Copyright © 1998 Robert L. Sommers, all rights reserved.
Note: This article deals with abusive trust arrangements (I call them "trust scams") whereby taxpayers are "sold" a set of fraudulent trusts and told that if they place their property and assets into these trusts, they can avoid tax on the income and estate taxes on their death. Typically, these trusts illegally claim tax deductions for the personal expenses of the taxpayer and his family, including food, housing costs, medical expenses, travel, entertainment, vacations and educational expenses.
The IRS describes the scheme as follows:
"Establishing a foreign or domestic trust for the purpose of hiding income and assets from taxation is illegal. Abusive Trust Schemes typically involve the creation of one or more trusts into which the taxpayer transfers his or her personal and/or business assets and to which the taxpayer assigns his or her income. The taxpayer, the promoter, or someone who will allow the taxpayer in reality to control the activities of the trust is then assigned as the trustee."
To learn more about these trusts, read: IRS Notice 97-24 and the articles appearing on the Trust Scam Bulletin Board.
A TYPICAL EMAIL FROM A CRITIC:
Question: Why bother writing about the tax scams? After all, the U.S. government and its IRS are abusive, tyrannical and immoral. In fact, those who preach tax resistance should be commended, not scorned. After all, they have the moral high ground and you tax attorneys merely serve these forces of evil solely for financial profit.
Answer: On the contrary, regardless of your political view of the U.S. government or the IRS, these promoters are not acting out of moral conviction or engaging in civil disobedience, they are ripping off the public with their lies and are as corrupt, evil and immoral as those who sell fake medicine to the terminally ill. And the Internet has become their vehicle of choice for promoting all kinds of tax frauds that could be extremely hazardous to your freedom and pocketbook.
Congress is well-aware of IRS abuses and is currently addressing the subject with new legislation. My website contains articles critical of IRS conduct and I have proposed my own version of radical tax reform.
This is not about morality or philosophy, its about the law. It is about what the law actually says and the real consequences if you become a tax evader.
Tax scams are big business. Often, victims pay many thousands of dollars to buy worthless tapes, books or forms. Worse, they rearrange their business affairs in ways that will cause them financial ruin. Often, these victims never receive a another opinion regarding the legality. They never learn about the absolute failure of these trusts when challenged by the IRS in court and the expensive penalties, in addition to the full taxes plus interest, their victims incur.
In a recent California seminar called Antidotes for Estate Planning Scams, Botched Trusts and Other Disasters (April 1998, California Continuing Education of the Bar), there were several hundred attorneys in attendance. When a panelist asked how many attorneys were confronted with issues involving estate planning scams, over 80% of the attendees responded affirmatively. The panelist noted the tremendous increase in the number of attorneys confronting these issues in their everyday practice.
Many scam artists specifically target the elderly, especially in the estate planning area. Both the IRS and the state attorneys general have expressed interest and even alarm at this development.
Tax Protestors vs. Trust Scams - different approaches, same fraudulent result
The trust scam artists differ from the tax protester brethren in that they implicitly concede the U.S. tax system is valid and constitutional. In fact, they sell their bogus trusts as an expensive tax dodge. In contrast, the tax protesters believe the U.S. tax system is unconstitutional and can be avoided by not filing tax returns in the first place. Resorting to exotic trust schemes is not even considered.
It's Tax Scam Season
With the passing of April 15th, it is now high season for the tax scam artists to begin searching for their prey: Frustrated and gullible taxpayers, angry at the current tax system and governmental waste, are easy marks for these promoters. Emotion takes the place of logic and reason: people want to believe there is a simple, magical cure that will eliminate their tax obligations.
Enter the Web
Promoters are no longer limited to clandestine meetings in neighborhood homes. Unfortunately, the Web has extended the reach of these con artists world-wide.
Abusive trust arrangements are marketed under a variety of names, such as "pure," "pure equity," "constitutional," "common-law" or "family" trusts. Just type one of these terms in a popular search engine (Excite, Alta Vista, Yahoo, Infoseek) and about a dozen websites will appear.
