LAW OF THE LAND: Beware of ‘sham’ trusts to evade taxes

William L. Martin III
William L. Martin III

The Internal Revenue Service is warning the public about “sham" trusts set up to purportedly avoid liability for federal taxes. Ever on the lookout for tax evaders, the IRS has recently detected numerous illicit trust tax evasion schemes. The promoters of these schemes promise tax reduction and asset protection. However, in many cases, the “trusts” do not conform to state law and are in fact nothing more than an illegal tax evasion scheme.

Promoters of abusive trust arrangements typically promise greatly reduced tax liabilities without any change in the taxpayer's control over the trust’s income and assets. According to the IRS, the promised benefits may include:

• Reduction or elimination of income subject to tax;

• Deductions for personal expenses paid by the trust;

• 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.

Generally, all income a trust receives, from foreign or domestic sources, is taxable to the trust, the beneficiary, or the taxpayer unless specifically exempted by the Internal Revenue Code. In the illicit schemes, false or contrived expenses are charged against trust income at each trust layer. After the deduction of these expenses, the remaining income is distributed to another trust, and the process is repeated. At the end of the process, there is a decrease in the amount of income reported to the IRS because the “expenses” are siphoned out of income.

The IRS wants taxpayers to be aware that the IRS is actively examining these trust arrangements. Furthermore, the IRS is warning that taxpayers and/or the promoters of these trust arrangements may be subject to civil and/or criminal penalties.

Bill Martin is a former B-52 and B-1 pilot and senior attorney for the Federal Deposit Insurance Corporation and is admitted to the U.S. Tax Court. He is currently a partner in the law firm of Keefe, Anchors & Gordon in Fort Walton Beach, Fla.