We, the Internal Revenue Service (IRS) and the Department of Justice (DOJ) are witnessing a surge in fraudulent schemes involving trusts. The rise in these scams can be attributed to the general public’s lack of understanding regarding trusts and their taxation, coupled with the relatively unnoticed filing of trust tax returns, allowing them to operate under the radar.
The recent indictment of six individuals for promoting a combination of complex strategies involving abusive trust arrangements serves as a stark reminder that such scams are prevalent and thriving. These scams often involve so-called tax mitigation plans and are frequently intertwined with other financial and Ponzi-like schemes. As the adage goes, “If it seems too good to be true, it probably is.”
A common thread in these scams is the convincing presentation and apparent credibility of the promoters. They employ persuasive logic, tout their credentials, and leverage their perceived good character. Their preparedness in answering questions and addressing objections can be highly convincing.
Potential warning signs to be wary of include:
– Claims of being highly credentialed professionals, such as CPAs, CFPs, or attorneys.
– Advice to not disclose the information to your CPA or attorney, as they are unfamiliar with these “deals” and how they work.
– Promises of replicating the tax strategies used by the top 0.1% of the population.
These scams often follow specific patterns:
The Business Trust: The taxpayer transfers their business to a trust. The income from the business is then transferred to a series of trusts (Service Trusts), effectively hiding the income from the business owner and ultimately being distributed to a Family Foundation (Charitable Trust).
The Service Trust: This trust can charge the Business Trust inflated or personal expenses or make distributions to other trusts and take a distribution deduction, thereby eliminating taxable income and wiping out income in the Business Trust.
The Family Residence Trust: In this plan, the owner transfers their personal residence to a trust that purports to have the trust rent the residence back to the owner, taking deductions for operating expenses, real estate taxes, and depreciation while the owner continues living in the residence.
The Charitable Trust: Here, the taxpayer forms a trust and claims it is a charitable foundation, asserting that payments to the trust are charitable deductions. The foundation then loans the money back to the taxpayer or pays for the taxpayer’s expenses, children’s college education, or investments promoted by the scheme’s organizers.
Taxpayers may be convinced of the legitimacy of these arrangements as the promoters assist them in applying for charitable exemption with the IRS, and the IRS sends a letter granting the charitable status. However, knowledgeable tax professionals understand that this initial letter is valid only if the organization complies with the strict requirements imposed on charitable organizations. The official IRS letter granting charitable status provides a false sense of security to the unsuspecting taxpayer.
The Final Trust: After setting up several trusts, the plan often involves creating a Final Trust, potentially in a foreign country, where distributions can supposedly be made tax-free.
These scams and sham trusts do not work, and the promoters will face legal consequences, but the taxpayer will also be held accountable, even if they participated unwittingly. If discovered by the IRS, the taxpayer will be required to pay back the purportedly saved taxes, along with substantial penalties, interest, and expenses for hiring professionals to rectify these entities and address the IRS.
It is important to note that there are legitimate uses of trusts for transferring assets to others, estate planning, and managing financial affairs. In fact, the use of trusts is one of the most powerful tools available to professionals to accomplish their clients’ goals – it is the abuse of these devices that can cause significant harm. Avoid being lured by the euphoria of avoiding taxes through illegitimate means.
