April 03, 1997
IRS Cautions on Abusive Trusts
WASHINGTON - The Internal Revenue Service today cautioned
taxpayers to be wary of trust arrangements promising benefits that
are not allowed under the tax law.
"We receive more than three million trust returns annually and
will identify questionable ones for further review," said IRS Chief
Compliance Officer James Donelson. "We'll assess taxes and
penalties against the participants and promoters of the trusts we
find abusive, and seek criminal charges where warranted."
The IRS advised taxpayers who may have used such trusts in the
past that they should file correct returns for 1996 and amend their
earlier filings. "Taxpayers need not be concerned about legitimate
trusts, which are used in such matters as estate planning,
charitable giving, or to hold property for minors and those unable
to manage their financial affairs," said IRS Commissioner Margaret
The trust arrangements of concern to the IRS ignore the true
ownership of assets or the substance of transactions. Promoters of
such arrangements claim that they allow the owner to retain full
benefit from business or personal assets while reducing or
eliminating taxes. Often, multiple trusts are involved to cover the
different financial aspects of a taxpayer's life.
For example, a person may put his business in an unincorporated
business trust, transfer business equipment to an equipment trust,
place his home in a family residence trust, and set up a foreign
trust to hold the other trust units and to receive the trusts'
income. According to the promoters, little or no tax would be paid.
Contrary to promoters' claims, however, established legal
principles govern the taxation of trust income. The substance of a
transaction, rather than its form, controls for tax purposes. Either
the trust, the beneficiary or the transferor will pay the tax, as
appropriate. Thus, the IRS may find that the transferor of the
assets to the trust is liable for taxes on the trust's income and
that the property will be part of the transferor's estate upon
Taxpayers should be suspicious of arrangements that claim to
make personal living expenses deductible, to create charitable
contribution deductions for payments benefiting the transferor or
family members, or that otherwise result in a taxpayer having to pay
no tax with no change in control over his or her income or assets.
Promoters of such arrangements advertise their "investment seminars"
or "tax seminars" in the local media as well as through the
Taxpayers may also receive unsolicited mail or telephone
invitations to participate. Often the trusts have names that refer
to constitutional issues, fairness, equity, or patriotic themes,
In other cases, however, the trusts have names that are similar
to common business organizations or nonabusive trusts. Taxpayers
should be particularly wary if the promotional materials suggest
that the taxpayer not check the arrangement with a tax advisor, such
as an attorney or accountant, or with the IRS.
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