Abusive Trusts

Can a trust be too good to be true? The simple answer is yes.

Can a trust reduce or eliminate income or self-employment tax? Can a trust create the opportunity to take deductions for personal expenses paid by the trust? Can the use of a trust allow someone to take depreciation deductions on an owner’s personal residence and furnishings? The simple answer to the above questions is no.

Trusts that attempt to achieve the above are just “to good to be true.”

In fact, the IRS has characterized such trusts as “Abusive Trusts.” In recent years, the IRS has become very aggressive in its treatment of abusive trusts.

Abusive trusts are called many different names. Some of the more common names are “Constitutional Trusts,” “Pure Equity Trusts,” “Common Law Trusts,” or “Common Law Trust Organizations.” There have been a number of other names used to market these trusts as well.

Generally, the trust is established when the trustee issues units in the trust to the settlor (person forming the trust). The trustee, someone other than the settlor, has absolute discretion over making any distributions of income or principal back to the settlor.

Promoters claim that the settlor is no longer income taxable on the income and that both gift and estate taxes are avoided. Needless to say, the IRS does not share the same belief.

The IRS has recently undertaken a national coordinated strategy to address fraudulent trust schemes. IRS Public Announcement Notice 97-24 warns taxpayers to avoid fraudulent trust schemes that advertise bogus tax benefits.

In the public notice, the IRS warns that these abusive trust arrangements will not produce the tax benefits advertised by their promoters; that the IRS is actively examining them and that in some circumstances, taxpayers who participate in them may be subject to civil and/or criminal penalties. IRS Notice 97-24 can be found on the Internet at www.irs.ustreas.gov.

It must be noted that the IRS has specifically distinguished the “abusive trusts” explained in this article with legitimate trusts used in estate planning and charitable giving. The Internal Revenue Code provides numerous provisions for the use of trusts for minimizing taxes in an estate planning and charitable giving context. In all IRS publications regarding abusive trusts, the IRS distinguishes between abusive trusts and legitimate trusts.

Hopefully, by writing this article, those who have unfortunately become involved in abusive trust arrangements will be made aware of the serious problems related to such arrangements and will take steps to undo the problematic trust arrangements before the IRS confronts them.

Jeffery J. McKenna is a local attorney licensed in three states and serving clients in Utah, Nevada, and Arizona. He is a partner at the law firm of Barney, McKenna and Olmstead, with offices in St. George and Mesquite. He is a founding member of the Southern Utah Estate Planning Council. If you have questions or topics that you would like addressed in these Wednesday articles please email him at jmckenna@www.barney-mckenna.com or call 628-1711.