“Sham trusts” are names given to certain trusts that the IRS claims are illegal. They can be either domestic or foreign trusts or both. The promoters of these trusts claim that they reduce or eliminate income taxes, but the IRS and the courts disagree and are aggressively pursuing taxpayers who own them and their promoters.
The promoters charge high fees to set them up, but the structure doesn’t seem to have an actual business purpose other than evading taxes. The trusts don’t seem to actually change the ownership or control of the grantor’s property or income that was supposedly transferred to the trust.
Sham trusts often lack named beneficiaries and instead issue units or certificates of beneficial interests, which entitle the holders to certain distribution rights with respect to the trust income. They frequently include a purpose stated in religious or moral terms, patriotic principles or the grantor’s claimed constitutional rights.
The following are some of the erroneous claims made by the promoters:
- These trusts are merely contracts between a grantor and a trustee which are not taxable according to the U.S. Constitution.
- These trusts eliminate income taxes and self-employment taxes.
- These trusts allow personal living expenses to be deducted as business expenses and permits tax deductible depreciation to be claimed on a personal residence and furnishings.
- Property transferred to these trusts do not cause a taxable gift and is not subject to estate taxes.
- Trust assets are permitted a stepped-up in basis upon funding and are exempt from IRS seizure.
- Trusts can’t be compelled to disclose books and records to the IRS.
One example of how they claim to work:
A business is transferred to a trust (business trust), while the assets and equipment is owned by another (equipment trust). The equipment is leased back to the business trust at inflated rates equal to its income (leaving no income subject to tax in the first trust). The income earned by the equipment trust is distributed to a foreign trust.
Since the foreign trust’s income is foreign-based the claim is that there is no filing requirement. Once the assets are in the foreign trust, a bank account is opened either under the trust name or an entity referred to as an international business corporation.
Foreign and off-shore sham trusts are often located in countries that have no tax treaty agreement with the U.S. for the exchange of information.
These sham trusts have a variety of names:
- Pure Trusts, Constitutional Pure Equity Trusts;
- Contract Trusts, Freedom Trusts; Common Law Trust Organizations;
- Unincorporated Business Trusts; Massachusetts Business Trusts;
- Equipment Trusts, Service Trusts, Final Trusts, etc.
The IRS released Pub 2193 describing the most common abusive trust schemes and its intent to prosecute this type of tax fraud. The Department of Justice website posts recent scam prosecutions, which include these types of trusts.