Trusts are vehicles that can assist in the preservation of wealth and property for future generations, protect assets, or carry out a charitable purpose. A trust is an entity created and governed under the state law in which it was formed. A trust involves the creation of a fiduciary relationship between a grantor, a trustee, and a beneficiary for a stated purpose. Trusts continue to grow in popularity despite significant set up cost, the complexity of the filing and reporting, and the amount of fraud associated with abusive trust tax evasion schemes. Basic understanding of what a Trust is will be essential to not falling prey to fraudulent schemes trust schemes and ensure legitimacy. Trusts established to hide the true ownership of assets and income or to disguise the substance of financial transactions are considered fraudulent trusts.
Trusts continue to be part of the IRS Dirty Dozen
The Dirty Dozen is a list that is compiled annually by the IRS in order to alert taxpayers, tax professionals and financial institutions of tax scams that occur at any time during the year. This list has been published by the IRS for over 20 years. Abusive trust arrangements being promoted continue to be part of the IRS Dirty Dozen. The point of the Dirty Dozen is to alert all that Illegal scams will lead to significant penalties, including interest and possible criminal prosecution. IRS Criminal Investigation works closely with the U.S. Department of Justice to prosecute the criminals that continue to originate these scams and to shut them down.
Methods utilized to create a Trust:
- A declaration by the owner of property that the owner holds the property as trustee;
- A transfer of property by the owner during the owner’s lifetime to another person as trustee;
- A transfer of property by the owner, by will or by other instrument taking effect upon the death of the owner, in trust, to another person as trustee or
- An exercise of a power of appointment to another person as trustee or an enforceable promise to create a trust.
Understanding the terminology: Grantor, Trustee and Beneficiary
The grantor (also known as trustor, settlor, or creator) is the creator of the trust relationship and is generally the owner of the assets initially contributed to the trust. The grantor establishes in the trust instrument the terms and provisions of the trust relationship between the grantor, the trustee, and the beneficiary including: the rights, duties, and powers of the trustee; distribution provisions, ability of the grantor to amend, modify, revoke, or terminate the trust agreement, the designation and selection of a trustee or successor trustees and the designation of the state under which the terms and provisions of the trust agreement are to be governed.
The trustee (can also be known as the fiduciary) obtains legal title to the trust assets and is required to administer the trust on behalf of the beneficiaries according to the express terms and provisions of the trust agreement. A fiduciary is an individual or organization charged with the duty to act for the benefit of another.
The beneficiary or beneficiaries are those entitled to receive benefits from the trust.
There is complexity in the filing and reporting of Trusts and Trust-related tax returns such as:
- Form 1041, U.S. Income Tax Return for Estates and Trusts
- Form 1041A – U.S. Information Return Trust Accumulation of Charitable Amounts
- Form 3520 – Annual Return to Report Transactions with Foreign Trusts
- From 3520A, Annual Information Return of Foreign Trust With a U.S. Owner
- Form 926, Return by a U.S. Transferor to a Foreign Corporation
- Form 114, FinCEN Report of Foreign Bank and Financial Accounts
- Form 709, U.S. Gift Tax Return
- Form 5227, Split-Interest Trust Information Return
- Form 56, Notice Concerning Fiduciary Relationship
- Form 1040NR, U.S. Nonresident Alien Income Tax Return
- Form 1042, Annual Withholding Tax Return for U.S. Source Income of Foreign Persons
- Form 8804, Annual Return for Partnership Withholding Tax (under section 1446)
- Form 8938, Statement of Specified Foreign Financial Assets
Some Abusive trust scheme arrangements being promoted:
- “Put Your Money in a Trust and Never Pay Taxes Again”
- Schemes that charge a fee for “trust” packages. The fee enables taxpayers to have trust documents prepared, to use foreign and/or domestic trustees as offered by promoters or to use foreign bank accounts and corporations.
- Trusts formed in the U.S., and foreign trust packages formed offshore and outside the jurisdiction of the U.S. Trusts involved in both schemes are vertically layered with each trust distributing income to the next layer. The goal of this layered distribution of income is to reduce taxable income to nominal amounts.
- Promoters of abusive trust arrangements use a variety of methods to advertise their schemes including tax seminars, flyers, local media, social media, and the Internet.
- Give the appearance a person is giving up control of their assets and money, when in reality they still control how the money and assets are used.
- Establishing a trust will reduce or eliminate income taxes or self-employment taxes.
- Transferring income into a trust will eliminate income taxation on that income.
- Retain complete control over income and assets with the establishment of a trust.
- Deduct personal expenses paid by the trust on their tax return.
- Depreciate a personal residence and furnishings and take them as deductions on a tax return.
The IRS states that: “The public should not be misled by the word “trust”. Mere association of the term “trust” with a financial arrangement does not make it a legitimate trust for federal income tax purposes. No matter how carefully written the trust documents are, if the intent is to evade taxes, the trust will be treated as abusive. Should a taxpayer choose to participate in an abusive trust scheme, the taxpayer will not be shielded from potential civil and criminal sanctions. Violations of the Internal Revenue Code may result in civil penalties and/or criminal prosecution”.
If you answer Yes to any of the following questions, then you are probably involved with an illegal tax avoidance scheme.
- Underreport my income?
- Intentionally omit income?
- Overstate the amount of my deductions?
- Keep two sets of books?
- Make false entries in my books and records?
- Claim personal expenses as business expenses?
- Claim false deductions?
- Hide or transfer assets or income?
Best to consult your expert CPA before entering into a trust arrangement. ©