Wednesday, September 20, 2006

Are Private Annuity Trusts Being Challenged by the IRS?

Does the IRS challenge Private Annuity Trusts? Of course they do.

Does that mean you shouldn't have one if it is in your best interest? Of course not.

The key here, like with anything, is to have it set up, funded and administered properly according to IRS tax rules. If it's done right, it won't be challenged.

What are some of the red flags that trigger IRS challenges? Here's a few. These are all things done by parties trying to "bend" the IRS rules to suit their individual or joint purposes.

1. If setting up the trust can be viewed as "Constructive Receipt". This basically means, the trust was thrown together at the last minute for no other purpose than to avoid paying capital gains tax. If done while in escrow, there needs to be evidence of contingencies of sale not yet met when the trust is created.

2. The funds are invested in volatile investments which show losses in annual tax audits. The funds are supposed to be invested in prudent vehicles so that the trust has enough funds to satisfy the payment schedule to the annuitant set up when the trust is established. Advisors and some family member trustees may see this as a place to gamble with the investments- not keeping in mind their fiduciary responsibility to the annuitant.

3. There is evidence that the annuitant is controlling the investments within the trust. The PAT is a non-grantor trust. The annuitant can have no say in how the monies are invested once the trustee is overseeing the funds. This isn't to say that the annuitant can't fire the trustee for mismanaging his funds, but he or she can't be calling up the trustee and telling him/her when to buy or sell assets within the trust.

4. The trust documents were not prepared and filed properly. This can happen when an attorney not familiar with the PAT draws up documents without the proper language, or doesn't follow proper federal filing procedures.

5. The trust's annual tax returns are not filed properly or on time. The trust is now its own entity and must file an annual return.

These are just a few reasons the IRS might challenge a PAT. In most cases, they should be challenged if someone did not do their job properly.

The future annuitant should work with experienced professionals who are fully aware of all aspects of the trust, the tax laws, and the financial and administrative details as well.

There are always a few bad apples that spoil the image of a perfectly good tax strategy and the sooner they are removed from the field the better.

Paula Straub
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