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While trusts have long been viewed as flexible estate planning tools that offer the opportunity for tax savings, efforts to avoid federal tax liability through the use of trust arrangements can go too far. The Internal Revenue Service (IRS) has identified an uptick in the use of abusive trust arrangements in recent years, and it has stated publicly that it is prioritizing enforcement in this area. In this article, Washington D.C. tax lawyer Kevin E. Thorn, Managing Partner of Thorn Law Group, discusses the risks for estate planners, their clients and their clients’ beneficiaries.

“Abusive Trust Tax Evasion Schemes” Violate the Internal Revenue Code

The IRS is cracking down on what it calls “abusive trust tax evasion schemes” involving all types of trusts. While these “schemes” (which are often misguided estate planning strategies crafted without an adequate understanding of the Internal Revenue Code) can involve a variety of issues, they all ultimately involve the underpayment of federal tax liability—whether by the grantor, the trust or the trusts’ beneficiaries. In its crackdown, the IRS is targeting all types of trusts used for estate planning purposes, including:

• Charitable trusts (including charitable lead trusts and charitable remainder trusts)
• Common law trusts
• Foreign trusts
• Irrevocable life insurance trusts (ILITs)
• Grantor Retained Annuity Trusts (GRATs)
• Grantor Retained Income Trusts (GRITs)
• Qualified personal residence trusts (QPRTs)

While these types of trusts, among others, can be used for valid tax planning purposes, estate planners can exceed the permissible extent of tax avoidance if they aren’t careful. Errors involving the use of trusts can trigger interest and penalty liability for trusts, grantors and beneficiaries; and, in many cases, estate planners can face liability as well.  

Audit Triggers Related to Abusive Trust Arrangements

Liability for the use of abusive trust tax evasion schemes generally results from an IRS audit. While these audits can result from a broad range of factors, the IRS has identified several common audit triggers related to abusive trust arrangements. For example, according to the IRS, the following are all red flags for a potential abusive trust arrangement:

• Deductions for personal expenses paid by the trust
• Depreciation deductions for grantors’ personal expenses paid by the trust
• Depreciation deductions for grantors’ personal residences and furnishings
• Stepped-up basis for property transferred to a trust
• Reduction or elimination of self-employment, gift and estate, and/or income tax liability

While IRS audits targeting abusive trust arrangements are most likely to lead to civil penalties, criminal penalties can also be on the table in some cases. In particular, if it appears that an estate planner intentionally attempted to help a grantor or third party evade tax, or if it appears that a grantor, trust administrator or beneficiary knew that a trust arrangement was abusive, these are circumstances in which criminal charges are a very real possibility.

Request an Appointment with Washington D.C. Tax Lawyer Kevin E. Thorn

If you need to know more about the IRS’ efforts to target abusive trust arrangements, we encourage you to contact us promptly. Please call 202-349-4033, email ket@thornlawgroup.com or send us a message online to request an appointment with Washington D.C. tax lawyer Kevin E. Thorn, Managing Partner of Thorn Law Group.