Because a trust is a legal entity created under state law, the requirements for a trust’s creation vary depending on the state. The following methods summarize the usual methods to create a trust:

• •

  the property owner declares that he or she holds it as trustee for another;

• •

  the transfer of property by the owner to another person(s) during the owner’s lifetime when the recipient of the property is stipulated as trustee in a trust agreement;

• •

  the owner transfers property by will, or an instrument taking effect upon the death of the owner, in trust, to another person as trustee; or

• •

  an exercise of power of appointment of another person as trustee, or an enforceable promise to create a trust.

There are many types of trusts. Two broad trust classifications are:

1. 1. 

   ordinary trusts, and

2. 2. 

   business trusts.

You may encounter a “family estate trust”. Despite its name, it is not a trust. For more information on family estate trusts, see RS 02101.600L.

The real character of an organization will not change if the organization more nearly resembles a corporation or a partnership than an ordinary or strict trust. The following are common to trusts and corporations:

• •

  centralization of management,

• •

  continuity of life,

• •

  free transferability of beneficial interests, and

• •

  limited liability.

To decide whether a trust is a business trust, rather than an ordinary trust, you must ask the following questions: does the trust have associates and an objective to carry on business, and divide business gains? If a trust has these characteristics, we treat it as a business trust, or as an association classifiable as a corporation.

We treat an arrangement as an ordinary or strict trust if the purpose of the arrangement is to vest property in trustees’ responsibility for protecting and conserving it for beneficiaries who cannot share in the discharge of this responsibility and, therefore, are not associates in a joint enterprise for the conduct of business for profit.

Upon accepting the fiduciary position, a trustee takes legal title to the trust property. The document creating the trust, state law, and common law details the trustee’s power and duties. A trustee has the following duties:

• •

  act without making a secret profit from the trust;

• •

  purchase trust property only with express authority;

• •

  act fairly between beneficiaries;

• •

  act unanimously where trust powers are vested in two or more trustees;

• •

  comply with the terms of the trust;

• •

  retain records and provide information and accounts to beneficiaries upon request;

• •

  read and understand the trust deed (or will);

• •

  take reasonable care in exercising their powers as trustees; and

• •

  use specialized skills if the trustee has represented to the settlor that he or she possessed any unusual capacities.

The trustee also has the power to:

• •

  advance capital to a beneficiary;

• •

  delegate his or her powers and duties;

• •

  distribute income to a beneficiary; and

• •

  invest funds held in trust.

If you must determine the coverage status of a trustee, you need to determine the status of the organization involved first. Next, obtain all of the information and evidence necessary to resolve the issue. For information on determining the proper classification of a business entity for social security purposes, see RS 02101.500C. Refer to the following paragraphs for rules about determining the employment status of trustees.

If there are only one or two trustees, they are not employees of the trust. However, if there are three or more trustees, a trustee may be an employee of the trust if:

• •

  the majority of the trustees exercise control over such work;

• •

  the trustee performs extraordinary work (outside the scope of his or her official duties as trustee); and

• •

  this exercise of control is pursuant to the authority created by the trust.

A trustee’s services are not extraordinary, unless evidence shows that the trust instrument, a court, or a special action of the trustees acting as a group, specifically recognizes his or her services outside the scope of the trustee’s duties.

If a trustee is not an employee, we will not find him or her to be self-employed, except in situations where the trustee is a professional fiduciary. For information on the self-employment status of trustees, see RS 01802.033.

If a business trust has the characteristics of a corporation, a trustee of such organization whose work is similar to an officer of a corporation is an employee with respect to that work. For additional information about common characteristics of trusts and corporations, see RS 02101.600D in this section. For information on officers or directors of a corporation, see RS 02101.016.

If a business trust has the characteristics of a corporation, a trustee of such organization whose work is similar to work performed by a director of a corporation is self-employed.

See Also

• •

  For information on forming a corporation, see RS 02101.510A.

• •

  For information on officers or directors of a corporation, see RS 02101.016.

If the business trust has the characteristics of a partnership, we consider a trustee, whose status is like that of a partner, self-employed.

A trustee may have a dual status. In the position as a trustee, he or she may be self-employed. However, when working outside the scope of duties as a trustee, he or she may be an employee of the trust estate.

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.