ROBERT L. SOMMERS
Note: This exercise is for educational purposes only and is not intended to be legal or tax advice. Your particular facts and circumstances must be considered when applying the U.S. tax law. You should always consult with a competent tax professional with respect to your particular situation.
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Trust scam promoters have been conducting expensive seminars
across the country, encouraging frustrated and disillusioned
citizens to violate tax laws.
Abusive trust packages use names such as "Unincorporated
Business Organization" (UBO), "Common Law Trust"
or "Pure Equity Trust." Promoters employ fear tactics,
suggesting that you are paying more than your share of taxes;
that without their seminar, you may loose all your assets as a
result of litigation or medical expenses; or that your heirs will
have to deplete your assets to pay inheritance taxes. Often,
these trusts have patriotic or constitutional themes which have
nothing to do with the trust's actual terms and conditions, and
can serve as a red flag to tax examiners.
The IRS has announced a nationwide crackdown on the
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.
If you placed your assets in an abusive trust, remember, mere
technical compliance with trust law can still be illegal: When
challenging trust arrangements, the tax authorities scrutinize
the substance, not merely the form, of transactions. When all is
said and done, if you enjoy the benefits of your property, you
are taxed as the owner. It matters not that you placed your
property into a trust with your uncle, spouse, children or the
trust promoter as trustee, and created complex paperwork to hide
your ownership.
These tax seminars invariably skip the critical issue: After
the paper shuffle, who has the beneficial use and enjoyment of
the property? If it is the original taxpayer, then all
intermediate documentation is ignored and the taxpayer is
responsible for all tax consequences.
In addition, changes in tax law now cause trusts to be taxed
in the highest bracket -- 39.6% on taxable trust income over
$7,900 (individuals pay 39.6% on taxable incomes over $263,750).
There is clear disincentive to accumulate income within trusts.
Also, multiple trusts generally cannot reduce this tax rate.
The IRS warns that several lawsuits will be filed against
high-profile trust promoters in the Bay Area shortly. Stay tuned.
Many homeowners, facing the bleak prospect of foreclosure,
also own "upside-down" mortgages (loans exceeding the
value of their homes). In addition to losing their home, their
credit is also damaged. However, another nasty side to these
foreclosures is that taxpayers may also have taxable income!
If you are personally liable on a $200,000 mortgage and your
home's value drops from $250,000 to $150,000, foreclosure at
$150,000 relieves you of $50,000 in mortgage debt (the
foreclosure is considered a sale at fair market value).
Generally, if you are solvent, the tax code treats this $50,000
cancellation of indebtedness as income.
Into this dire predicament steps a purported savior, usually a
"financial institution," stating it can save your
credit and prevent the tax on cancellation of your mortgage debt.
Often, these companies search public real estate records for
homes in foreclosure.
Watch out! Their tax fraud works like this: For a fee (usually
1% of the mortgage), the company takes title to your home and
assumes the outstanding mortgage obligation (in this case
$200,000). (By the way, the seller receives no money from this
transfer.) The company then rents it to you, without charge,
until foreclosure or sale.
The company then attempts to negotiate a "short
sale" with the lender (the property is sold for $150,000
which is paid to the lender, which forgives the loan balance --
$50,000 in our example). Under federal law, the lender must issue
a Form 1099 for $50,000, but the owner of the property is now the
company -- not you -- and the Form 1099 is issued to the company,
supposedly sparing you from paying taxes on the $50,000
cancellation of indebtedness of your original loan. If
foreclosure occurs, generally the same result applies.
The IRS and California attorney general consider these
transactions a "shell game" because the transfer of
title to the company is transitory and without economic
substance. The company is acting merely as your agent, selling
your home for a fee, and you remain fully liable for the $50,000
debt reduction. The IRS has declared it will not recognize these
as bona fide sales, and you are not eligible for the
forgiveness-of-debt information reporting or income recognition.
Thus, you -- not the company -- will realize forgiveness of
indebtedness income when the property is finally sold or
foreclosed.
If you underpay income tax as a result of these bogus schemes,
the IRS warns that you will be liable for tax deficiency,
interest and penalties. Remember: if it seems too good to be
true, it probably is. Consult your original lender or an
independent tax advisor.
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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 should always be consulted before utilizing any of the information contained at this site.**