SHAM TRUSTS WHEN IT’S TOO GOOD TO BE TRUE BY CLARK YOUNGMAN & NATE PATTERSON, KOLEY JESSEN WHEN IT COMES TO TAX STRATEGIES, IF SOMETHING SOUNDS too good to be true, it probably is. It is especially important for advisors to have a high-level understanding of what to watch out for when their clients are inevitably pitched sham or high-risk tax-planning strategies. In the world of trust planning, two schemes are currently circulating that advisors should be able to recognize so they can effectively advise their clients of the potential risks involved. TRUST 1: THE “NON-GRANTOR IRREVOCABLE COMPLEX DISCRETIONARY SPENDTHRIFT TRUST” While sometimes pitched under different names, this first scheme is typically referred to as a “non-grantor irrevocable complex discretionary spendthrift trust.” The basic proposition goes something like this: If a taxpayer transfers assets to one of the promoted trusts, no income tax will need to be paid on income earned by the trust so long as (i) the income comes from capital gains or is classified by the trustee as “extraordinary dividends,” and (ii) no distributions are made to trust beneficiaries. The promoter will typically advertise these as “income-tax-free” vehicles, at least until some tax may have to be paid when distributions are finally made to trust beneficiaries. Sounds enticing, doesn’t it? To arrive at their ill-advised solution, promoters of this scheme rely on an out-of-context interpretation of Section 643 of the Internal Revenue Code (IRC or Code). IRC § 643(a)(3) states, “[g]ains from the sale or exchange of capital assets shall be excluded to the extent that such gains are allocated to corpus and are not paid, credited, or required to be distributed to any beneficiary during the taxable year.” IRC § 643(a)(4) provides, “[t]here shall be excluded those items of gross income constituting extraordinary dividends … which the fiduciary, acting in good faith, does not pay or credit to any beneficiary by reason of his determination that such dividends COUNSELOR’S CORNER CONTINUED ON PAGE 20 19 nescpa.org
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