Update on Trust Scams

This column, in slightly different format, originally appeared in The San Francisco Examiner Newspaper, May 28, 2000.

Copyright 2000  Robert L. Sommers, all rights reserved.

Update on Trust Scams

Abusive trust packages often use names such as "Unincorporated Business Organization" (UBO), "Common Law Trust" or "Pure Equity Trust." Designed as tax-cheating tools, these trusts are shams: Their owners (called "creators") retain control of their assets as if the trust never existed. [See sidebar: How to Spot an Ilegal Trust]. Note: These trusts have nothing in common with legal trusts used for estate planning purposes drafted by licensed attorneys.

Despite repeated warnings by IRS of a nationwide crackdown on promoters of phony trusts, the trust scam business is apparently thriving on the Internet. There are email lists and discussion groups debating the validity of these devices, oblivious to court decisions that have unanimously considered these arguments frivolous.


IRS Criminal Investigation Division's Report to Congress

In an unprecedented published report to Congress, IRS Criminal Investigation Division (CID) candidly outlined its efforts to criminally prosecute trust scam promoters involved in tax evasion.

CID claimed that in 1999, there were 35 indictments with an 85.7% incarceration rate and a 35-month average jail term. As of February 2000, there were 130 criminal investigations; 55% involving foreign trust scams. Illegal foreign trusts are directed toward wealthy taxpayers and usually rely on layers of paperwork and the bank secrecy laws of foreign jurisdictions to evade IRS detection.


Foreign Trust Scams

CID noted that taxpayers often use foreign bank accounts in these schemes. Taxpayers may access their money through debit or credit cards issued by the foreign bank to pay for expenses in the U.S. Because foreign banks are used, IRS has a harder time tracing the transactions to the taxpayer.

In another ploy, the foreign trust transfers funds to an International Business Corporation (IBC), which is still controlled by the taxpayer and formed in a tax-haven jurisdiction (a country that prohibits disclosure of financial information to IRS). The money is then accessed by the taxpayer through supposedly legitimate loans from the IBC. Because loan proceeds are not reported on a tax return, the transaction avoids detection.


Use of Sham Trusts to Defraud Creditors

In addition to income tax evasion, fraudulent trusts have been used to hide assets from IRS collection efforts. For example, a taxpayer transfers title of his residence to a phony trust, then continues to live in the residence as the trust’s "caretaker." The taxpayer claims that he no longer owns the home, and therefore it is not an asset that IRS can reach to satisfy taxes. Phony trusts are also being used in bankruptcy cases to hide personal assets from creditors.


The "Tax-Sovereign State" Argument

The latest twist in the trust-scam business is the claim that these trusts are U.S. tax-free because they are located in a tax-sovereign state (i.e. Minnesota is not part of the United States), a theme touted by traditional tax protestors and militia groups.

Supposedly, IRS jurisdiction is limited to Washington, D.C. and does not extend to the 50 states, unless the taxpayer voluntarily submits to federal jurisdiction by filing a tax return or claiming federal benefits such as social security. Thus, the trust is now "foreign" (not located within IRS jurisdiction), and not subject to our tax laws. The taxpayer is paid by a foreign trust, and claims a foreign earned income exclusion ($74,000 in 2000). In addition, the trust makes annual tax-free gifts to the taxpayer and his family.

Of course, none of this is legal: Just ask Minnesota-based trust promoter Karl Foster who, according to the CID report, used this "Freeman-meets-the-trust-scam-promoter" argument to sell his trusts and managed to land 78-month term in prison.


Conclusion

In conclusion, IRS has launched a vigorous two-pronged offensive against domestic and foreign abusive trusts: Its criminal division is focusing on jailing the promoters, while the examination division is coordinating audits against the tax-dodgers using these trusts, charging them with back taxes, interest and penalties.



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All contents copyright 1995-2003 Robert L. Sommers, attorney-at-law. All rights reserved. This internet site provides information of a general nature for educational purposes only and is not intended to be legal or tax advice. This information has not been updated to reflect subsequent changes in the law, if any. Your particular facts and circumstances, and changes in the law, must be considered when applying U.S. tax law. You should always consult with a competent tax professional licensed in your state with respect to your particular situation. The Tax Prophet® is a registered trademark of Robert L. Sommers.