Federal Gift Tax Issues of Abusive Trust Tax SheltersDoug H. Moy
February 22, 2008 — 2,873 views
A federal gift tax is imposed on property transferred by gift. The gift tax applies whether the transfer is in trust or otherwise, direct or indirect, and whether the property transferred is real or personal, tangible or intangible. The transfer of trust property in which the trustee has no beneficial interest is not a gift by the trustee to the donee. However, such a transfer of property may be treated as a gift by the trustor, if, until the transfer, the trustor had the power to change the beneficiaries by amending or revoking the trust.
A gift of property must be complete in order for the property transferred to be subject to federal gift tax. A gift is complete if the donor has irrevocably parted with dominion and control of the property (or interest in the property) as to leave in the donor no power to change its disposition, whether for the donor’s own benefit or the benefit of another. But, if, upon a transfer of property (whether in trust or otherwise), the donor reserves any power over its disposition, the gift may be wholly incomplete or may be partially complete and partially incomplete, depending upon all the facts in the particular case. Accordingly, in every case of a transfer of property subject to a reserved power, the terms of the power must be examined and its scope determined.
A gift is incomplete if the donor reserves the power to revest the beneficial title to the property in the donor. A gift is also incomplete if a reserved power gives the donor the power to name new beneficiaries or to change the interests of the beneficiaries as between themselves, unless the power is a fiduciary power limited by a fixed or ascertainable standard. A donor is considered to have a power if it is exercisable by the donor in conjunction with any person not having a substantial adverse interest in the disposition of the transferred property or the income therefrom. A trustee, as such, does not have an adverse interest in the disposition of the trust property or its income, unless the trustee is also a beneficiary. Finally, the relinquishment or termination of a power to change the beneficiaries of transferred property, occurring otherwise than by the death of the donor, is regarded as the event that completes the gift and causes the gift tax to apply.
Certificates of Beneficial Interest
Certificates of beneficial interest (or UBIs) convey no legal or equitable interest of any kind in the assets (i.e., the trust estate) of the family estate trust, including management or control of the trust estate, rights, powers, privileges or interest not specified in the family estate trust. Yet, as a general rule, no restrictions are placed on the property (assets) transferred by the trustor to the family estate trust. The effect of restrictions in the UBIs is not relevant in determining the value of the property transferred as a gift; rather, it is the value of the property transferred to the family estate trust underlying the UBIs that is the subject of the gift, and it is the underlying property that must be valued for gift tax purposes. Moreover, it is the transfer of the trustor’s control over the beneficial enjoyment of the underlying property of the UBI that creates the gift taxable event. Taxation of a transfer of property is not so much concerned with the refinements of title as with actual command over the property. Retention of control over the disposition of trust property, whether for the benefit of the donor or others, renders the gift incomplete until the power is relinquished. Accordingly, it is the underlying asset(s) (property) represented by the UBI that is the subject of the gift and not the UBIs themselves.
Transfer of Property to Family Estate Trust Not a Completed Gift.
Generally, a transfer of property to a family estate trust is not a completed gift for federal gift tax purposes because the trustor, as donor, retains virtually unlimited powers as trustee and continues in dominion and control of the property transferred to the trust. However, subsequent distributions from the trust to anyone other than the donor (trustor) renders the transfer complete for federal gift tax purposes because the distributed property will have finally been placed beyond the grantor’s (trustor’s) dominion and control. Such gifts would be subject to federal gift tax.
As a trustee, Mary possessed substantial control over the property transferred to the Declaration of Trust by virtue of the explicit grant of powers held by her as trustee-beneficiary, for example: (1) by “...[E]xercising their best judgment and discretion, in accordance with the Trust Minutes, making distributions of portions of the proceeds and income as in their discretion, ...and upon final liquidation distributing the assets to the beneficiaries [i.e., to the trustors] as their interests may appear;” (2) to “...[P]erform and function for any purpose on behalf of any individual, group or combination of individuals, severally or collectively;” and (3) to “...[F]ix and pay compensation of all offices, employees, or agents in their discretion, and may pay themselves such reasonable compensation for their services as may be determined by a MAJORITY of the Board of Trustees.”
The foregoing powers were exercisable by a majority of the trustees (i.e., Roy and Mary during Roy’s lifetime), and Mary was the only trustee following the death of Roy, thereby, rendering her a majority of one. Mary’s retention of these powers made the transfer of assets to the trust previously titled (registered) in her name an incomplete gift, because she did not part with dominion and control as to leave in her no power to change the disposition of the property.
Notwithstanding the foregoing, promoters continue to relentlessly pursue targets to purchase abusive trust tax shelters. Misuse of trusts tops the Service’s list of “Dirty Dozen” tax scams. In its fiscal year 2006 budget, the IRS expresses its “. . . concern over the proliferation of abusive trusts and shelters. . . ,” and that such tax avoidance schemes “. . . require new and innovative approaches to combat noncompliance.” The federal income, estate, and gift tax consequences, together with potential civil and/or criminal penalties (including time in federal prison), which may be imposed on both the promoter and taxpayers who purchase such abusive tax schemes, can be potentially life-ruining. In the words of Mark E. Matthews, Chief IRS-Criminal Investigation, involvement in such scams “. . . can be a very expensive detour in someone’s life.” Seemingly, the form of the family estate trust, though substandard at best, may operate to create an irrevocable trust; but, clearly, the substance of the trust and the powers retained by the trustor, acting as trustee, operate to nullify and void any federal income, estate, and gift tax benefits heralded by the promoters of such abusive trust tax shelters. In the sixth and concluding part in this series, the author will discuss how the family estate trust is established and operates, the process of terminating a family estate trust, and suggestions for counseling clients against using the family estate trust.
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Doug H. Moy
Consulting Specialist, Estate/Gift Taxation and Planning; Educator
Copyright 2004-2005 by Doug H. Moy. All rights reserved. Without limiting the rights under copyright reserved above, no part of this publication may be reproduced, stored in or introduced into a retrieval system or transmitted, in any form or by any means (electronic, mechanical, photocopying, recording or otherwise), without the prior written permission of the author and copyright holder of this material. This publication is designed to provide accurate and authoritative information in regard to the subject matter covered. It is made available with the understanding that neither the author nor Doug H. Moy, Inc. and/or employees is/are engaged in rendering legal or accounting services. If legal advice or accounting assistance is required, the services of a competent professional should be sought. These articles previously published in TAXPRO Journal, the official Journal of the National Association of Tax Professionals (NATP), Part I, Spring 2004; Part II, Summer 2004; Part II, Fall 2004; Part IV, Winter 2005, Part V, Spring 2005; Part VI, Summer 2005. Copyright 2004-2005 by the author and NATP. Reprinted with permission.
Doug H. Moy
Doug H. Moy is a nationally recognized author, consulting specialist, seminar instructor and educator. He has an undergraduate degree from Willamette University and a Masters degree from Washington State University. Since 1979, Mr. Moy has consulted to attorneys, tax practitioners and their clients, as well as assisted practitioners representing clients before the IRS Conference of Right and Appeals Division and Settlement Conference Negotiations. He is noted for his ability to communicate his unparalleled knowledge and experience to practitioners at all levels in his field of expertise; namely, estate/gift taxation and planning, with special expertise in living trusts; community property; lottery prize winnings; structured settlement trusts; extricating clients from abusive trust tax shelters; designing effective estate plans; and preparation of Form 706 Estate Tax Returns and 709 Gift Tax Returns. He offers particular assistance and exceptional skill designing creative, practical solutions to challenging and difficult estate planning situations.