by Chris Moss CPA
Welcome to TaxView with Chris Moss CPA Tax Attorney
Are you planning on a large gift to charity after you die? The Charitable Remainder Unitrust (CRUT) and the Charitable Remainder Annuity Trust (CRAT) as per IRS Code 664 are great tax strategies for charitable giving. The CRUT for example allows you to take an immediate charitable deduction on your income tax return, deferring the actual donation of the remainder of the trust until after your death, but at the same time allowing for you to live off the income of the trust while you are alive. Sounds too good to be true? It’s true, but unfortunately the IRS seems to be thinking otherwise, waiting perhaps patiently I might add, until you die only to commence a CRUT Audit with disastrous results for for your children and other heirs at the conclusion of the CRUT Audit. So if you have already established a CRUT or are thinking about setting up a CRUT stay with us here on TaxView with Chris Moss CPA Tax Attorney to find out how to bullet proof your CRUT and related tax returns from adverse Government audit action when the IRS CRUT audit team arrives shortly after you have passed.
While the Joint Committee on Taxation has always favored charitable giving deductions, Congress strictly limits the deductibility of the Charitable Remainder of your CRUT on your personal tax return to the present value of the CRUT remainder using a current qualified appraisal, as defined in § 1.170A-13(c)(3), from a qualified appraiser, as defined in § 1.170A-13(c)(5). Section 664(d)(2)(D) requires that the valued remainder be at least 10% of the property’s net fair value on the date of contribution. After the initial appraisal year IRS Regulations 1.664.1, and 1.664.3 generally with some exceptions allows you to pay to yourself annually not less than 5% of the net fair value of the trust corpus. Sounds pretty easy, but as Arthur Schaefer’s Estate found out in Schaefer v IRS US Tax Court (2015) there are IRS traps surrounding CRUTS after you die which could make you turn over in the grave.
On February 21, 2006 Schaefer created a CRUT with a slight variation, an exception to the general rule as per Section 664(d)(3)(A). The exception allowed Schaefer to distribute only the trust income for the year but limited by a fixed percentage. Trusts created under this exception are called Net Income Charitable Remainder Unitrusts (NICRUTs). Additionally, 664(d)(3)(B) allowed Schaefer to distribute to himself the current trust income in excess of the fixed percentage to the extent that the aggregate amounts distributed in prior years were less than the aggregate of the fixed percentage amounts for those prior years. Trusts using this provision are Net Income with Makeup Charitable Remainder Unitrusts (NIMCRUTs) and this is the trust Mr. Schaefer created.
Sure enough after Schaefer died, and after the Estate tax return Form 706 was filed, the IRS came knocking on Schaefer’s Estate door and indeed audited and disallowed the NIMCRUT charitable deduction in its entirety because the trusts did not meet the requirements of Section 664(d)(2)(D) in that the value of each remainder interest be at least 10% of the net fair value of the property on the date of contribution claiming Schaefer used an incorrect valuation method. Schaefer’s appealed to Tax Court in Schaefer v IRS US Tax Court (7/28/2015).
Judge Buch opined that while the legislative history is rather unclear on this matter, nevertheless Congress gave the IRS the power to issue administrative guidance on the subject of valuing a remainder interest in a NIMCRUT citing Rev. Rul. 72-395, sec. 7.01 superseded by Internal Revenue Bulletin: 2005-34, which includes all the relevant Revenue Procedures including Rev Proc 2005-52, 2005-53 and 2005-54 requiring the remainder interest of a NIMCRUT to be valued using the fixed percentage stated in the trust instrument, regardless of the fact that distributions are limited to trust income. The Court observes that Schaefer was using a rate that was less than stated in the trust instrument. When the Court converted the Schaefer rate to the fixed rate required by IRS regulations the Schaefer NIMCRUT remainder fell below the 10% threshold thereby terminating the entire NIMCRUT. IRS wins Schaefer loses.
A second IRS trap, as Joseph Mohamed found out, is the requirements for a “qualified appraisal” in Mohamed v IRS US Tax Court (2012). Mohamed set up a CRUT in 2003 worth millions with the remainder to go to the Shriners Hospitals for Children. Mohamed filed his tax returns along with Form 8283 claiming millions of dollars of charity deductions. The IRS noticed this almost immediately and commenced a CRUT audit. It turns out that Mohamed self-appraised his donations, albeit on the low side, but nevertheless, in violation of IRS regulations requiring a qualified appraisal by a qualified appraiser. Mohammed retained a qualified appraiser, while the audit was ongoing, to perform a qualified appraisal and even though the remainder asset value appraised higher than Mohamed’s charitable tax deduction, the appraisal was performed simply too late to do any good. The IRS invalidated the entire CRUT and disallowed the millions of deductions that Mohamed had claimed as a charity deduction. Mohamed appealed to US Tax Court in Mohamed v IRS US Tax Court (2012).
The Court reluctantly ruled for the Government in that Mohamed did not comply with IRS regulations. Judge Holmes sadly opines that this result is harsh–a complete denial of charitable deductions to a couple that did not overvalue, and may well have undervalued, their contributions–all reported on forms that even to the Court’s eyes seemed likely to mislead someone who didn’t read the instructions. But the problems of bad appraisals of property was so great that Congress was quite specific about what the charitably inclined have to do to defend their deductions, and we cannot in a single sympathetic case undermine those rules. IRS wins Mohamed loses.
What does this mean for all of us who want to set up CRUT’s? First, make sure you get a qualified appraiser to do a contemporaneously performed qualified appraisal of the remainder interest property that you are currently deducting as a charitable donation on Sch A of your Form 1040. Complete Form 8283 and attach the appraisal to the tax return in a PDF file at the time you file your tax return. Second, hire the best tax attorney you can find to give you a written opinion that your CRUT, CRAT, NICRUT or NIMCRUT complies with IRS Code 264 and IRS Revenue bulletin 2005-34 including Revenue Procedure 2005-52, 2005-53 and 2005-54. Give that legal opinion to your children to hold on to as there is a good chance the IRS is out there patiently waiting for your passing. Finally, introduce your children to your tax attorney so they know what to expect after your pass. There is a good chance your Estate be subject to an IRS CRUT audit after your passing, and at least you can rest in peace knowing that your tax returns will survive with your Estate protected and safe from harm’s way.
Thanks for joining us on TaxView with Chris Moss CPA Tax Attorney
Make sure to join us next time on TaxView when we will take closer look at where Domestic Asset Protection Trusts DAPTs and Spousal Lifetime Access Trusts SLATs are trending in 2015.
Chris Moss CPA Tax Attorney