If It Sounds Too Good to Be True, It Probably Is.

Recently, criminal investigations into bogus trusts from across the country have received national attention, including several from Michigan.

In 2001, the Internal Revenue Service (IRS) issued a nationwide alert warning taxpayers not to fall victim to tax scams of "untaxing" oneself

from the system. Currently, there are several prevalent fraudulent schemes being promoted including both domestic and foreign trusts. These schemes often are introduced by a network of promoters and sub-promoters that may charge from $5,000 to $70,000 for their services. The targeted audience is usually upper-income professional and business taxpayers, who make more than $100,000 a year.

One Michigan promoter, John Modena, received a 60-month sentence for conspiracy to commit income tax evasion for creating and promoting a "sham" trust. As part of the conspiracy, the promoter assisted five brothers, Denver, Daniel, Jack, Orval, and Timothy Russell, who owned a metal die cast business. As part of their scheme, they used a business trust to conduct personal business and make personal purchases. The brothers received sentences ranging from 33 months to 54 months imprisonment.

A Michigan dentist, Dr. Lyle Hotchkiss, was sentenced to 27 months of imprisonment for tax evasion. As part of his scheme, he deposited receipts totaling $1.5 million in taxable income from his dental practice into fraudulent trusts. The judge found that the sham trusts used by Hotchkiss were for tax evasion purposes and to funnel money out of the country.

In 1996, the IRS first became aware of the emerging magnitude of the bogus trusts when the owner of a Grand Cayman Islands bank began cooperating with Federal authorities and provided financial information on hundreds of individuals who appeared to be engaging in on-going tax fraud. As a result, the IRS issued Notice 9724 announcing a nationwide crackdown on bogus trusts. The Criminal Investigation department of the IRS did nor start to track these investigations until the end of 1998.

A legitimate trust is a form of ownership, which is controlled and managed by a designated independent trustee that completely separates responsibility and control of assets from the benefits of ownership.

The IRS recognizes numerous types of legal trust arrangements, which are commonly used for estate planning, charitable purposes and holding assets for beneficiaries. The independent trustee manages the trust, holds legal title to trust assets and exercises independent control. The income the trust receives, whether from foreign or domestic sources, is taxable either to the trust, the beneficiary or the taxpayer unless specifically exempted by the Internal Revenue Code (IRC).

The following arrangements have been used to promote fraudulent trust schemes:

Asset Management Company (AMC): In many promotions, the taxpayer is advised to create an AMC where someone on the promoter's staff is recorded as the trustee. Shortly thereafter, this individual is replaced by the taxpayer. The purpose of the AMC is to give the appearance that the taxpayer is not managing his or her business and to start the layering process.

Business Trust: The owner of a business transfers the business to a trust. The business trust makes payments to "unit holders" or other trusts to create the appearance of limited taxable income.

Equipment and/or Service Trust: This is established to hold equipment that is "rented or leased," and/or provide services to the business trust, often at inflated rates. The business trust then reduces its income by claiming deductions for income to the equipment and/or service trust.

Family Residence Trust: Family residence and its furnishings are transferred to a trust. The trust claims to be a rental business and rents the residence to the owner, who is the caretaker of the property.

Charitable Trust: Assets or income are transferred to a trust claiming to be a charitable organization. The trust or "charitable organization" pays for personal, educational or recreational expenses. The payments are then claimed as "charitable" deductions.

Final Trust: Often established in a foreign country that will impose little or no tax on the trusts, the final trust contains multiple arrangements allowing the money to flow through several trusts unit the cash is ultimately distributed or made available to the original owner.

Criminal Investigation's enforcement strategy to combat these schemes is to focus primarily on the promoters and their clients who have willfully used the trust promotions to egregiously evade taxes. Civil penalties may include up to 75 percent of the underpayment of tax attributable to the fraud, in addition to the taxes owed. Criminal penalties may include fiveyear felony charges of Title 18 USC 371, Conspiracy to Defraud the IRS, Title 26 USC 7201, Tax Evasion, and Title 26 USC 7206 (2), Aiding or Assisting in a False Tax Return, among other charges.

Taxpayers need to know that following false, misleading or unorthodox tax advice is seldom free. Upfront, the taxpayer pays a fee to subscribe to fraudulent trust schemes and in the end, may pay even more in penalties, interest and fines for following the bad advice. Knowingly participating in fraudulent trust arrangements has led to the incarceration and/or financial ruin of many taxpayers. The bottom line: If it sounds too good, it probably is.

If you are interested in further information on Criminal Investigation, watch for future articles in Leaders' Edge, and visit the CI Web site at www.treas.gov/irs/ci.

About the Author

Special Agent Stephen Moore is serving in a new IRS position as Public Information Officer of Criminal Investigation. Detroit.