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Can You Trust a Trust?
If you are planning on investing in a trust this year, please know that not all trusts are legitimate. The IRS has identified certain types of trusts that are considered “sham trusts”. These sham trusts claim to provide a tax benefit to the taxpayer, but instead can incur penalties and interest. Here are some types of sham trusts you should look out for:
• So-called business trusts: In a business trust sham, a business owner will make it appear that they have released all control over the business in order to reduce income and self-employment taxes, as well as estate taxes in the event of the owner’s death. Ultimately, there is no reduction in taxes provided by this arrangement.
• Equipment/service trusts: These are formed to reduce income taxes in many ways. They do this by renting equipment or providing services to the trust at inflated costs. Once again, the tax reduction is not accepted by the IRS.
• Family residence trusts: This type of trust transfers ownership of a family home and belongings to the trust, which then attempts to deduct depreciation and maintenance costs. The IRS does not recognize these costs as deductible.
• Certain alleged charitable trusts: These are trusts that falsely claim to be charitable organizations. In this type of sham, an individual would “donate” to the charitable fund, which would then turn around and cover personal, recreational and educational costs for the individual and claim them as charitable deductions. These so-called charitable deductions are not legitimate or deductible.
• Certain trusts that are located in foreign countries: When investing in a foreign trust, people often believe that due to lower taxation on trust funds in foreign countries distributions from those trusts will be untaxed. This is not true; the IRS recognizes this income as fully taxable when received back by the individual.
There are plenty of legitimate trusts that can assist you in your estate planning and tax needs. Marital deduction trusts enable you to transfer assets to your spouse that will be given to any children in the event of your spouse’s death. There are many types of trusts one can use to transfer property to children with lowered gift and estate taxes. Some of these are the GRATs (Grantor Retained Annuity Trusts), GRUTs (Grantor Retained Unitrusts) and QPRTs (Qualified Personal Residence Trusts). One can manage charitable deductions with CRATs (Charitable Remainder Annuity Trusts) or CRUTs (Charitable Remainder Unitrusts). There are also many special types of trusts that can be used to reduce or eliminate the gift tax when giving funds to children while protecting the funds from being spent carelessly. Life insurance trusts can be used to keep the proceeds from a life insurance policy from being taxed federally within the insured’s estate. Income and estate taxes can be saved by giving S-corporation stock to underage children in a trust while the trustee maintains control until the child is of age. Lastly, there are revocable trusts in which property passes to a beneficiary immediately after death without going through the probate process. For all of these trusts, it is important to consult an expert in this field since the estate tax rules in 2010, and possibly future years, are in a state of uncertainly.
If you are planning on investing in a trust, please consider the above and verify that the trust vehicle is legitimate.
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