Untrustworthy Trusts

Tax and Financial News

October 1999

Untrustworthy Trusts

The word trust has a way of making you feel safe. This word can be deceiving in the financial world. Each year, the IRS investigates hundreds of fraudulent trust schemes that naive taxpayers may have been told is a way of reducing their taxes. The number of IRS investigations has drastically increased, and so have the civil and criminal convictions, so buyer, beware.

A trust is used commonly in estate planning to hold assets for beneficiaries and giving to charities. A designated independent trustee manages a trust. The independent trustee manages the trust, holds legal title to the trust's assets, and exercises independent control. The grantor must give up control of income and assets. The courts look upon many trust arrangements to not be so truthfully put together. Trusts should not be set up to pay personal expenses with pretax dollars, to reduce tax liability or avoid paying income or employment taxes. Some of the trusts that are closely being looked at by the IRS are:

Charitable trusts
Charitable deductions are not allowed when the donor receives personal benefit from the alleged gift. You cannot have the trust pay for recreation expenses, education, or personal expenses on behalf of the taxpayer or family members. Several charitable organizations often do not qualify and have no IRS exemption letter, and contributions are not deductible.

Business trusts
You cannot transfer an ongoing business to a trust, an unincorporated business organization, a pure trust, or a constitutional trust, and it appears that you have given up control of your business. If you still run day-to-day activities or control the business's income stream, this trust will not provide tax relief. The courts uphold that the business income is taxable to taxpayers under concepts such as lack of economic substance, assignment of income, or that this arrangement is a grantor trust. You could even be taxed as a corporation.

Family residence trusts
You cannot transfer your family residence, including the furnishings, to trust and rent the home from the trust. Some people have thought this to be a way of helping lower personal maintenance bills. Some have had the trusts pay for pool service, pay for utilities, and even plant the garden. The courts have been looking at these trusts and taxing income to the taxpayer, disallowing personal and nondeductible expenses.

Service and equipment trusts
If you formed this trust to hold leased equipment to the business trusts, be sure your rates are legitimate and not inflated. The business trust reduces its income by claiming deductions for payments to the equipment trust, but the business trust problems also apply here.

Foreign trust
Some foreign countries impose little or no tax on trust. This may seem attractive, and these trusts are being widely promoted to give the appearance of separating responsibility and control from the benefits of ownership. Typically, these trusts are set up for taxable funds to flow through several trusts or entities until the funds ultimately are distributed or made available to the owner at a nominal amount. Beware of anything like this, as it is one of the most fraudulent arrangements being looked at by the IRS.

Violation of the Internal Revenue Code intends to evade income taxes may result in a civil fraud penalty or criminal prosecution. The IRS cautions taxpayers to avoid trusts that advertise bogus tax benefits. Contact your CPA or financial professional before entering into a trust.

These articles are intended to provide general resources for the tax and accounting needs of small businesses and individuals. Service2Client LLC is the author, but is not engaged in rendering specific legal, accounting, financial or professional advice. Service2Client LLC makes no representation that the recommendations of Service2Client LLC will achieve any result. The NSAD has not reviewed any of the Service2Client LLC content. Readers are encouraged to contact their CPA regarding the topics in these articles.