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September 1997 Hot Topics

September 1997 - ANATOMY OF A TRUST SCAM

In April of this year, the IRS announced a nationwide crackdown on approximately 200,000 phony trusts filed annually. Taxpayers have been warned to come forward and file proper returns, or face civil or potentially criminal penalties, if caught.

The IRS has targeted five phony trusts: (1) small business trusts where the beneficiary (person receiving the benefits) is the same person as the grantor (creator); (2) equipment or service trusts which rent equipment or perform services for the business trust; (3) family-residence trusts which assume ownership of the home and furnishings in which the grantor (owner) is the renter (beneficiary) or occupant; (4) charitable trusts which treat non-deductible payments (tuition for the grantor’s children) as charitable distributions; and (5) final trusts which oversee multiple abusive trusts and are often located in foreign jurisdictions.

The federal government has made good on its threat and has indicted 3 people for allegedly engaging in criminal tax evasion through the promotion of off-shore trusts and other devices designed to hide taxable income.

Note: The following is a discussion involving portions of the indictment issued against 3 individuals accused of violating federal tax laws. Remember, these individuals are presumed innocent until proven guilty in a court of law. The allegations made by the government are just that – allegations only. The indictment, however is of public record and is useful because it provides an insight on how the federal government views this type of conduct. Note: The allegations in the indictment have been summarized for easier reading. The term "Defendants" refers to two U.S. taxpayers and the term "Defendant (foreign)" refers two their foreign accomplice.


THE INDICTMENT

Count One:

18 U.S.C. Section 371 - Conspiracy to Defraud the United States

1. Defendants solicited wealthy clients, particularly medical professionals, to participate in a program they marketed as an "off-shore program."

2. Defendants, assisted offshore by their business associate, Defendant (foreign) operated the "off-shore program."

3. The off-shore program involved sending client income through a series of at least 5 sets of transactions, all with the knowledge and participation of the clients. Defendants referred to the full cycle of funds through the off-shore program as a "pass".

4. Client income was transferred to an account in the United States controlled by the defendants. Client funds were transferred by wire from that account to one of several off-shore bank accounts controlled by Defendant in a tax haven country in the Caribbean or Central America.

5. Defendant (foreign) would transfer the funds through additional off-shore bank accounts he controlled which were also located in tax haven countries.

6. Defendant (foreign) would transfer the client funds back to a bank account in the United States controlled by defendants.

7. The funds were transferred from this account back to bank accounts controlled by the clients.


Comment: This is a circular flow of money which is apparently designed to hide the taxable source of the funds; namely, the taxpayer who earned the funds. This arrangement does not rely on any trust theories or legal arguments -- it is a money laundering operation designed to hide the true source of income which is taxable under U.S. law.


 

Indictment Continued

9. Defendants and their clients took further steps to conceal the nature of the scheme and the source of the income by:


Comment: This is a continuation of money laundering and does not involve the use of trusts. So far, the indictment is alleging a primitive and straightforward money laundering operation designed to hide the source of income and to avoid the cash reporting requirements.


Indictment Continued

9. Defendants counseled and advised their clients on how to conceal the income that had passed through the "off-shore program" from the IRS.

10. Defendants prepared tax returns and assisted their clients in preparing tax returns that falsely concealed the existence of such income.

11. Defendants counseled and assisted their clients in unlawfully evading federal income taxes through the use of trusts, or so-called "unincorporated organizations," which they created on behalf of their clients.

12. Clients were counseled and assisted in transferring their businesses, medical practices, homes and other assets into the unincorporated organizations or to bank accounts corresponding to these entities.

13. Although the unincorporated organizations had nominal trustees or administrators, the entities were actually under the management and control of the clients, who operated the entities, and maintained full control of the bank accounts and other assets transferred to the entities.

14. The unincorporated organizations were used to funnel money into and out of the off-shore program and to otherwise evade income taxes.


Comment: The use of unincorporated business organizations and other non-traditional business structures are typical of many trust scam operations. This part of the indictment is describing the garden variety trust scam. These scams have never worked and the IRS and courts have consistently ruled against them.

The recent Tax Court case, Buckmaster v CM. T.C. Memo 1997-236 is illustrative of the typical trust scam and the court’s response. In Buckmaster, the court found the trust was a sham, assessed the taxpayer the full taxes owing, plus interest, a 20% accuracy-related penalty and $5,000 penalty for asserting a "frivolous and groundless" position.

