IRS Warns: Don't Trust These Trusts

The number of illegal, abusive trusts is on the rise, the IRS warns. Even if you're a victim, you could face criminal and civil penalties. If you've been approached about setting up a trust, or have done so already, here's what you need to know.

Nobody likes taxes, but some people will go to great lengths to avoid the pain of paying up. One method of tax avoidance that’s often hawked by tax-scam hustlers is a complex trust, usually billed as a legal way to thumb your nose at the IRS. Bottom line: Buyer beware.

If the trust is not legitimate, you are liable for taxes on any income it generates no matter what a “trust consultant” may say. Promoters of abusive trust arrangements usually advertise through seminars, flyers, and online.

What to watch out for: For a fat fee, scam artists will typically offer to set up a trust for you that they claim will allow you to control the assets in the trust and avoid taxes at the same time. Such abusive trusts, say tax experts, come in a variety of disguises, often mimicking legal trusts like family limited partnerships or other business trusts. Often the scam involves layered trusts, each holding different assets and each distributing assets to the others. The goal is to provide the trusts with inflated or false expenses to reduce the tax burden.

“While there are many legitimate, valid uses of trusts in tax and estate planning, some promoted transactions promise reduction of income subject to tax, deductions for personal expenses and reduced estate or gift taxes,” according to an IRS statement. “Such trusts rarely deliver the tax benefits promised and are used primarily as a means to avoid income tax liability and to hide assets from creditors, including the IRS.”

The IRS said it has reported an increase in the improper use of private annuity trusts and foreign trusts to shift income and deduct personal expenses. The IRS says that roughly 200,000 of the 3.6 million active domestic trusts in the U.S. today are considered "highly suspicious," and 10,000 of them are being audited. Of that 10,000, some 500 may be prosecuted for criminal activity.

Tax enforcers naturally look skeptically at such arrangements -- if you keep control of the assets, you must pay taxes on any income the trust produces. The IRS also warns that these abusive trusts will not deliver the promised tax benefits and taxpayers who get involved in them face both civil and criminal penalties. Civil penalties can go up to 75% of the tax avoided through the trust scheme; criminal convictions can result in a $250,000 fine and/or five years in prison. In addition, abusive trust promoters and their clients have a dismal record in court, with no wins and hundreds of convictions.

To learn more about scam trusts, and whether you might be a victim of such a scheme, click here.