the Internal Revenue Service (IRS) proposed a new rule governing charitable remainder annuity trusts (CRATs). The new rule, if finalized, would curtail the use of CRATs as a tax avoidance mechanism.

The new proposed rule (REG-108761-22, RIN 1545-BQ58) was issued under the authority of Internal Revenue Code (IRC) Section 6011, the portion of the tax code that deals with tax shelters. It focuses on and limits use of CRATs as a way to avoid taxes.

IRS said there are two CRAT-derived tax avoidance schemes that the new proposal targets: use of a single premium immediate annuity to allow beneficiaries to avoid recognition of ordinary income or capital gain; and characterizing a transfer of appreciated property to a CRAT as eligible for step-up in basis tax treatment.

The proposed rule requires that the trust treat the annuity amount as accumulated ordinary income, then as accumulated capital gain, and then as other income. The proposed rule also dictates that the transfer is a gift, for federal tax purposes, thus eliminating the possibility of it getting step-up in basis tax treatment.

Also included in the proposed rule is a requirement that material advisors and certain participants using impacted CRATs report their transactions to the IRS.

 Prospects: The proposed CRAT regulation is subject to comments from the public. The IRS plans to hold a hearing on the proposed regulation on July 11.

NAIFA Staff Contact: Jayne Fitzgerald – Director – Government Relations, at jfitzgerald@naifa.org.