The taxpayer transferred his assets to a trust called "Ideal Management." The beneficiary of this trust was a foreign trust based in Gibralter in 1992 and in Belize in 1990 and 1991. The taxpayer transferred his business property , including work tools and two vehicles, to the trust for 100 capital units. He then began working for the trust as an independent contractor for $300 a month.

The pertinent parts of the court’s decision are set forth below, (Note: The legal citations in the opinion have been omitted and some of the legal terms, such as petitioner and respondent, have been changed to taxpayer and IRS, respectively, for easier reading):

[14] We agree with respondent [IRS] that the disputed income is includable in petitioner's [Taxpayer’s] 1992 gross income because Ideal Management [the Trust] was a sham; i.e., it lacked economic reality. We find first that the IRS's determination rests on a solid foundation. The IRS performed properly a bank deposit analysis of Taxpayer's and Ideal Management's bank accounts, with the knowledge that Taxpayer was subject to an outstanding Federal tax lien aggregating almost $100,000, that he was connected with Ideal Management, and that his reported gross income and itemized deductions for 1992 had decreased dramatically from prior years.

The IRS reached its determination in light of United States v. Scott, 37 F.3d 1564 (10th Cir. 1994). In Scott, the Court of Appeals for the Tenth Circuit examined certain trusts involving IBA and Mr. Yung, and found that these trusts were fraudulent. Id. at 1572. The Court of Appeals set forth an extensive analysis of these trusts, all of which were remarkably similar to Ideal Management.

[15] We find that Ideal Management was merely a device conjured up for Taxpayer and other taxpayers seeking to avoid Federal income tax. Taxpayer testified that he was not tax motivated when he joined Ideal Management, and that he joined Ideal Management mainly to protect his assets from creditors. Taxpayer testified that he transferred to Ideal Management his entire ownership interest in his assets so that his personal creditors would not be able to seize them if he was ever unable to pay a judgment or other liability. Taxpayer testified that he worked for Ideal Management in 1992 for $400 a month, when his services generated earnings of almost $6,000 a month. Taxpayer testified that he agreed initially to work for Ideal Management for $300 per month, performing basically the services he performed for almost 20 times that amount the year before. Taxpayer asks the Court to believe his testimony and hold for him. We decline to do so. We find his testimony incredible.

[16] The Court of Appeals' opinion in United States v. Scott, supra, is most helpful to us in understanding the form, substance, and operation of Ideal Management. The opinion describes in detail how the trusts were marketed as a device for a purchaser to eliminate his or her income tax liability without losing control of his or her money and other assets. Like the trust at hand, the trusts in Scott were generally structured so that it would appear that the trust income was distributed to foreign trust beneficiaries, which then redistributed the income to other foreign trust beneficiaries that were outside the reach of the U.S. taxing arm. Id. at 1570. Other relevant characteristics of the trusts examined in United States v. Scott, supra, include that:

(1) The purchasers transferred their property, including houses, into a trust;

(2) The trusts claimed depreciation deductions for the property;

(3) The trusts were reported to the Commissioner as simple trusts;

(4) Mr. Yung was a trustee;

(5) Foreign trusts in Belize acted as beneficiaries of the purchasers' trusts, and the foreign trusts owned the capital units;

(6) The purchaser was never the named capital unit holder;

(7) Each trust was established by a fictitious domestic trust,named "Cache Properties", for a nominal amount of $100;

(8) The second trust was usually a foreign trust with a trustee named Dennis Smith;

(9) A purchaser could ensure perpetual control of his or her trust by naming himself or herself as secretary or manager;

(10) A purchaser could not be removed or fired except with 30 days' notice; and

(11) The trusts were "sold" by IBA for $2,500 apiece.

Following our detailed review of the facts surrounding Ideal Management, with our knowledge of the facts in Scott, we reach the conclusion that Ideal Management was devised and operated similarly to the trusts examined in Scott. We conclude that Ideal Management, like the trusts in Scott, was a sham.

[17] Our conclusion is strengthened by our analysis of a number of factors that this Court has previously considered to help ascertain whether a purported trust lacks economic substance for Federal income tax purposes. These factors include: (1) Whether the taxpayer's relationship, as grantor, to the property differed materially before and after the trust's formation; (2) whether the trust had an independent trustee; (3) whether an economic interest passed to other beneficiaries of the trust; and (4) whether the taxpayer felt bound by any restrictions imposed by the trust itself or the law of trusts. Our analysis of each of these factors supports our conclusion.

