Asset Protection and Income Tax Avoidance Trusts
No trust can provide complete asset protection, although some trust arrangements can make it more difficult for claimant to reach person’s assets.
Once thought to be available only through offshore jurisdictions, some states have recently adopted statutes that purport to allow domestic asset protection trusts.
Asset protection trust arrangements that promise avoidance of federal income taxes for residents of United States are scams and may subject both preparer and client to criminal prosecution for tax evasion or conspiracy to evade taxes.
Various trust arrangements have been devised in an effort to provide that protection. Whether any of these planning strategies can actually provide the promised asset protection, when vigorously attacked, is doubtful.
In April 1997, the Internal Revenue Service issued a warning to taxpayers to avoid “abusive” trust arrangements that seek to shift the taxpayers’ income to another entity for tax purposes, or to make one’s personal living expenses tax deductible.
In Notice 97-24, the IRS described several examples of such abusive trusts and announced the formation of a special task force to discover the existence of such trusts, and to commence tax evasion prosecutions against both the taxpayers who establish such trusts, and those who assist them in setting up the trusts.
In Notice 97-24, the IRS points out the well-established taxation principle that substance controls over form: i.e., the Grantor’s retained control over, and benefits from, the trust assets makes the trust a “Grantor Trust” under I.R.C. §§ 671–677, so the Grantor is treated as the owner of the trust assets and must report all income from the assets on the Grantor’s personal tax return; I.R.C. § 679(a) provides that the transfer of assets by a U.S. person to a foreign trust that has a U.S. beneficiary results in the transferor being treated as the owner of those assets and, therefore, liable for income taxes on the income generated by those assets.
The false promises about use of a trust for income tax avoidance is so well established as to be beyond the scope of reasonable debate, at least as to the application of those theories to individuals who remain residents of the United States.