Domestic Trust Schemes The IRS Deems Abusive

Domestic trusts are trusts created in California and the rest of the country. Here are some common abusive domestic trust schemes:

Family residence trust
My wife and I transfer family residences and furnishings to a trust, which sometimes rents the residence back to us. The trust deducts depreciation and the expenses of maintaining and operating the residence including gardening, pool service and utilities. The courts have consistently collapsed these types of trusts, taxing income to us and disallowing personal expenses.

Charitable trust
My wife and I transfer assets or income to a trust claiming to be a charitable organization. The trust or organization pays for personal, education or recreation expenses on behalf of me and my wife or family members. The trust then claims the payments as charitable deductions on its tax returns. These alleged charitable organizations often are not qualified and have no IRS exemption letter; hence, contributions are not deductible. Charitable deductions are not allowed when the donor receives personal benefit from the alleged gift.

Business trust
This involves the transfer of an ongoing business to a trust. Also called an unincorporated business organization, a pure trust or a constitutional trust, it gives the appearance that I have given up control of my business. In reality, through trustees or other entities controlled by me, I still runs the day-to-day activities and control the business’s income stream. Such arrangements provide no tax relief. The courts have held that the business income is taxable to me under a variety of legal concepts, including lack of economic substance (sham theory), assignment of income, or that the arrangement is a grantor trust. In some circumstances, the trust could be taxed as a corporation.

Asset protection trust
These trusts are promoted as a means of avoiding liability for judgments against an individual or business. However, beware of any asset protection trust marketed as part of a package to reduce federal income or employment taxes. The courts can ignore such trusts and order my property sold to satisfy the outstanding liabilities.

Equipment or service trust
This trust is formed to hold equipment that is rented or leased to the business trust, often at inflated rates. The business trust reduces its income by claiming deductions for payments to the equipment trust. This type of arrangement has the same pitfalls as the business trust, and it will result in no tax reduction.

Do you think you are involved in one of these and would like to extricate yourself? Call Mitchell A. Port, a California tax attorney, at (310) 559-5259.