[18] With respect to the first factor, we look to the economic reality of a purported arrangement to determine who actually is the settlor of a trust, whether or not named as settlor in the related documents. Although the documents at hand list Cache as the settlor of Ideal Management, the fact of the matter is that Cache acted merely as a "straw man" to form Ideal Management. We find that Taxpayer paid a $2,500 fee to transfer his assets to Ideal Management, and that Ideal Management's only assets during 1992 were Taxpayer's transferred assets including, possibly, the residence. We find that Taxpayer used all of these properties as his own both before and after the transfer; i.e., he used his tools and vehicles to generate large revenues, and he and Webb lived in the residence. Although it is true that Taxpayer ostensibly made monthly "rent" payments to Ideal Management, Ideal Management applied these payments mainly to the residence's mortgage, property taxes, and other expenses. Thus, we see clearly that Taxpayer stood in exactly the same spot with respect to his assets before and after their transfer to Ideal Management. We find that the first factor points to a sham.

[19] We find likewise with respect to the second factor; i.e., Ideal Management lacked a bona fide independent trustee. Contrary to the assertions of Taxpayer and R. Richard Evans, the named trustee of Ideal Management during 1992, Mr. Evans could not prevent Taxpayer from using Ideal Management's property for his own purposes. Taxpayer had signature authority over the Ideal Management account, which meant that he had access to the funds contained therein. Taxpayer also could not be removed from his position as Ideal Management's manager without 30 days' notice, which, in turn, gave Taxpayer perpetual control of Ideal Management. Taxpayer's use of the residence and the tools of his trade also were free from restraint.

[20] As to the third factor, we find no probative evidence in the record to indicate that Taxpayer transferred an economic interest to a third party when he transferred his assets to Ideal Management. Taxpayer asks the Court to find as a fact that he transferred his entire beneficial interest in Ideal Management to Clark for no consideration 1 day after he joined Ideal Management. We decline to do so. The facts of this case preclude such a finding. Ideal Management's minutes for an April 1989 meeting, for example, state that all 100 capital units would revert back to Taxpayer and Webb upon Clark's liquidation. Likewise, Clark's address during 1992 was Taxpayer's home address, which points to the conclusions that Taxpayer controlled Clark and that the purported transfer of the capital units to Clark did not actually give Clark any meaningful rights or interests in Ideal Management. We also believe it is implausible that Taxpayer would have transferred away all of his legal and beneficial interests in his assets, including the tools of his trade, for practically nothing in return. Following our review of the record, we are satisfied that Taxpayer was the actual beneficiary of Ideal Management.

[21] As to the fourth factor, we find that Taxpayer was not bound by any restrictions imposed by Ideal Management or the law of trusts as to the use of the transferred property. Taxpayer's unrestricted use of Ideal Management's property leads us to believe that it was not restricted in any meaningful manner, including fiduciary restraints.

With respect to penalties, the Court stated:

[26] We agree with the IRS that Taxpayer is liable for a penalty under section 6673(a)(1), and we require him to pay a penalty to the United States in the amount of $5,000. Taxpayer's conduct throughout this proceeding has convinced us that he instituted and maintained this proceeding primarily for delay. His position in this proceeding also is groundless and frivolous. See Coleman v. Commissioner, 791 F.2d 68, 71 (7th Cir. 1986); see also Neitzke v. Williams, 490 U.S. 319 (1989) (defining legal frivolousness). Petitioner's insistence on pursuing his fruitless arguments has consumed time and effort of this Court (and of the IRS) that could have otherwise been devoted to resolving bona fide claims of other taxpayers. See Cook v. Spillman, 806 F.2d 948 (9th Cir. 1986).


Indictment Continued

On or about March 13, 1995, and May 31, 1995, Defendant sent letters to Defendant (foreign) enclosing copies of a book by Defendant on unincorporated organizations, and copies of documents relating to unincorporated organizations.

On or about June 9, 1995, Defendant sent an application for participation in a foreign trust program to clients in Marysville, California.

Count Two:

(18 U.S.C. Section 371 - Conspiracy to Defraud the United States)

1. On or about July 31, 1995, Defendant formed Heritage Estates Lifetime Planning Services ("HELPS") in Roseville, California.

2. On or about September 21, 1995, Defendant opened bank accounts at a Wells Fargo Bank in Antelope, California.

3. On or about October 18, 1995, a client of HELPS wrote a check in the amount of $35,000, drawn on a Wells Fargo Bank account in Fresno, made payable to an "unincorporated organization" controlled by Defendant.

4. On or about October 23, 1995, Defendant caused $42,900 to be transferred by wire from an account at a Wells Fargo Bank in Antelope, California, to an account at Banco Nacional de Mexico in Chetumal, Mexico.