Trust Scammers Begin Attacking Their Own
These websites are remarkably similar in appearance, tone and worthless content. Each uses similar phony arguments and citations to irrelevant and outdated case law. There is never a discussion about the risks of implementing the scheme or a rebuttal to the IRS position that such programs are considered abusive trust arrangements. No court has ever accepted any argument raised by either the trust abusers or the tax protesters; in fact, their arguments have been consistently ridiculed as frivolous and specious.
Apparently, the trust scam business is very competitive since many of these websites routinely bad-mouth their rivals, insisting that only their particular brand of alchemy is worth your money. Ironically, their criticisms of the competition apply to their own propositions as well.
The So-Called "Secret" Law that Applies to These Trusts
Trust scammers call their trusts a variety of names, pure trust, pure equity trust, equity pure trust, business trust, common-law trust, constitutional trust, complex trust, family trust, contract trust. The rationale for these terms is that the trust exists under "common-law" or pursuant to the U.S. constitution and, therefore, is not subject to state law "statutory" interpretation.
This "secret," evidently known only to trust scam promoters, apparently escapes every tax attorney in our country, because (as the fiction goes) we are licensed in "statutory" law, not "pure" law. Therefore, we tax attorneys (including, presumably, those working in the largest law firms, accounting firms, brokerage houses and highest circles of government) cannot possibly understand the legal underpinnings of these trusts!
This argument, of course, is insulting as well as completely bogus. There is nothing in the common-law or U.S. constitution that restricts federal or state courts from enforcing their business and tax laws with respect to these trusts.
Although these trusts masquerade under different names, they all serve a similar function: to illegally evade U.S. taxes. If caught, the taxpayer can anticipate a civil fraud penalty of 75%, in addition to the taxes and interest otherwise owing. If the taxpayer is involved in the promotion of the illegal scheme, usually by selling the program to friends or relatives for a kickback, then he can expect criminal prosecution.
And the cost for creating such a trust could be between $5,000 to $15,000 -- two to six times the cost of a comprehensive legal estate plan prepared by an experienced estate planning attorney! Now, thanks to the Internet, some promoters are selling their fill-in-the-blank forms for as little as $850.00 (such a deal!). Victims can now cut their costs dramatically for these worthless scraps of paper.
Honesty Among Thieves
At least one of these promoters tells it like it is. Buried on his webpage is the following answer to a question regarding the disadvantage of using a "pure trust."
Q. WHAT IS THE MAIN DISADVANTAGE OF MANAGING A PURE TRUST?
A. The one main disadvantage of managing a PURE TRUST is that you must not commingle any personal finances with those of the PURE TRUST that you manage. If PURE TRUST funds are used to pay personal expenses or PURE TRUST funds are commingled with personal funds, a court could rule that the PURE TRUST was merely the "alter-ego" of the individual, and the transfer with the PURE TRUST a "sham", and in that manner, set the PURE TRUST aside.
In fact, every court dealing with the tax consequences of a pure trust have found them shams. The victims invariably use the trusts for their personal finances, but even if they did not, the taxpayers retain such a degree of control over the trust that they are taxed on the income under the grantor trust rules.
However, dont take that honesty too far: National Trust Services comes up with a different answer to essentially the same question:
Q: Do I Still Own the Assets in the Trust?
A: No! You will have transferred ownership of the assets to the TRUST, which is "controlled" by you. Your "use" of the assets (i.e. cars, house, etc.) can be considered a condition of your contract as Trustee. In fact, you should adopt a Minute that says exactly that. Once you transfer your assets into the Trust, you adopt an appropriate Minute that gives the Trustee limited use of those assets as a condition of the trustee's employment. (http://www.trusts.org/)
National Trust Services, which claims to have been around for 20 years, is notorious in the abusive trust arena. One of their victims, Arthur J. Ford, an anesthesiologist recently pled guilty to tax evasion, according to the following press release issued on December 2, 1996 by the United States Attorney for the District of Arizona:
According to the plea agreement, Ford who was the 100 percent shareholder of Mohave Anesthesia, P.C., filed false and fraudulent personal and corporate federal income tax returns and used a series of fraudulent trusts purchased from National Trust Services of Sunnyvale, California, to evade income taxes of approximately $144,000.
Selling of "Pure Trust" is a Fraud in California.
