Earlier this year, the IRS and other government agencies warned us of some of the most daring and hard-to-decipher scams in recent memory. Victims of these schemes can lose staggering amounts of money, identities and even estates can be impacted. The world of trusts is not much different. To assist you from unwelcomed surprises and lost tax benefits, The Tax Warriors® at Drucker & Scaccetti look to steer you in the right direction concerning legitimate trusts vs. “sham trusts.”
Estate tax planning can be extremely complex as there are countless decisions to be made and laws to understand. There are a number legitimate trusts that, when executed properly, can be created to accomplish specific tax and estate planning objectives. On the other hand, in considering your trust options, you should also know that the IRS has identified a number of sham trusts (i.e., trusts that don't produce claimed tax benefits and can trigger interest and penalties) that defeat the original purpose of your plans.
To help you steer away from these sham trusts, The Tax Warriors® have outlined a summary below of some of the legitimate trust tools available to help accomplish your planning objectives:
- Marital deduction trusts, which are designed to qualify for the federal estate tax marital deduction, can be used to transfer assets to your spouse without paying gift or estate tax while ensuring that the trust assets will be available for your beneficiaries upon your spouse's death.
- Grantor retained annuity trusts (GRATs), grantor retained unitrusts (GRUTs) and qualified personal residence trusts (QPRTs), any of which can be set up during your lifetime to lower gift and estate tax costs of transferring property to your beneficiaries.
- Charitable remainder annuity trusts (CRATs), charitable remainder unitrusts (CRUTs) and pooled income funds may yield income, gift and estate tax charitable deductions that can benefit you and your beneficiaries.
- Special types of trusts can be used to make gifts to your beneficiaries in amounts that would qualify for the gift tax annual exclusion and yet minimize the risk that your beneficiaries will misuse the funds.
- Life insurance trusts can be used to keep life insurance proceeds from being taxed in the insured's estate while providing more protection than directly naming a beneficiary to a policy.
- Qualified Subchapter S Trusts (or QSST) to make gifts of S corporation stock to a beneficiary to save income and estate taxes while maintaining trustee control and management of the stock.
- Revocable trusts that provide a benefit in having property pass to beneficiaries on the death of the owner without having to go through the probate process.
As mentioned above, the IRS has also identified a number of sham trusts including:
- So-called business trusts
- Equipment or service trusts
- Family residence trusts (not QPRTs)
- Certain purported charitable trusts
- Certain trusts located in foreign countries
The so-called business trust arrangement makes it appear that an individual has given up control of his or her business in an attempt to secure a reduction in income and self-employment taxes and an elimination of estate tax on the business owner's death. This arrangement does not provide the claimed tax relief.
The equipment trust is formed to hold equipment that is rented or leased to the business trust, often at inflated rates, and the service trust is formed to provide services to the business trust, often for inflated fees. These trusts seek to reduce income taxes in different ways but the IRS warns that they do not work.
With a family residence trust, an individual transfers the family residence, including furnishings, to a trust, which rents it back to the individual. The trust deducts depreciation and the expense of maintaining and operating the residence including, pool service and utilities. These expenses are not deductible and the IRS will disallow them. These should not be confused with legitimate Qualified personal residence trusts often referred to as (QPRTs).
The purported charitable trust involves a transfer of assets or income to a trust claiming to be a charitable organization. The trust or organization pays for personal, educational, and recreational expenses on behalf of the transferor or one of his or her family members. The trust then claims the payments as charitable deductions on its tax return. The IRS says that many of these organizations are not exempt from tax and contributions to these trusts are not deductible.
Some individuals say that tax can be avoided by using trusts located in foreign countries that impose little or no tax on trusts and provide financial secrecy. Abusive arrangements enable taxable funds to flow through several trusts or entities until the funds are ultimately distributed or made available to the original owner. The trust promoter claims that this distribution is tax-free. But the IRS says that the income from these arrangements is fully taxable. And, with more collaborative efforts amongst worldwide governments to share banking and financial information on the rise, the idea of foreign secrecy is slowly but surely eroding away.
Needless to say, you should avoid promoters of sham trust schemes. However, it can be hard to tell which is real and which is not. If you'd like to accomplish a particular tax or estate planning objective through the use of a trust vehicle, you can call on The Tax Warriors® to discuss setting up the appropriate legitimate trust that will meet your needs. You can count on Drucker & Scaccetti to help you decipher the good from the bad and know that we are always prepared to help you with this or any other tax-related matter.