5. On or about January 11, 1996, Defendant caused $60,855 to be transferred by wire from an account at a Wells Fargo Bank in Antelope, California, to an account at the McLaughlin Bank in Curacao.

6. On or about March 8, 1996, Defendant (foreign) caused funds in the amount of $34,542 to be transferred by wire from an account at the McLaughlin Bank in Curacao to a Wells Fargo Bank account in Antelope, California.

7. On or about April 2, 1996, a client of HELPS purchased a cashier’s check in an amount of $25,000 at a First Interstate Bank in Yuba City, made payable to an "unincorporated organization" controlled by Defendant.

8. On or about April 3, 1996, Defendant caused $23,750 to be transferred by wire from an account at a Wells Fargo Bank in Antelope, California, to an account at the McLaughlin Bank in Curacao.

9. On or about April 20, 1996, Defendant traveled to Belize for the purpose of meeting Defendant (foreign) concerning the off-shore program.

10. On or about June 24, 1996, Defendant (foreign) transmitted information to Defendant by e-mail concerning the trustee of an off-shore trust.

11. On or about July 22, 1996, Defendant contacted defendant Defendant (foreign) by e-mail to inquire about the status of certain fund transfers in the off-shore program.

12. On August 28, 1996, in a telephone discussion between Defendant and a client of his who was participating in the HELPS off-shore program, Defendant told his client that, in light of the Internal Revenue Service inquiries about the matter, the client should collect all copies of foreign trust documents in his possession and provide them to Defendant so that he could destroy them. Defendant also told the client not to provide any documents or information to the Internal Revenue Service.


Comment: If allegation 12 is true, then the defendants refused to stand by their legal arguments and documents when an IRS examination was imminent. Such a position contradicts any good faith believe in their principles.


Indictment Continued

13. On or about August 28, 1996, Defendant sent Defendant (foreign) an e-mail message concerning inquiries by the Internal Revenue Service about the off-shore program and steps that should be taken in response, and seeking Defendant (foreign)’s "advise and direction".

Count Three:

18 U.S.C. Section 371 - Conspiracy to Defraud the United States

1. Defendants renamed FEPA to Defendants & Associates ("GGA") no later than approximately December 1, 1995, which was based in Roseville, California.

2. On or about August 1, 1995, Defendants opened bank accounts at the WestAmerica Bank in Roseville, California.

3. On or about August 24, 1995, a client of GGA purchased a cashier’s check in the amount of $18,500 at a First Interstate Bank in Yuba City, California, made payable to an "unincorporated organization" controlled by Defendants.

4. On or about August 25, 1995, Defendants caused $17,575 to be transferred by wire from an account at WestAmerica Bank in Roseville, California, to an account at Banco Nacional de Mexico in Chetumal, Mexico.

5. On or about February 9, 1996, Defendants caused $117,500 to be transferred by wire from an account at WestAmerica Bank in Roseville, California, to an account at the McLaughlin Bank in Curacao.

6. On or about February 28, 1996, Defendant (foreign) billed defendants Defendants for fees associated with the creation of foreign trusts for clients of GGA.

7. On or about February 29, 1996, Defendant (foreign) caused $46,675 to be transferred from an account at the McLaughlin Bank in Curacao to an account at a WestAmerica Bank in Roseville.

8. On or about March 4, 1996, Defendants caused $46,730 to be transferred by wire from an account at WestAmerica Bank in Roseville, California, to an account controlled by FEPA clients at a Bank of America in Redding, California.

9. On or about March 5, 1996, a GGA client transferred $98,650 from an account at a Wells Fargo Bank in Fresno to an account at a WestAmerica Bank in Roseville, and Gaskill and Goodrich caused $98,630 to be transferred by wire from an account at a WestAmerica Bank in Roseville, California, to an account at McLaughlin Bank in Curacao.

10. On or about March 7, 1996, Gaskill wrote a letter to an Internal Revenue Service Agent concerning an IRS audit of a GGA client.

11. On or about March 8, 1996, Defendants caused $46,635 to be transferred by wire from an account at a WestAmerica Bank in Roseville, California, to an account controlled by a GGA client at a First Interstate Bank in Yuba City, California.

12. In March 1996, Defendants traveled with a GGA client to Belize for the purpose of meeting Defendant (foreign).

13. On May 9, 1996, Goodrich, in a telephone discussion with a client of GGA, told the client that the transfer of funds in the off-shore program was structured to avoid leaving a documentary trail that the movement of funds was "a circle".

