Aggressive Tax Deferral Scheme Purveyors Ordered to Cease Operations and Turn Over Client List

The Gerhardt v. Commissioner Case: Hoffman Associates' Abusive CRAT

In the recent case of Gerhardt v. Commissioner, 160 TC No. 9 (2023), Hoffman Associates, purveyors of an abusive Charitable Remainder Annuity Trust (CRAT) were permanently enjoined from continuing to operate in any capacity and required to pay a $1,100,000 judgment. Perhaps more importantly, the decision requires them to identify to the IRS the customers who participated in the CRAT Tax Scheme.

While CRATs have been a valid estate planning tool for many years, any tool can be abused. In this CRAT scheme, property was contributed to a trust, sold by a trustee, who then used the proceeds to purchase a retail five-year annuity, payable to the property owners. However, the sale proceeds realized on the sale of the property by the CRATs was gimmicked to substantially exceeded its tax cost basis to eliminate any taxable gain from the sale of the property. In turn, the annuity payments conveyed no taxable gain attributable to the sale of the property.

The Red Flag: Promises of Tax-Free Income and Changing Taxable Income

This should be a red flag to any advisor or Seller - anyone who promises you they can magically change taxable income to tax-free income should be viewed with a high degree of skepticism. Tax exemptions in the regulations and Code are very narrowly construed and typically do not involve changing the tax basis of a transaction.

Department of Justice (DOJ) Complaint and Investigation

On February 23, 2022, the Department of Justice (DOJ) filed a complaint in the U.S. District Court for the Western District of Missouri against one of the promoters of the CRAT Tax Scheme, alleging that they were promoting an abusive tax scheme that claimed to eliminate or “legally forgive” the federal capital gains tax on income derived through the sale or other disposition of property. The DOJ also alleged they were engaging in conduct that substantially interfered with the administration and enforcement of the internal revenue laws and, through their collective conduct, have caused an estimated $40,000,000 of taxable income to go unreported, resulting in upwards of at least $8,000,000 in tax revenue loss to the United States Treasury. The Complaint indicated at least seventy (70) known CRATs were the subject of investigation.

The District Court's Order: Permanently Enjoining Hoffman Associates

The Order permanently enjoining Hoffman Associates from continuing to operate was issued by the District Court on May 23, 2023. The court described the CRATs capital gain disappearing act as magic worthy of a Penn and Teller show.?

CRATs and the "Dirty Dozen" Tax Shelter Schemes

The IRS is now including these abusive CRATs in their "dirty dozen" tax shelter schemes, which also include the abusive Monetized Installment Sale, which bears significant similarity to a previously invalidated mechanism called a Private Annuity Trust. The IRS Notice can be found here: https://www.irs.gov/newsroom/dirty-dozen-watch-out-for-schemes-aimed-at-high-income-filers-charitable-remainder-annuity-trusts-monetized-installment-sales-carry-risk.

Seeking Alternative Capital Gain Deferral Mechanisms

Sellers looking for capital gain deferral (not a magical capital gain elimination) would be well served to look into older, more conservative deferral mechanisms like the Structured Installment Sale offered by Structured Assignments or Met Life.?