In the Monopoly game of life, there is a type of trust that could take you straight to jail.
Like all good scams, this trust has gone by different names over the years, with the most popular being called “Pure Trust,” “Constitutional Trust,” or “Common Law Trust.” Most recently it has gone by the catchy name “Non-grantor, irrevocable, complex, discretionary, spendthrift trust.”
What Is a Non-Grantor, Irrevocable, Complex, Discretionary, Spendthrift Trust?
The trust is marketed as a structure to avoid tax on the income of the assets that are placed in the trust. It is complicated, which is a hallmark of scams.
The general structure is that a third party (not you) sets up an irrevocable trust on your behalf. You are appointed as a “Compliance Overseer.” You are not the beneficiary of the trust, although in some of the marketed trusts your spouse or children are.
The trustee is given sole discretion over the distributions of principal and income. The trust is ambiguous about whether you can veto or direct the distributions. The trust supposedly provides asset protection to the assets in the trust.
How Does the Non-Grantor, Irrevocable, Complex, Discretionary, Spendthrift Trust Work?
You fund the trust by selling the assets to it. The trust gives you a promissory note for the purchase price. The trust then leases the assets back to you.
The promotional materials state that none of the current income of the trust is taxable as long as the trustee allocates the income to the corpus. The materials rely on Internal Revenue Code Section 643(a)(3) to provide the loophole to avoid taxation.
To which the IRS replies “Bull***” (or words to that effect). The trust has become so popular that the IRS Chief Counsel was prompted to issue a Chief Counsel Advice Memorandum describing why the trust does not avoid taxation.
The Warning from the IRS
Without going too deeply into the technical discussion, here is the gist of the Memorandum: Section 643(a)(3) does not address the taxability of income; it merely addresses whether the tax on the income is paid by the trust or by the beneficiary. The promotional materials fail to mention Section 641, which describes how taxable income is computed and whether it can be held in the trust or distributed to a beneficiary. The promotional materials skip right by Sections 61 and 63 which define gross income and taxable income.
The Memorandum states that it does not discuss any other questions that such a trust might present, such as whether the transfers to or from the trust are taxable events, the trust provides asset protection, the gross income is an extraordinary dividend, the trust could be challenged as a “sham trust”, and the transactions could be “reportable transactions.” The mere inclusion of that list, of course, is a powerful hint to sellers and buyers of the trust that they will need to set aside years of their lives to defend the trust in an audit. And money – lots of it.
Two main takeaways from the Memorandum are:
- You should not rely on promotional materials for either tax or estate planning
- Do your research before you spend good money on these schemes
The IRS also released its 2023 Dirty Dozen list of tax scams:
- Phishing and smishing
- Unscrupulous tax return preparers
- Fake charities
- Offer in compromise mills
- Employee retention credit claims
- False fuel tax credit claims
- Online account help from third-party scammers
- Social media advice containing fraudulent form filing and bad advice
- Spear Phishing and cybersecurity for tax professionals
- Charitable Remainder Annuity Trusts
- Bogus tax avoidance strategies
- Offshore accounts
Hammerle Finley Can Help You Avoid Common Law Trust and Other Scams
If you need assistance with your trust, Hammerle Finley’s experienced attorneys can help with those needs. Schedule a consultation today to discuss your options. And remember – be careful when you play the tax game!
Virginia Hammerle is an accredited estate planner and represents clients in estate planning, probate, guardianship and contested litigation. She may be reached at firstname.lastname@example.org. This blog contains general information only and does not constitute legal advice.