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AMBRECHT & BRITTAIN, LLPSCAM TRUSTS & TRUST SCAMSBy Stephan R. Leimberg |
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Thank you to Stephan R. Leimberg for permission to reprint his "News of the Week" email newsletter from February, 2000, here. You can see other newsletters and resources pertaining to trusts, estates, and taxes at his website, http://www.leimberg.com.
Promoters of scam trusts - and those who help promote trust scams - and those involved in trust scams - and those thinking "they'll never catch me if I get involved in this scam" should read IRS Publication 2193. [This Publication was issued January 7, 2000, and builds on IRS Notice 97-24.] This pub makes its point: YOU HAVE BEEN WARNED! The title says it all: "Too Good to Be True: Should Your Financial Portfolio Include Trusts." Notice it's not a question. Of course, this IRS pronouncement is not intended for all trusts – only those considered "abusive" or "fraudulent." What's that? An abusive or fraudulent trust is one established to hide the true ownership of assets and income or to disguise the substance of your financial transactions. THE SWEET: Trusts, a form of ownership which separates responsibility and control of assets from the benefits of ownership, have been used for centuries. They are a cornerstone of sophisticated estate planning and can be useful in saving income taxes, estate taxes, probate costs, and protecting against creditors and predators. They are among the most commonly used devices to facilitate the genuine charitable transfer of assets and to hold assets for minors and those unable or unwilling to handle their financial affairs. THE BITTER: Everything comes at a cost - and there are no "free lunches" – even with respect to such useful and highly regarded tools as trusts. Here are some points made in the IRS Pub: * ALL trusts must comply with tax laws. Those laws can be found [Internal Revenue] Code Sections 641-683. * If you violate these Code Sections, you may face civil penalties and/or criminal prosecution. * The civil sanctions can include a fraud penalty. This means – with respect to the tax attributable to the fraud – you must pay a penalty of up to 75% of the amount of tax you should have paid – but did not. And of course, you must also pay the tax you legitimately owe. * You may be faced with a criminal charge. Your conviction on that charge may result in fines up to $250,000 and/or up to five years in prison – for each offense. * You can't hide behind your tax return preparer. If you sign the return, you are responsible for the tax on income – no matter who prepares your return.
Here's how you can tell if something is wrong. The fraudulent trust promoter will say something like: * "We can set up a trust for you that will reduce or eliminate your income taxes or self-employment taxes." (The truth is that someone must pay taxes on the income generated by property held in trust. That responsibility may be the trust's, the beneficiary's, the transferor's, or be split among the parties. But what was taxable income before is taxable income after an income producing asset has been placed into a trust. No trust in existence can alter basic tax law or turn what is taxable into what is non-taxable). * "We can set up a trust that will allow you to retain complete control over your income and assets - yet avoid estate and income tax and be completely protected from the claims of creditors." (The truth is that to obtain tax benefits, you must give up actual and significant control over income and assets. You can't have your cake and eat it too. An independent trustee must be named to hold legal title to the trust assets, to exercise independent control over the trust, and to manage it.) * "We can set up a trust that will allow you to deduct your personal expenses (such as your home mortgage or utilities) paid by the trust on its tax return." (The truth is that there is no way to change what is a non-deductible personal living expense into deductible expenses merely by assigning assets and income to a trust.) * "We can show you how to depreciate your home and its furnishings and take them as deductions by assigning the residence to the trust we create for you." (The truth is that a residence and furnishings used solely for personal use can not be depreciated by assigning the residence to a trust.)
Business Trust: The promoter tells you to transfer your business to a trust which is designed to make it look like you have given up control of your business – but in reality, through trustees or other entities you control, you still run day-to-day activities and control the business's stream of income – almost the same as you did before. These scam trusts are often called an "unincorporated business organization", a "pure trust" or a "constitutional trust." Of course, these arrangements provide no tax relief. Equipment or Service Trust: The promoter tells you to form a trust. Then you rent or lease equipment to the trust at inflated rates. The trust reduces its income by claiming deductions for payments it must make for the equipment. These scam trusts provide no tax relief. Family Resident Trust: The promoter tells you to transfer your family residence, including furnishings, to a trust. The trust then rents the residence back to you. The trust deducts depreciation and the expense of maintaining and operating the residence including your utilities. These scam trusts do not result in expense deductions. Charitable Trusts: The promoter tells you to transfer assets or income to a trust or other entity claiming to be a charitable organization. The trust or organization pays for your personal, educational, and recreational expenses. The trust then claims the payments as charitable deductions on its tax return. Foreign Trusts: The promoter tells you they will set up a trust for you in a foreign country that imposes little or no tax on trusts and also provides financial secrecy. They tell you that through a circular path, their foreign trust arrangement will enable otherwise taxable funds to flow through several trusts or entities until the funds are ultimately distributed or made available - tax-free - back to you, the original owner. These "tax-free" foreign trusts are not effective as claimed and the income from these arrangements are fully taxable.
Suspect a problem if the promoter says: * "Our trust can reduce or eliminate income and self-employment tax." * Our trust will result in deductions for any of your personal expenses paid by the trust." * Our trust will enable depreciation deductions on your personal residence or furnishing." * "Our fees for your trust package will be offset by promised tax benefits." * "Don't worry about these back-dated documents." * "We'll enable you to replace the trustee - at any time - for any reason - and still obtain the tax benefits we've promised." * "Don't worry. The trustee's in our pocket." Make No Mistake: The IRS is looking for fraudulent trust schemes and has created a special national task force . This high profile team dedicated to stamping out abusive and fraudulent trusts can recommend prosecution of EVERYONE (promoters, marketers, and clients) involved. The task force and this Publication demonstrates the IRS' strong commitment to penalize "over-the-edge" uses of trusts. The irony is that legitimate trusts work - and work well - and provide many meaningful and significant tax breaks. The problem is that some marketers, promoters, and taxpayers just don't know when to stop. Hope this information is useful. Be sure to check out our extensive Archive of other abusive trusts (both in Recent Cases and Rulings on the left hand side of our home page - and in the Archives). Also, there's an entire chapter on scam trusts in The New Book of Trusts which you can find at http://www.leimberg.com. Steve Leimberg
[See also:] IRS Publication 2193 January 7, 2000; IRC Sec. 671; IRS Public Announcement Notice 97-24; www.irs.ustreas.gov. Suspected tax fraud can be reported to a local IRS office at 1-800-829-0433 or at the [U. S. Treasury's] Criminal Investigation Division Internet site: www.ustreas.gov/irs/ci.
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