If a trust scam promoter lives in California, he could be committing a state crime. California has declared that promoting a "pure trust" constitutes a fraud. People vs. Lynam, 261 CA 2d 490 (1968). Since the term, "pure trust" can be used interchangeably with the other trust scam definitions, promoters operating in California are staring at criminal fraud violations of state law in addition to federal tax law infractions.
In an earlier case, People ex. Rel. Mosk v Lynam (253 Cal App 2d 959, 61 Cal Retr. 800) (1967), a California Appellate Court held that advertising the benefits of a pure trust to avoid income taxes amounted to false and deceptive advertising practices under Californias Business and Professions Code Section 17500). The court enjoined (prevented) the defendants from promoting "pure trust" plans for the management of personal assets. This case occurred 30 years ago, demonstrating that these con games have been around for decades.
Pure Equity, Common-law or Constitutional Trusts do not Circumvent State Court Jurisdiction
Trust scam promoters often claim their trusts are not subject to state law jurisdiction. Nonsense, according to the Lynam decision, wherein the court stated:
The statements to the effect that no state can regulate pure trusts because such trusts are guaranteed by the United States Constitution are untrue and misleading. Since beneficial certificates are issued by the trust, and since the trust may operate as a substitute for a voluntary association or corporation, the trust would be subject to regulation by the state. [citation omitted]. With reference to the purported "guarantee" by the United States Constitution, Lynam [the defendant] stated in his deposition that immunity from state regulation was guaranteed by that clause of the United States Constitution which protects contracts from abrogation. No contract contrary to public policy, however, is protected by that clause. (See Clay v Sun Ins. Office, Ltd. 377 U.S. 179 [12 L. Ed. 2d 229, 84 S.Ct. 1197]).
The statements to the effect that income accruing to the trust is not taxable to the trust (as an entity) are untrue and misleading (see Rev & Tax Code, Sec. 17331; McCulloch v Franchise Tax Board, 61 Cal.2d 186, 189-192, 198 especially when such statements are considered in conjunction with the statements that the trust can operate as a substitute for a corporation.
Defendants Lynam and Estate Organization Service also knew, or by the exercise of reasonable care should have known, that the statements with reference to the legal consequences of pure trusts were untrue or misleading.
In a criminal case for grand theft based on misrepresentations in the sale of trusts, the court in People vs. Lynam, 261 CA 2d 490 (1968) found three defendants guilty of conspiracy to commit grand theft and grand theft. The conviction arose from misrepresentations made by the defendants in the sale of trust indentures known as "Pure Trust Family Circle Organization." The defendants, in their promotion of pure trusts, falsely claimed that:
.. the creator of the trust could control the future of his estate as he desired while maintaining it as a "living estate for his family and that the trust would avoid probate and court costs, eliminate estate and inheritance taxes and avoid personal liability.
The court found there was ample evidence of the falsity of these statements and upheld the conviction for conspiracy and grand theft.
Basic State Trust Law Violations
Even without the fraudulent promotions and bogus tax benefits, the trusts drafted by many of these promoters do not comply with simple state trust laws, and, therefore, are not considered valid trusts to begin with.
For instance, in California a trust must have beneficiaries. A trust which has no beneficiaries is not a trust. Issuing the taxpayer Unincorporated Business Interests ("UBIs") or some other form of trust certificates that are freely transferable, instead of naming or providing for reasonably ascertainable beneficiaries in the trust document itself, violates California trust law. Consequently, arrangement cannot be a trust.
Since UBIs are similar to stock, the entity should be classified as an association taxable as a corporation, thereby subjecting both the corporation and the taxpayer (as the UBI shareholder) to a double tax on dividend distributions (corporations pay tax on earnings and shareholders usually pay tax again on the dividend distribution). This, of course, is a disastrous result and could cause a combined income tax well in excess of 50%.
The IRS has successfully used the "association taxable as a corporation" theory in a trust scam case. Arcadia Plumbing Trust v CM., TCM 1994-455. In Arcadia, the taxpayer transferred his plumbing business which was operated as a sole proprietorship (income and deductions reported on Schedule "C" Form 1040) to a trust in exchange for 100 trust certificates. The trust functioned through a board of trustees.
