Editor: Greg A. Fairbanks, J.D., LL.M.
In Notice 2008-99, the IRS identified a new transaction of interest (TOI) for purposes of the reportable transaction disclosure and list maintenance rules under Secs. 6011, 6111, and 6112. A transaction of interest is defined in Regs. Sec. 1.6011-4(b)(6) as "a transaction that is the same as or substantially similar to one of the types of transactions that the IRS has identified by notice, regulation, or other form of published guidance as a transaction of interest."
Although TOIs are a category of reportable transaction under Sec. 6011, they are not necessarily considered abusive by the IRS. Unlike a listed transaction, which is a category of reportable transaction also specifically identified in published guidance, a TOI is not determined to be a "tax avoidance transaction." The IRS added the TOI category in order to gather information about transactions that it believes have the potential for tax avoidance but for which it lacks sufficient information to determine if the transaction should be identified as a tax avoidance transaction (i.e., a listed transaction). The transaction described in Notice 2008-99 is the third transaction identified by the IRS as a TOI. (The others were identified in Notices 2007-72 and 2007-73; see Emilian and Jamouneau, "IRS Issues Reporting Requirement for Transactions of Interest," Tax Clinic, 39 The Tax Adviser 81 (February 2008).)
Notice 2008-99 identifies certain transactions involving the use of charitable remainder trusts and substantially similar transactions as TOIs. A charitable remainder trust (CRT) is a vehicle through which a donor (grantor) contributes property that provides income to the grantor (or his or her designated beneficiaries) but provides that the remainder interest (or principal) is received by a designated charity. CRTs provide tax benefits in the form of capital gains savings (on the donated property), an income tax deduction (based on the value of the remainder interest), and estate planning (i.e., the donated property is removed from the estate).
The use of CRTs is quite common and does not by itself invite IRS scrutiny. The type of CRT transaction identified in Notice 2008-99, however, involves a tax benefit that the IRS believes has the potential for tax avoidance or evasion. Specifically, the IRS is concerned that the Notice 2008-99 transaction allows the CRT grantor to permanently avoid recognition of gain on the sale or other disposition of appreciated assets.
Transaction Steps and ResultsThe transactions described in Notice 2008-99 generally involve four entities: a grantor or donor (Grantor) who seeks tax benefits by donating appreciated property to a CRT, the CRT itself, a charity or other tax-exempt entity (Charity) that holds the remainder interest in the CRT, and an unrelated third party ( X ) to whom Grantor and Charity sell their respective interests in the CRT.
Notice 2008-99 outlines the basic framework and tax results of the TOI as follows:
- Grantor creates the CRT and contributes appreciated assets to the CRT. Grantor retains a term interest in the CRT and designates Charity as the CRT's remainder beneficiary. Upon contributing appreciated assets to the CRT, Grantor claims a charitable contribution deduction for the present value of the charitable remainder interest, which is based on the fair market value of the assets attributable to the remainder interest.
- The CRT sells the appreciated assets and reinvests the proceeds from the sale in other assets (e.g., a diversified portfolio consisting of money-market funds and marketable securities). The CRT is not taxed on the proceeds of the sale of the appreciated assets because of its tax-exempt status (see Sec. 664) and will have a basis in the newly purchased assets equal to the purchase price.
- Grantor and Charity sell their entire respective interests in the CRT to X for the fair market value of all the CRT's assets, including the newly purchased assets. The CRT terminates immediately following the sale. On the sale of all the CRT interests to X, Grantor and Charity take the position that they have sold their entire interest in the trust for purposes of Sec. 1001(e)(3) and that Sec. 1001(e)(1), which would operate to disregard basis in the sale of a term interest in the CRT, does not apply. Grantor asserts that, for purposes of computing gain on the sale of interests in the CRT, the relevant basis is the portion of the cost basis of the new assets allocable to the interests in the CRT (see Regs. Secs. 1.1014-5 and 1.1015-1(b)), rather than the basis of the appreciated assets originally contributed to the CRT.
