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Lakewood, CO 80401
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September 13, 2017

The IRS has successfully pierced the asset protection aspects of a trust that was set up in New Jersey. In the past, I have published some accounts of other situations in which the federal government was able to treat assets in a trust as being property of its beneficiary because the trust agreement described a specific purpose for the trust. The trust agreement’s inclusion of such a purpose-statement sufficiently established a basis for the beneficiary to assert certain rights to the trust assets. Since the provisions of those trusts were so explicit, this allowed the trust assets to rise to the status of being property of the beneficiary, making such property subject to creditor attachment (for example, see https://dslawcolorado.com/will-third-party-trust-created-family-safe-irs-tax-collector-federal-actions-restitution/).

Other cases that I have summarized in the past addressed a similar result when the beneficiary demonstrated that he or she has access to and control over the trust assets (for example, the beneficiary holding the power to replace trustees with or without cause, coupled with a history of receiving distributions from the trust).

The most recent case however, cited below, uses a whole different line of attack to gain access to the trust assets (i.e., imposing an IRS income tax lien on the trust assets). This line of attack showed the trust to be a mere nominee of the beneficiary. As such, the trust could be totally disregarded.

This case involved a husband and wife who were promoters of trusts that they claimed could avoid US income taxes (using the old argument that Congress had no authority to give the IRS tax-collection powers, which is a losing argument in the US Tax Court). A conviction followed for defrauding the US and for attempting to commit tax evasion. The husband and wife also owed about $360,000 in income taxes to the IRS. After knowing of the existence of this tax liability, the husband and wife transferred their New Jersey residence into a trust. The wife was a trustee. The court determined that the trust was a mere title holder of the residence for the husband and wife’s benefit.

Treating a trust as a nominee is not new. In past cases, courts have reached such a conclusion when: (1) assets are transferred in to the nominee’s name in anticipation of a lawsuit or other liability while the transferor remains in control of the property; (2) there is a close relationship between the nominee and the transferor; (3) they failed to record the conveyance; (4) the transferor retains possession; (5) the transferor continues to enjoy the benefits of the transferred property; and (6) the transfer was made for no consideration (i.e., a gratuitous gift).

In the case at hand, the court reached the conclusion that the trust was a nominee due to a similar analysis, specifically as applied to the following bad facts: (1) the transfers made to the trust were motivated by the desire to avoid the now well-established IRS tax assessment (i.e., engaged in a fraudulent transfer); (2) the (now divorced) wife admitted the trust was fictitious and set up for the purpose of protecting assets from liability; (3) the husband continued to live in the house (except while he was incarcerated) without any lease arrangement (and therefore retained the benefits of ownership although he no longer held legal title); and (4) the husband and then-wife controlled the trust bank account. There was no discussion in the court’s opinion about whether the trust was a self-settled discretionary trust (in which the husband and wife were named as beneficiaries). If it had been such a trust, and assuming it was a New Jersey trust, that would have been the end of the discussion, since such a trust would have provided no asset protection, without the need to consider any nominee trust status or fraudulent transfer determinations.

Cite: U.S. v. Balice, Case 2:14-CV-03937-KM-JBC, (D.N.J. August 9, 2017)

By Edward D. Brown, Esq., LLM. CPA

Check out our latest blog, “Filing 2016 Gift Tax Returns—Is there a Need to Disclose Noncompliance with Proposed Treasury Regulations Under Code Section 2704 with respect to Discounted Valuation Gifts?”