Abusive Trust Arrangements- General Overview
This notice describes some typical abusive trust arrangements, as well as the tax benefits promised by promoters, and then explains the correct tax principles that apply to these trust arrangements. Taxpayers should be aware that abusive trust arrangements will not produce the tax benefits advertised by their promoters and that the Internal Revenue Service is actively examining these types of trust arrangements as part of the National Compliance Strategy, Fiduciary and Special Projects. Furthermore, in appropriate circumstances, taxpayers and/or the promoters of these trust arrangements may be subject to civil and/or criminal penalties.
Abusive trust arrangements typically are promoted by the promise of tax benefits with no meaningful change in the taxpayer's control over or benefit from the taxpayer's income or assets. The promised benefits may include: reduction or elimination of income subject to tax, deductions for personal expenses paid by the trust, depreciation deductions of an owner's personal expenses paid by the trust, depreciation deductions of an owner's personal residence and furnishings, a stepped-up basis for property transferred to the trust, the reduction or elimination of self-employment taxes and the reduction or elimination of gift and estate taxes. These promised benefits are inconsistent with the tax rules applicable to the abusive trust arrangements, as described below.
Abusive trust arrangements often use trusts to hide the true ownership of assets and income, or to disguise the substance of transactions. These arrangements frequently involve more than one trust, each holding different assets of the taxpayer (for example, the taxpayer's business, business equipment, home, automobile, etc.) as well as interests in other trusts.
Funds may flow from one trust to another trust by way of rental agreements, fees for services, purchase and sale agreements, and distributions. Some trusts purport to involve charitable purposes. In some situations, one or more foreign trusts also may be part of the
Examples of Abusive Trust Arrangements
Described below are five examples of abusive trust arrangements that have come to the attention of the Internal Revenue Service. An abusive trust arrangement may involve some or all of the trusts described below. The type of trust arrangement selected is dependent on the particular tax benefit the arrangement purports to achieve. In each of the trusts described below, the original owner of the assets that are nominally subject to the trust effectively retains authority to cause the financial benefits of the trust to be directly or indirectly returned or made available to the owner.
For example, the trustee may be the promoter, or a relative or friend of the owner who simply carries out the directions of the owner whether or not permitted by the terms of the trust. Often, the trustee gives the owner checks that are pre-signed by the trustee, checks that are accompanied by a rubber stamp of the trustee's signature, a credit card or a debit card with the intention ofpermitting the owner to obtain cash from the trust or otherwise to use the assets of the trust for the owner's benefit.
The Business Trust.
The owner of a business transfers the business to a trust (sometimes described as an unincorporated business trust) in exchange for units or certificates of beneficial interest, sometimes described as units of beneficial interest or UBI's (trust units). The business trust makes payments to the trust unit holders or to other trusts created by the owner (characterized either as deductible business expenses or as deductible distributions) that purport to reduce the taxable income of the business trust to the point where little or no tax is due from the business trust.
In addition, the owner claims the arrangement reduces or eliminates the owner's self-employment taxes on the theory that the owner is receiving reduced or no income from the operation of the business. In some cases, the trust units are supposed to be canceled at death or "sold" at a nominal price to the owner's children, leading to the contention by promoters that there is no estate tax liability.
The Equipment or Service Trust.
The equipment trust is formed to hold equipment that is rented or leased to the business trust, often at inflated rates. The service trust is formed to provide services to the business trust, often for inflated fees. Under these abusive trust arrangements, the business trust may purport to reduce its income by making allegedly deductible payments to the equipment or service trust. Further, as to the equipment trust, the equipment owner may claim that the transfer of equipment to the equipment trust in exchange for the trust units is a taxable exchange.
The trust takes the position that the trust has "purchased" the equipment with a known value (its fair market value), and that the value is the tax basis of the equipment for purposes of claiming depreciation deductions. The owner, on the other hand, takes the inconsistent position that the value of the trust units received cannot be determined, resulting in no taxable gain to the owner on the exchange. The equipment or service trust also may attempt to reduce or eliminate its income by distributions to other trusts.
The Family Residence Trust.
The owner of the family residence transfers the residence, including its furnishings, to a trust. The parties claim inconsistent tax treatment for the trust and the owner (similar to the equipment trust). The trust claims the exchange results in a stepped-up basis for the property, while the owner reports no gain. The trust claims to be in the rental business and purports to rent the residence back to the owner; however, in most cases, little or no rent is actually paid. Rather, the owner contends that the owner and family members are caretakers or provide services to the trust and, therefore, live in the residence for the benefit of the trust. Under some arrangements, the family residence trust receives funds from other trusts (such as a business trust) which are treated as the income of the trust. In order to reduce the tax which might be due with respect to such income (and any income from rent actually paid by the owner), the trust may attempt to deduct depreciation and the expenses of maintaining and operating the residence.
The Charitable Trust.
The owner transfers assets to a purported charitable trust and claims either that the payments to the trust are deductible or that payments made by the trust are deductible charitable contributions. Payments are made to charitable organizations; however, in fact, the payments are principally for the personal educational, living, or recreational expenses of the owner or the owner's family. For example, the trust may pay for the college tuition of a child of the owner.
The Final Trust.
In some multitrust arrangements, the U.S. owner of one or more abusive trusts establishes a trust (the "final trust") that holds trust units of the owner's other trusts and is the final distributee of their income. A final trust often is formed in a foreign country that will impose little or no tax on the trust. In some arrangements, more than one foreign trust is used, with the cash flowing from one trust to another until the cash is ultimately distributed or made available to the U.S. owner, purportedly tax free.
Today, I’m going to do a very short video telling you to stay away from pure trusts. You only need to hear about it for two minutes because they’re a major fraud. A week doesn’t go without someone emailing me saying they want to do this, or they say help me out with this. I need to know what to do. The bottomline is, ‘pure trusts’ are nothing but pure crap. They’re pure fraud. Tax fraud per se. They are illegal and unethical. Anytime someone does a trust for you and promises that it will eliminate or reduce your income tax liability, run away from it.
There is no such thing as a trust that eliminates your income tax liability and the promoters of this touch on many things. They touch on the Constitution. They focus in on a clause that says the government can't interfere with your right to contract. They focus in on the language in the old federalists papers that deal with the feds not being able to impose taxes on the States. All that was right, but the problem is in the 200 years since the founding of our country, the federal government has gotten the power to impose income taxes on any trust. There are thousands of places on the internet trying to sell this garbage to you. I’m not going to spend a lot of time on it because it's not worth a lot of time; but if you see the word pure trust, constitutional trust, business trust, you run. You run to your accountant and you run to your lawyer. Pure trusts are pure crap period.
Now, I’m going to show you the first place I think you should run to. Go to AssetProtectionCorp.com. It has 4,000 pages. About 200 of them are on pure trusts. Pure trusts don’t work. If someone promises to save you taxes, you get out of the way because you know what, you're very likely to end up in jail if you fall for one of these awful scams. Do you know what you should do next? Read Notice 9724. This is a notice that was given out in the olden days about abusive tax relationships. You should download Notice 9724 because it outlines the basics of the ‘too good to be true’ trusts that you'll see. If you see a pure trust offered to you, run away from it, go to your accountant, go to your lawyer and stay away.