5 Trusts which The IRS considers suspect

• The Business Trust
• Service Trust
• Family Residence Trust
• Charitable Trust
• Final Trust

Article from MSN MoneyCentral

Capitol Connection

5 trusts the IRS doesn't trust

The IRS is cracking down on five types of trusts now deemed illegal. From 'charitable' to 'final' trusts, the feds are targeting these tax-evading schemes.
By Tom Woodruff

The Internal Revenue Service has lost its faith in trusts. For the past year, the criminal investigations unit of the IRS has looked into one of the most popular ways for individuals and corporations to shield income from taxation as potentially illegal tax dodges.

The unit concluded recently that it plans to target five specific types of trusts for potential prosecution. The IRS especially wants to get those people and organizations that sell these trusts through cold-calling and high-pressure sales tactics and promise potential clients that they can all but eliminate their annual tax liabilities.

Of the 3 million active trusts in the U.S. today, about 200,000, or 6%, are considered "highly suspicious," according to the IRS. About 10,000 of these are in their active "audit stream" and about 500 currently are being considered for criminal prosecution. Even though exact estimates are not available, IRS bean counters say that revenue lost to the federal government each year due to the fraudulent trust run into the billions of dollars.

Even if you are just a buyer of one of these trusts, you can face fines and jail, according to Dennis Crawford, the IRS' director of National Operations for Criminal Investigations.

"If we can develop sufficient intent and knowledge on the part of the person who purchased, they are subject to criminal prosecution," said Crawford. Even if you can prove that you had no knowledge that the trust that you purchased was illegal, you would still be subject to income tax and penalties.

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Most have nothing to fear

Not all trusts are being targeted by the IRS, and the government says that most trust holders have nothing to fear. Millions of individuals and businesses use trusts to set aside funds for certain individuals, corporations or organizations and are not the focus of this campaign.

The trust arrangements that concern the IRS ignore the true ownership of assets or the substance of transactions. According to the IRS, promoters of these illegal trusts claim that they allow the owners to retain full benefit of business or personal assets while reducing or eliminating taxes. The arrangements often involve more than one trust. A person may, for example, put business assets in an unincorporated business trust, transfer its 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 trust income. In other words, it's a "family of trusts" that the IRS says are created solely to evade taxes.

The IRS is warning you to be suspicious of arrangements that claim to make personal living expenses deductible, to create charitable deductions for payments benefiting you or your family or that otherwise result in you having to pay no tax while not changing your control over your assets.

The IRS says promoters of these arrangements advertise "investment seminars" or "tax seminars" in local media, such as radio personal-finance shows and the Internet. The trusts, says the IRS, may have names that refer to constitutional issues, fairness, equity or patriotic themes, but often have names that are similar to common business organizations and legitimate trusts.

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Five types of trusts are targets

The Criminal Division of the IRS has identified five types of trusts that it will target in the upcoming year. If someone tries to offer you one or more of the following, expect that you may become the subject of an IRS investigation:

1. The Business Trust

The owner of a business transfers the business to a trust (sometimes described as an unincorporated business trust) in exchange for units or certificates of beneficial interest, sometimes described as units of beneficial interest or UBIs (trust units). The business trust makes payments to the trust unit holders or to other trusts created by the owner (characterized either as deductible business expenses or as deductible distributions) that purport to reduce the taxable income of the business trust to the point where little or no tax is due from the business trust.

2. The Equipment or Service Trust.

The equipment trust is formed to hold equipment that is rented or leased to the business trust, often at inflated rates. The service trust is formed to provide services to the business trust, often for inflated fees. Under these arrangements, the business trust claims to reduce its income by making allegedly deductible payments to the equipment or service trust. The equipment or service trust also may attempt to reduce or eliminate its income by distributions to other trusts.

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3. The Family Residence Trust.

The owner of the family residence transfers the residence, including its furnishings, to a trust. The trust claims the exchange results in a stepped-up basis for the property, while the owner reports no gain. The trust claims to be in the rental business and purports to rent the residence back to the owner; however, in most cases, little or no rent is actually paid.

4. The Charitable Trust.

The owner transfers assets to a purported charitable trust and claims either that the payments to the trust are deductible or that payments made by the trust are deductible charitable contributions. Payments are claimed to be made to charitable organizations; however, in fact, the payments are principally for the personal, educational, living or recreational expenses of the owner or the owner's family. For example, the trust may pay for the college tuition of a child of the owner.

5. The Final Trust.

In some multi-trust arrangements, the U.S. owner of one or more fraudulent trusts establishes an additional trust (the "final trust") that acts as the trust for the others and receives all income from the other trusts. A final trust often is formed in a foreign country that imposes little or no taxes on the trust. In some arrangements, more than one foreign trust is used, with the cash flowing from one trust to another until the money ultimately is distributed or made available to the U.S. owner, purportedly tax-free. The IRS says this is nothing more than a money-laundering scheme.

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