IRS Cautions on Abusive Trusts

WASHINGTON - The Internal Revenue Service today cautioned taxpayers to be wary of trust arrangements promising benefits that are not allowed under the tax law.

"We receive more than three million trust returns annually and will identify questionable ones for further review," said IRS Chief Compliance Officer James Donelson. "We'll assess taxes and penalties against the participants and promoters of the trusts we find abusive, and seek criminal charges where warranted."

The IRS advised taxpayers who may have used such trusts in the past that they should file correct returns for 1996 and amend their earlier filings. "Taxpayers need not be concerned about legitimate trusts, which are used in such matters as estate planning, charitable giving, or to hold property for minors and those unable to manage their financial affairs," said IRS Commissioner Margaret Milner Richardson.

The trust arrangements of concern to the IRS ignore the true ownership of assets or the substance of transactions. Promoters of such arrangements claim that they allow the owner to retain full benefit from business or personal assets while reducing or eliminating taxes. Often, multiple trusts are involved to cover the different financial aspects of a taxpayer's life.

For example, a person may put his business in an unincorporated business trust, transfer business equipment to an equipment trust, place his home in a family residence trust, and set up a foreign trust to hold the other trust units and to receive the trusts' income. According to the promoters, little or no tax would be paid.

Contrary to promoters' claims, however, established legal principles govern the taxation of trust income. The substance of a transaction, rather than its form, controls for tax purposes. Either the trust, the beneficiary or the transferor will pay the tax, as appropriate. Thus, the IRS may find that the transferor of the assets to the trust is liable for taxes on the trust's income and that the property will be part of the transferor's estate upon death.

Taxpayers should be suspicious of arrangements that claim to make personal living expenses deductible, to create charitable contribution deductions for payments benefiting the transferor or family members, or that otherwise result in a taxpayer having to pay no tax with no change in control over his or her income or assets. Promoters of such arrangements advertise their "investment seminars" or "tax seminars" in the local media as well as through the Internet.

Taxpayers may also receive unsolicited mail or telephone invitations to participate. Often the trusts have names that refer to constitutional issues, fairness, equity, or patriotic themes, among others.

In other cases, however, the trusts have names that are similar to common business organizations or nonabusive trusts. Taxpayers should be particularly wary if the promotional materials suggest that the taxpayer not check the arrangement with a tax advisor, such as an attorney or accountant, or with the IRS.

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