Dubious Estate Plans

Some people greatly fear a potential personal lawsuit leading to the loss of some or all of their assets. Others fear an "oppressive" IRS which would "seize" their estates. In both cases they seek a type of estate plan which would totally insulate their estate from a lawsuit and which would lower or eliminate income taxation. This is an impossibility. You will have more success inventng the perpetual motion machine or the sky hook. Still, people try.

There are certain basics in U.S. law. One of these is that neither a trust nor a corporation can be set up for any illegal purpose. Evading the claims of legitimate creditors or legitimate income (and other) taxes has long been considered an illegal activity. This automatically makes some trusts and corporations invalid.

Irrevocable Trusts. An irrevocable trust is one which, after having been created and funded, cannot be changed. Along this line have also come recent Alaska and Delaware trusts. These are designed to frustrate creditors. The proplem is that those selling these trusts are off somewhat in their thinking. "Irrevocable" simply means that the creator of the trust can make no changes in it. A court of law can penetrate and set aside any trust with legal reason. No created trust is higher than U.S. law.

Family Limited Partnerships/ These is a legal arrangement where an asset's ownership is subdivided into shares among close family members where the original owner retains management control over the whole. In doing so, it is claimed that the value of the asset (as a whole) can be "discounted" (assuming smaller shares would be worth less than a unified whole).

This plan ran into a number of IRS problems where aggressive discounting was used. In addition, if among the several partners there were to occur a divorce, bankruptcy, lawsuit, or tax lien, the entire arrangment would be affected. A successful lawsuit against a minor partner could introduce the presence of an unwanted and adversarial new "partner."

Even where legally used this is limited to business assets and business inventory assets only. One cannot place personal assets into such an arrangement. It may work for a family farm or small business which carries an inventory, but as an over-all estate plan it leaves a great deal to be desired. In addition, it has stringent bookkeepiig and records requirements. It is not a simple plan. Nor is it an inexpensive plan.

Off-Shore Trusts. Off shore trusts are legal, but are also somewhat unwise for a number of reasons.

  1. You are placing assets under the rule of law of another country. Anyone experiencing a trial in a Mexican court can expect a very lengthy delay before that court reaches a decision. One's assets could be tied up for generations in this arrangement.
  2. Assets placed in a trust beyond U.S. law must pay a special tax found in IRC 1491. In addition, if the creator of the trust (the Trustor) retains any powers over the trust (ie. can make withdrawals, change trustees, change beneficiaries, etc.), then the trust is a simple Granto Trust under IRC 671-679. This means that creditors and the IRS would have full access to such trusts.
    An important tax case in 1999 was FTC v. Affordable Media, LLC (9th Cir). In this case the Trustors had their assets in an off shore trust to avoid creditors. It was shown in court that the Trustors had certain powers over the trustee of the trust. The judge simply ordered the Trustors imprisoned for contempt of court until they had ordered the trustee to return to the U.S. the assets in question. Their assets may have been safe, but the defendants were in jail until they cooperated with the court.

Nevada Corporations. One particular former debt-collector attorney designed an interesting plan. This was after he was suspended from the Colorado Bar for fraudulent conveyance. He sells a plan for clients to create a Nevada Corporation, with its own tax identification number, and they transfer their assets into it. It is then claimed by the owner of the corporation that they, as individuals, "own nothing" - the corporation owns everuthing. Hence, their assets are beyond the reach of creditors.

There are three problems with this:

  1. First is the "doctrine of merger." If the creator of this arrangment has the same use and enjoyment of the assets as they formerly had, then no real change has been made.
  2. By transferring assets to another entity with its own IRS tax number without a legitimate sale, the person is violating gift tax laws. If the assets are exchanged for "corporate shares" and the person retains the use and enjoyment of these same assets, then the arrangement has violated IRC 1031 (A)-(E). If no gift taxes were reported, no exchange is recognized. If it can be shown that the individual formerly held these assets in their name then the entire arrangement is a sham.
  3. This entire arrangement is a fraudulent conveyance simply to avoid creditors and taxes.

2408 Meadow Rue Drive, Modesto, Ca. 95355
Tel. 209-574-9451~ Fax 209-574-9279
email - hatcher@thevision.net