IRS May Trash Tax Shelter

The owner of a waste disposal firm thinks he can convert a potential hefty tax payment into an even larger tax benefit. The Internal Revenue Service isn't so sure.

Two years ago, the 70-year-old owner decided to sell his hauling company. His objective: to provide financial security for his daughter. The proposed sale, however, had a troubling downside: an enormous capital gains tax. The owner's original investment of $30,000 in 1969 had grown to several million dollars.

A garden-variety sale would have enabled the IRS to collect about $700,000. Instead, his lawyer proposed a creative and elaborate strategy: a charitable family limited partnership. The owner would donate nearly all of the company to a charity but, for a while, would continue to manage operations. He'd take a tax deduction for the fair-market value of his charitable gift. After the charity sells the business (with no capital-gains tax) and pockets the proceeds, he would direct the charity to pay income from the proceeds to his daughter for 25 years. Thereafter, the charity would fully control all principal and income.

The tax advantages being too good to ignore, the owner gave 98 percent of the partnership to his alma mater. His daughter now enjoys a sizable income from the arrangement, while his income tax deductions can be used and carried forward for five years. Meanwhile, the university plans to establish a faculty chair in its business school to honor the donor and his wife.

Engaging a charity as a business partner has become a popular tax-avoidance device for wealthy individuals. Deals totaling some $3 billion have been arranged using the "char-flip," according to promoters that include accountants and financial planners.

Rich people long have known about the tax benefits of donating appreciated stock to charities. What's new is making gifts of more unwieldy assets: real estate and operating businesses, for example. Because charities generally won't undertake day-to-day business operations or real estate management, the selling point for the char-flip is the donor's willingness to run the business until it is sold.

Some arrangements are structured to allow family members to buy back the business from the charity, before sale, thus accomplishing a transfer between generations without an estate tax. For its part, a charity might welcome an early cash-out option.

The technique has been widely advertised by financial planners, who even have trademarked and licensed their versions. But all this activity caught the IRS' attention, particularly when a promoter on the Internet bragged that "the only loser is the IRS."

Charitable family limited partnerships "are under serious scrutiny," according to Marcus Owens, IRS chief of tax-exempt organizations. "Quite possibly, we could determine this is an abusive tax shelter," he says.

In June, an IRS internal task force began examining the charitable family limited partnership and other tax-planning techniques involving charitable-giving arrangements. The agency is expected to complete its investigation and announce its position before Labor Day.