14. On June 4, 1996, Goodrich told a client during a meeting with the client and Gaskill, that the off-shore program is structured so that the Internal Revenue Service could not trace the funds past the first trust account.


Comment: If allegations 13 and 14 are true, then it is clear the defendants were engaged in a simple money laundering scheme under the guise of using trusts. There is no attempt to avoid taxes with trusts (which clearly does not work in any event). This program was designed to hide and disguise taxable income from the IRS.


Indictment Continued

1. On or about June 4, 1996, Defendant (foreign) caused the transfer OF $52,070 from an account at the McLaughlin Bank in Curacao to an account at a WestAmerica Bank in Roseville, California.

2. On or about June 17, 1996, Defendants caused a cashier’s check to be purchased in the amount of $47,717.62 at the WestAmerica Bank in Roseville, California, made payable to an "unincorporated organization" controlled by FEPA clients.

3. On June 18, 1996, Goodrich told a client during a telephone discussion that, with respect to the foreign trusts, the client did not want to be in possession of account numbers.

4. On July 9, 1996, Goodrich explained to a client during a meeting with the client and Gaskill, why funds in the off-shore program pass through an account controlled by Defendants on their way to the foreign accounts, and stated that they were "not doing anything but making a big circle."

Count Four:

26 U.S.C. Section 7602(2) - Aiding and Assisting in the Preparation and Presentation of a False and Fraudulent Income Tax Return

Between January 18, 1994, and April 15, 1994, Defendants willfully aided and assisted in the presentation to the IRS of a joint U.S. Individual Income Tax Return, Form 1040 of a Taxpayer, for the calendar year 1993, which was false and fraudulent as to a material matter, in that said return falsely represented that the Taxpayer had taxable income in an amount of $69,970, and falsely represented that the Taxpayer had no interest in a financial account in a foreign country, whereas defendants knew that the Taxpayer had interests in financial accounts in foreign countries, which defendants used for the purpose of holding and concealing the Taxpayer’ income.

Count Five:

26 U.S.C. Section 7602(2) - Aiding and Assisting in the Preparation and Presentation of a False and Fraudulent Income Tax Return

Between January 18, 1994 and April 14, 1995, Defendants willfully aided and assisted in the preparation and presentation to the IRS of a joint U.S. Individual Income Tax Return, Form 1040 of a Taxpayer, for the calendar year 1994, which was false and fraudulent as to a material matter, in that said return falsely represented that the Taxpayer had zero taxable income, falsely represented that the Taxpayer were entitled to an Earned Income Tax Credit in the amount of $2,038, and falsely represented that the Taxpayer had no interest in a financial account in a foreign country, whereas defendants knew that the Taxpayer had substantial additional income which was not reported, consisting of approximately $405,000, which the defendants had routed through off-shore trusts on the Taxpayer's behalf, and the Taxpayers did not qualify for an Earned Income Tax Credit, that the Taxpayer had interests in financial accounts in foreign countries, which the defendants had caused to be used for the purpose of holding and concealing the Taxpayer’s income.

Count Six:

26 U.S.C. Section 7602(2) - Aiding and Assisting in the Preparation and Presentation of a False and Fraudulent Income Tax Return

Between January 1, 1995 and June 4, 1996, Defendants willfully aided and assisted in the preparation and presentation to the IRS, of a joint U.S. Individual Income Tax Return, Form 1040, of Taxpayer, for the calendar year 1995, which was false and fraudulent as to a material matter, in that said return falsely represented that the Taxpayer had taxable income of $8,325, and falsely represented that the Taxpayer had no interest in a financial account in a foreign country, whereas defendants knew that the Taxpayer had substantial additional income which was not reported, of approximately $145,000 which the defendants had routed through off-shore trusts on the Taxpayer’s behalf, and the Taxpayer had interest in financial accounts in foreign countries, which defendants had caused to be used for the purpose of holding and concealing the Taxpayer’s income.

End of Indictment


Conclusion

This indictment illustrates how the U.S. Attorney’s office will view similar behavior. It is instructive since gullible taxpayers attending trust scam seminars only hear the "hard-sell" of the promoters and never have the opportunity to study how the government might analyze the transaction. Also, when "push came to shove," the defendants alleged told their clients to rip up the trust documents -- hardly the comforting advice and support one would expect after shelling out between $5,000 to $10,000 for one of these "fool-proof" trusts! In fact, the only fool-proof conclusion one can draw is that those who are foolish enough to buy into one of these trusts will wind up suckered and scammed.




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