The IRS, relying on IRC Reg. 301.7701-2, reclassified the entity for tax purposes as an association taxable as a corporation. The court focused on six characteristics that distinguish a corporation and found that all six factors were present in the trust. These factors are almost always present in the current abusive tax schemes being promoted to unwary taxpayers. Those characteristics are:
(2) An objective to carry on business and divide the gains therefrom;
(3) Continuity of life;
(4) Centralization of management;
(5) Liability for corporate debts limited to corporate property; and
(6) Free transferability of interests.
Note: These characteristics are prevalent is almost all scam trust documents, consequently, the IRS could successfully assert the association taxable as a corporation theory to cause a double-tax on the trust's income (i.e. income is taxed to the corporation and then taxed to the individual).
The Arcadia trust had associates, namely, the taxpayer and his wife. The trust had a business objective since it conducted a plumbing business. There was also continuity of life because the death, bankruptcy or insolvency of the taxpayer would not terminate the trust and, although the trust obstensively had a 25-year term, the trustees had the perpetual right to extend the trusts term. As with most scam trusts, the taxpayers were in control as trustees and had full rights to manage the trust and its assets. Based on these factors, the court held that the trust was, in reality, an association taxable as a corporation.
The Common-Law Business Organization Scheme
Even if the trust promoter could draft a trust that met the minimum state standards, the resulting entity provides no protection against taxes. Promoters tout the "business trust" or "business organization" as a vehicle to evade taxes. These entities "hold" the taxpayers assets, and, as the theory goes, the entity, but not the taxpayer, will be subject to taxes on the income earned. The taxpayer transfers assets to the trust in return for a certificate or unit of beneficial interest, which supposedly, has no value. Magically, the tax gain on the transfer disappears since the taxpayer received nothing of value for the transfer. In reality, such a transfer would be subject to the gift tax laws (the tax on gifts can reach as high as 55%).
Moreover, under settled tax law, if one transfers an asset and receives property that is difficult to value, the value received is measured by the asset transferred. For example, if a taxpayer has an asset worth $1,000 with a basis of $10 and sold it to a trust in return for a CBI, the CBI is valued at $1,000 and the taxpayer has a $990 tax gain ($1,000 consideration received, less $10 basis).
Because these entities, if valid, would be taxed as complex trusts, at the highest rates under the tax code (39.6% on taxable income over $8,000), these trusts often phony up deductions by paying otherwise non-deductible expenses of the taxpayer, such as personal living expenses, medical expenses and educational expenses of children.
A new twist to this scheme has the trust making distributions to a so-called charitable trust and taking a tax-deduction for the contributions. The charitable trust is usually owned or controlled by the taxpayer (surprise!) and the funds are then used in large part for the same non-deductible personal expenses described above. These so-called charitable entities almost never qualify as a charity under the strict rules and procedures for establishing a non-profit organization under the Internal Revenue Code and even if they did, the acts of self-dealing between a private foundation and foundation donors or related parties are prohibited (Code Section 4941).
These donors and related parties are termed "disqualified persons." A progressive series of excise taxes are imposed against the disqualified persons and against any foundation manager who willfully engages in self-dealing. In addition, in the case of willful repeated acts of self-dealing, or a willful and flagrant act, the IRS may impose a penalty, terminate foundation status and impose a termination tax.
In addition, since the so-called charity fails to meet the definition of a non-profit organization, it is subject to tax on its income. Therefore, both the main trust and the non-profit trust would be subject to income tax at 39.6% on taxable incomes over $8,000.
To illustrate: Main trust has $100,000 in income and makes a distribution to a charitable trust. If these entities were valid for tax purposes, the main trust would have a charitable deduction of probably 30% of the amount distributed and the charity would not have income.
Because both trusts are phony, however, the main trust has a federal tax of $39,600 and so does the charitable trust, for a total federal tax of $79,200 on the $100,000 (if these trusts are operating in a jurisdiction that imposes state taxes, the tax amount could reach 100%).
It is clear the variety of trust scams polluting the Web are worthless, even dangerous to those who would actual use them. However, despite repeated warnings from the IRS of an imminent nationwide crackdown, nothing much has happened to these promoters. Whether the IRS will actually take decisive action against these people remains to be seen.
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**NOTE: The information contained at this site is for educational purposes only and is not intended for any particular person or circumstance. A competent tax professional licensed in your state, should always be consulted before utilizing any of the information contained at this site.**