The IRS Cracks Down on Promoters of Abusive Sham Trusts

In recent years, the Internal Revenue Service has been aggressively cracking down on abusive trusts and other tax shelter arrangements. Recently, an indictment (and then a superseding indictment) came down in a complex tax shelter trust case in which the alleged scheme involves three sham trusts and a Private Family Foundation. In this particular matter, the U.S. government takes the position that Defendants acted together to entice taxpayers into investing in certain tax promotions through different trusts that would ultimately serve as a way to (improperly) avoid income tax on income that the owners generate. The defendants have allegedly made millions of dollars selling this tax promotion, but the U.S. government takes the position that it was abusive and improper — and that the defendant should be held accountable. This case is a good example of how intricate these types of tax promotions are, so let’s take a brief look at how this particular abuse of trusts allegedly played out.

Tax Seminars to Sell the Trust Promotion

As is common with these types of tax promotions, oftentimes tax promoters will put on free seminars at hotels designed to attract taxpayers who may be interested in the promotion. Noting, that just because a tax promotion is given to a large group and may involve a ‘gray area’ of tax planning does not in and of itself mean that there is anything inherently wrong with putting on or attending one of these types of tax promotions. The problem comes when the IRS takes the position that the tax promotion has crossed the line from tax avoidance to tax fraud or tax evasion, which is what allegedly occurred in the large-scale recent indictment.

Three Sham Trusts and a Private Family Foundation

With this particular alleged scheme, the government alleges that the taxpayer concocted a tax shelter that involved three trusts and a Private Family Foundation. The promoters charged upwards of $25,000 to $50,000 to sell the promotion to each taxpayer and then provided these clients with instructions on how to proceed with establishing and executing the arrangement, which resulted in the clients relinquishing substantial ownership of their business — without really relinquishing any control of their business.

Clients Remain as the Trustees

It is important to note, that even though the clients’ business ownership rights were being assigned, they would not typically lose any rights over how the income was being transferred from one trust to the next (and ultimately into the private foundation) since the owners would remain as trustees of this whole operation.

Business Trust (Trust One)

As part of the operation, Clients would assign 98% ownership to a business sham trust to give the impression that income assigned to the trust was not earned by the client. This is because, with a non-grantor trust, the beneficiaries would only be taxed on the income that is distributed to them, because technically they are not the owner of the trust (with a grantor trust, the owner is taxed on the income, even if it s distributed to other beneficiaries and/or even if it is not distributed at all).

Second Trust and Third Trust

Next — and to make it harder to follow the money — the income from the business sham was then distributed to a second sham trust, which then distributed the money to a third sham trust. In conjunction with the income distributions from trust-to-trust, the distributing trust would also report deductions that were the same as or greater than the income — so that there would not be any taxable income being distributed from one trust to the next.

Donation Into a Private Family Donation

Finally, any income that was remaining would then be transferred into a Private Family Foundation that was set up as a trust. The trust would then loan money back to the client’s business so that the business was not technically generating income and this distribution would be tax-free. Here, the circle closes and taxpayers receive loans but have no taxable income.

Why is this Arrangement Allegedly Improper?

The IRS is cracking down on these types of trust comments because at the end of the day, the only purpose of the trust is to avoid income tax and the method used to avoid income tax is illegal. There is no real legal purpose for transferring money from one trust to the next trust and ultimately into a Private Family Foundation aside from the fact that the owners are seeking to attempt to avoid paying taxes. There is no proof that any of the deductions taken by the trusts each time they transferred distributions to the next trust were legitimate deductions.

Late Filing Penalties May be Reduced or Avoided

For Taxpayers who did not timely file their FBAR and other international information-related reporting forms, the IRS has developed many different offshore amnesty programs to assist taxpayers with safely getting into compliance. These programs may reduce or even eliminate international reporting penalties.

Current Year vs Prior Year Non-Compliance

Once a taxpayer missed the tax and reporting (such as FBAR and FATCA) requirements for prior years, they will want to be careful before submitting their information to the IRS in the current year. That is because they may risk making a quiet disclosure if they just begin filing forward in the current year and/or mass filing previous year forms without doing so under one of the approved IRS offshore submission procedures. Before filing prior untimely foreign reporting forms, taxpayers should consider speaking with a Board-Certified Tax Law Specialist who specializes exclusively in these types of offshore disclosure matters.

Avoid False Offshore Disclosure Submissions (Willful vs Non-Willful)

In recent years, the IRS has increased the level of scrutiny for certain streamlined procedure submissions. When a person is non-willful, they have an excellent chance of making a successful submission to Streamlined Procedures. If they are willful, they would submit to the IRS Voluntary Disclosure Program instead. But, if a willful Taxpayer submits an intentionally false narrative under the Streamlined Procedures (and gets caught), they may become subject to significant fines and penalties.

**Need Help Finding an Experienced Offshore Tax Attorney?**

When it comes to hiring an experienced international tax attorney to represent you for unreported foreign and offshore account reporting, it can become overwhelming for taxpayers trying to trek through all the false information and nonsense they will find in their online research. There are only a handful of attorneys worldwide who are Board-Certified Tax Specialists and who specialize exclusively in offshore disclosure and international tax amnesty reporting.

Golding & Golding: About Our International Tax Law Firm

Golding & Golding specializes exclusively in international tax, specifically IRS offshore disclosure. Contact our firm today for assistance.