The notice indicates that the IRS is not concerned with the creation and funding of a CRT, with or without appreciated assets, or the CRT's reinvestment of any contributed appreciated property. Instead, the focus of concern is on the Grantor's claim to an increased basis in its CRT interest together with the termination of the CRT in a coordinated transaction designed to avoid tax on gain from the sale of the appreciated assets. Other trust arrangements with details that vary from the situation described above also will be considered TOIs if they fit the general pattern in substance, if not the exact form or order. Such variations include the use of trust vehicles similar to a CRT or the use of CRTs that have been in existence prior to the sale of trust interests, situations in which appreciated assets are already in the trust prior to the commencement of the transaction, and the contribution of appreciated assets to a passthrough entity, which in turn contributes the assets to a trust.
Effective Date and ParticipationA transaction that is the same as, or substantially similar to, the transaction described in Notice 2008-99 is a TOI as of October 31, 2008 (the release date of the notice). Notice 2008-99 states that the tax-exempt entity taking a remainder interest in the CRT assets is not a participant if it sold or disposed of its interest in the trust at issue on or before October 31, 2008. However, other participants who entered into this TOI on or after November 2, 2006, must disclose participation in the transaction in the manner prescribed in Sec. 6011 and the regulations thereunder. States may also require disclosure.
Disclosure RequirementsAlthough Notice 2008-99 is effective as of October 31, 2008, a transaction that is the same as, or substantially similar to, the identified transaction must be disclosed if it was entered into after November 2, 2006. Generally, a taxpayer who participates in such a transaction after November 2, 2006, must disclose its participation in the transaction with its tax return reflecting the tax consequences or tax strategy of the transaction.
The disclosure regulations have special rules when a transaction is identified as a TOI after the filing of the taxpayer's return reflecting the tax consequences or tax strategy of the TOI. In such situations, if the statute of limitation on assessment for the prior return is still open, the general rule is that the taxpayer is required to file Form 8886, Reportable Transaction Disclosure Statement, with the Office of Tax Shelter Analysis (OTSA) within 90 days after the date on which the transaction is identified as a TOI. However, if the transaction at issue was entered into prior to August 3, 2007, the taxpayer must provide disclosure with its tax return next filed after the date the transaction is identified as a TOI (i.e., October 31, 2008) regardless of whether the taxpayer participated in the transaction during 2007.
The following examples illustrate the application of the disclosure rules described above:
- If a taxpayer participated in the TOI after November 2, 2006, and has not yet filed a tax return claiming tax benefits from the TOI, it must include the Form 8886 disclosure when it files that tax return.
- If the taxpayer has already filed a tax return without the Form 8886 disclosure and the TOI was entered into after November 2, 2006, but prior to August 3, 2007, the taxpayer is required to file Form 8886 with its next tax return filed after October 31, 2008.
- If the taxpayer already filed a tax return without the Form 8886 disclosure and the CRT transaction was entered into on or after August 3, 2007, the taxpayer is required to file Form 8886 with OTSA within 90 days of October 31, 2008 (i.e., by January 29, 2009).
ConclusionIt is critical for practitioners and taxpayers to understand and meet their respective obligations with regard to TOIs. As with any type of reportable transaction, there are substantial penalties applicable to taxpayers and material advisers (who must disclose this transaction on Form 8918, Material Advisor Disclosure Statement, on or before January 31, 2009) who do not comply in a timely manner, and such penalties cannot be waived. Therefore, practitioners should work with both colleagues and clients to evaluate transactions that could be considered the same or substantially similar to the TOI described in Notice 2008-99 and, if it is determined that the notice applies, take timely appropriate action.
Greg A. Fairbanks, J.D., LL.M., is a tax manager with Grant Thornton LLP in Washington, DC.
For additional information about these items, contact Mr. Fairbanks at (202) 521-1503 or firstname.lastname@example.org.
Unless otherwise noted, contributors are members of or associated with Grant Thornton LLP.