A “family estate trust” is a term often applied to entities that create these trusts
under false pretenses to avoid or reduce federal taxation of the grantors or beneficiaries
of such trusts. Usually, a taxpayer buys information, including trust forms and manual
instructions, to establish a “family estate trust” from a promoter. The promoters
sometimes call their packages “constitutional,” “pure,” or “equity” trusts. The taxpayer
completes the trust forms to transfer his or her property, and the right to his or
her lifetime services, to the trust in exchange for certificates of beneficial interest
for his or her family members. After establishing the trust, the taxpayer becomes
trustee with broad management powers.
Such a trust deducts all of the trustee’s personal expenses as business expenses.
The trust also allows the trustee to use property, such as the family residence. Pursuant
to the trust agreement, the trust pays the taxpayer’s earnings from his or her employer
or business to the trust. However, payment of family expenses greatly depletes such
earnings. Since only the undistributed income of the trust is subject to taxation,
little remains for taxing after the deduction of expenses. Any distributions of the
remaining trust income to family members will split income among family members, and
further reduce the total family tax liability.
The Internal Revenue Service (IRS) and the Tax Court refuse to recognize such arrangements.
The IRS and the Tax Court consistently rule that assignment of income from an employee's
lifetime services is ineffective for federal tax purposes. The Tax Court also ruled
that control of the earnings process determines the proper taxpayer, regardless of
the eventual disbursement of income. Therefore, the wage earner pays taxes on compensation
for his or her services, despite his or her assigned right to those services to the
family estate trust.
An examination may reveal that some family estate trusts carry on a trade or business.
In these cases, the evidence will likely show that these trusts are really a sole
proprietorship. For more information on sole proprietors, see IRS Publication 334, Tax Guide for Small Business.