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On March 22, 2024, the Treasury Department published a proposed regulation relating to certain transactions involving Charitable Remainder Annuity Trusts (“CRATs”) investing in single premium immediate annuities (“SPIAs”). The rule would designate transactions seeking to exclude from income SPIA payments from a CRAT under Section 72(b)(2) of the Internal Revenue Code (the “Code”). Any transactions meeting the specific description in the proposed regulation, or any substantially similar transactions, must be reported to the Internal Revenue Service on a Form 8886, Reportable Transaction Disclosure Statement to avoid the penalties in Section 6707A of the Code.

What is a CRAT?

A CRAT, defined in Section 664(d)(1) of the Code, provides a fixed stream of annual income, ranging from five and fifty percent of the original fair market value of the trust, to one or more noncharitable beneficiaries with the remainder payable to one or more charities at the termination of the trust. The term of the irrevocable trust may be up to twenty years or for the life of the noncharitable beneficiary. Upon termination of the trust, the corpus must transfer to a charitable organization described in Section 170(c) of the Code and must have a fair market value of at least ten percent of the original fair market value of the trust assets. Under Section 664(b), distributions from a CRAT to the noncharitable beneficiaries take the character of the income realized by the trust, whether that be ordinary income, capital gain, or other income. Any distributions beyond the income recognized by the trust shall be treated as trust corpus.  

Specifics of the Listed Transaction

The Treasury Department has identified a transaction by which taxpayers contribute appreciated property to a CRAT, sell the appreciated property, and use the proceeds to acquire a SPIA. The taxpayer treats the annuity payment from the trust as if it were an annuity payment subject to Section 72 of the Code rather than a payment to be treated under the Section 664(b) classification of income. Accordingly, the payments will be treated predominantly as tax-free returns of capital from the annuity rather than as ordinary or capital gain income.  

Errors of Law Identified by Treasury

The proposed regulation critiques the application of Section 72 rather than Section 664(b) to the stream of annuity payments and questions whether the trust would qualify as a CRAT under Section 664(d)(1) in the first place. Treasury makes clear that Section 664(b) should control the classification of distributions from the trust because the taxpayer erroneously treats the income as if he or she owns the annuity “rather than the SPIA being an asset owned by the CRAT.” Applying Section 644(b) to the stream of payments results in the payments being applied first to the ordinary income portion recognized by the trust, and then to the one-time capital gain recognized on the sale of the initial asset.

The proposed regulation also makes clear that many such transactions also fail to meet the CRAT requirements of Section 664(d)(1). Specifically, many trust documents contain provisions either authorizing a current payment in lieu of the payment of the remainder interest described in Section 664(d)(1)(C) or authorizing the payment of an annuity amount in excess of the amount described in Section 664(d)(1)(A), both of which violate mandatory requirements of a valid CRAT.

Test for Transactions Described in the Regulation

To qualify as a transaction described in the proposed regulation, five requirements must be satisfied:

a. The grantor creates a trust purporting to be a CRAT under Section 664;

b. The grantor contributes appreciated property to the trust;

c. The trustee sells the contributed property;

d. The trustee uses some or all of the proceeds from the sale of the contributed property to purchase an annuity; and

e. The beneficiary of the trust treats the amount payable from the trust as if it were subject to Section 72 rather than Section 664(b).

Impact on the Parties to the Transaction

Participants to a transaction described in the proposed regulation must disclose that fact on a Form 8886. In addition to the disallowance of tax benefits, failure to make the required disclosure will extend the period of limitations under Section 6501(c)(10), incur enhanced accuracy-related penalties under Section 6662A, and incur failure to report penalties under Section 6707A. Material advisors providing aid, assistance or advise with respect to organizing, managing, promoting, selling, implementing, insuring, or carrying out the transaction described in the proposed regulation,  must also disclose participation in the transaction and maintain lists of clients advised to engage in such transactions.  Failure to comply with the requirements for material advisors will result in additional penalties. Finally, the charitable remainderman will not be deemed to be a participant merely due to its status as the remainderman, but Treasury specifically requested comments regarding what fees a charitable remainderman receives, “either directly or indirectly, for providing such material aid, assistance or advice.” Accordingly, charitable organizations serving as a remainderman to a CRAT should consider whether their participation could amount to that of a material advisor.

