Sometimes trusts try to reduce or eliminate taxes, both state and/or federal, in ways that aren’t allowed under state and federal laws. These ‘abusive’ trust arrangements are usually promoted by promises of tax benefits without meaningful changes in the taxpayer’s ability to control their income or assets, or benefit from those changes. Those promoting the ‘abusive’ trust arrangements do not live up to their promises of reductions or elimination of taxes, deductions of personal expenses that would be paid for by the trust and other things, such as increased depreciation of residences and furnishings, elimination of lowering of employment taxes and the reduction or removal of gift and estate taxes. All those benefits that may be promised are not compatible with state and/or federal tax laws and rules concerning trust arrangements.
These arrangements frequently involve two or more trusts for a taxpayer, each having certain assets the other does not hold. Sometimes they are also involved with other trusts, such as charities, or are organized in foreign lands. Sometimes money and other value may go from one trust to another trust in contractual agreements, such as leases and rentals, service fees and purchases.
The original owner of these ‘abusive’ types of trusts actually retains the power to affect the trust’s financial benefits to be directly or indirectly returned to or made available to the owner. There may be a relationship between the ‘trustee’ and the owner where the ‘trustee’ simply carries out the desires and orders of the owner, even if the ‘trust’ agreement does not allow that type of control or activity.
A legitimate trust, commonly used for estate planning for businesses or family, will pay the taxes on income generated by the trust property, unless the beneficiary or the transferor pay them. Trusts are not supposed to avoid tax liability for an owner by ignoring income or assets or the true nature of transactions. Any tax results promised by promoters of abusive trust setups are not allowable under state and federal laws, and those who participate in these arrangements may be included in civil and/or criminal penalties in certain
For more information, check IRS Notice 97-24, 1997-1 C.B. 409.