Why Asset Protection Trusts May Fail

by Sanford Millar
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In a recent federal income tax collection case, the trial court discusses the reasons why an asset protection trust failed to protect assets of a taxpayer from a tax levy. The court in Evseroff found that all the assets of an irrevocable trust were subject to collection by the IRS for the tax liability of the creator (settlor) of the trust. The court found that the transfer of assets by the taxpayer to an irrevocable trust was done with the actual intent to “avoid, hinder or delay” the collection of income tax. The court found that the critical element in the analysis was the degree of the taxpayer’s retained control over the assets of the trust.

The court look at whether the trust could be held responsible for the debts of the taxpayer under several theories. Was the trust the “alter ego” of the taxpayer or was it the “nominee” of the taxpayer. Under the “alter ego” theory the court would look at whether the taxpayer exercised control over the entity (the trust) and under the nominee theory the court looked at whether the taxpayer exercised control over the property transferred to the trust. Under both approaches the test ultimately comes down to whether the taxpayer exercised active or substantial control over the property.

One of the interesting features of Evseroff, is that the taxpayer appointed a series of family friends and business associates to serve as trustees, instead of an institutional trustee. The court found the degree of influence and control retained by the taxpayer coupled with the lack of formalities was fatal to the purposes of trust and subjected the trust assets to the tax liabilities of Evseroff.

The Evseroff case is a good lesson to taxpayers who want to retain control of their assets and yet create a firewall from creditors. The more control the taxpayer has the more likely the IRS will be able to successfully attack the trust. Evseroff was not criminally charged as this was a only a civil action for collection.

Of particular note is the nature of the attack by the IRS could just as easily apply to offshore asset protection trusts. Here though there are now specific disclosure rules that could, if violated result in criminal charges being brought. Under IRC Section 6048D assets transferred to an offshore irrevocable trust are deemed to be the assets of the taxpayer and subject to disclosure on new Form 8938. Form 8938 is part of Form 1040 and the failure to disclose assets which are required to be disclosed could result in charges for subscribing to a false tax return ( a false statement crime). The taxpayer in these circumstance may also have to file a Report of Foreign Bank Account (FBAR). As many taxpayer’s now know, the failure to file an FBAR on a timely basis has severe civil and criminal penalties.

Whether the risk is civil or criminal the costs of defense alone should cause taxpayers to carefully consider true and accurate disclosure for offshore trusts and for all asset protection trust, the maintenance of rigorous formalities.

 

 

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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