For further questions regarding CRAT regulations, contact Liskow attorneys John Rouchell, Leon Rittenberg III, and Kevin Naccari, Jr.

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Photo of John Rouchell John Rouchell

John Rouchell’s practice covers all aspects of state and federal tax law, as well as corporate and business law, estate planning and administration. He also represents authors, artists, and musicians in the New Orleans area, including his only child, John Michael, a professional

John Rouchell’s practice covers all aspects of state and federal tax law, as well as corporate and business law, estate planning and administration. He also represents authors, artists, and musicians in the New Orleans area, including his only child, John Michael, a professional musician and songwriter since the age of thirteen. John is a Board Certified Estate Planning & Administration Specialist and a Board Certified Tax Specialist – as certified by the Louisiana Board of Legal Specialization.

John is a Fellow of the American College of Trust and Estate Counsel. He has been recognized by Louisiana Super Lawyers in Estate Planning & Probate and Tax since 2007 and by the Best Lawyers in America in Business Organizations, Closely Held Companies and Family Businesses Law, Corporate Law, Elder Law, Tax Law, Trusts & Estates since 1995. New Orleans Magazine has also recognized John as one of their “Top Lawyers of New Orleans” for his work in Elder Law, Tax Law and Trusts & Estates since 2013.

John is a New Orleans native and Jesuit High School graduate. He attended Tulane University receiving a bachelor’s degree in English. He received a J.D. at Tulane Law School in 1976 and attended New York University where he received a LL.M. in Taxation in 1977. Prior to joining Liskow, John was a partner at Baldwin Haspel Burke & Mayer.

Photo of Leon H. Rittenberg III Leon H. Rittenberg III

Leon Rittenberg III is a New Orleans native. His practice focuses on serving the needs of small and mid-sized businesses and their owners; including philanthropy and non-profit law, taxation, finance, private equity, estate planning, probate, real estate, mergers and acquisitions and related matters.

Leon Rittenberg III is a New Orleans native. His practice focuses on serving the needs of small and mid-sized businesses and their owners; including philanthropy and non-profit law, taxation, finance, private equity, estate planning, probate, real estate, mergers and acquisitions and related matters. Leon represents the interests of a number of private investors, oil service businesses, marine transportation companies and physician groups. He is a Board Certified Tax Specialist and Board Certified Estate Planning & Administration Specialist, as certified by the Louisiana Board of Legal Specialization. He frequently lectures in areas such as taxation, estate planning and maritime transactions.

Leon is a Fellow of the American College of Tax Counsel. He has been recognized by Chambers USA (Louisiana Marine Finance – 2021; Louisiana Corporate/M&A: Tax section – 2017), Louisiana Super Lawyers (Tax, Estate Planning & Probate and Business/Corporate), and the Best Lawyers in America (Non-Profit/Charities Law and Trusts & Estates) since 2007, and by New Orleans Magazine as one of their “Top Lawyers of New Orleans” for his work in Equipment Finance Law, Mergers & Acquisitions Law and Tax Law. New Orleans City Business selected him for their Leadership in Law class of 2014, which “identifies and honors 50 outstanding legal professionals whose successes in law and contributions to the community have set the pace for the legal community.”

Photo of Kevin Naccari, Jr. Kevin Naccari, Jr.

Kevin Naccari is an associate in the firm’s Business Transactions practice group focusing on tax and corporate law. With a background in accounting, he brings over seven years of experience as a corporate accountant to his legal practice. His experience spans a diverse…

Kevin Naccari is an associate in the firm’s Business Transactions practice group focusing on tax and corporate law. With a background in accounting, he brings over seven years of experience as a corporate accountant to his legal practice. His experience spans a diverse range of businesses, from small-scale restaurants and convenience stores to large health insurance companies and pre-initial public offering retailers. During his time as an accountant, Kevin focused on inventory system design, maintenance, and financial operations optimization.

Kevin earned his bachelor’s degree in accounting from Louisiana State University before receiving his Juris Doctor, magna cum laude, from Loyola University New Orleans College of Law. During his time at Loyola Law, he served as a judicial extern to the Honorable Carl J. Barbier of the United States District Court for the Eastern District of Louisiana. Additionally, Kevin obtained an LL.M. from New York University.