Sham Trusts

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 What are Trusts?

Trusts are legal devices that allow individuals, called settlors, to distribute their assets to one or more beneficiaries. In order to create a trust, a settlor will put assets into that trust.

Individuals who are named as trustees then manage the trust and distribute the assets in that trust. The trustee completes these tasks in accordance with the wishes of the settlor who intended to create the trust.

What are the Different Kinds of Trusts?

There are numerous different kinds of trusts. All of these trusts, however, fall into one of two categories, living and testamentary.

A living, or inter-vivos, trust is created during the life of the trustor. A testamentary trust transfers property into a trust after the death of the testator through their will. Property in a testamentary trust must first pass through probate prior to the trust being created.

Although not an exhaustive list, types of trusts include:

  • Revocable trusts;
  • Irrevocable trusts;
  • Credit shelter trusts;
  • Generation-skipping trusts;
  • Qualified personal residence trust;
  • Irrevocable life insurance trust;
  • Land trust;
  • Charitable trust;
  • Secret trust;
  • Special needs trust;
  • Spendthrift trust;
  • Totten trust;
  • Discretionary trust;
  • Custodial trust;
  • Bypass trust;
  • Crummey trust; and
  • Asset protection trust.

Clearly, there are many different types of trusts that can be used for many different purposes. Because of this, it is helpful to consult with an attorney who will be familiar with the types of trusts and who can advise an individual regarding which types of trusts will be best for an individual and their loved ones.

What is Required to Create a Valid Trust?

A trust that a settlor intends to create is called an express trust. In order to create an express trust, the creator of the trust distributes funds or property into the trust.

The property in the trust is managed by the trustee, or the individual who holds the property, or res in trust, which means that the trustee holds legal title to the trust. The trustee holds the trust property in trust subject to the rights of the beneficiaries, who are the individuals who are entitled to the property that is in the trust.

The trust must also have been created for a lawful purpose in order to be valid.

What Can be Placed in a Trust?

As previously discussed, one important element of a trust is the assets which it contains. If the asset has a title, such as a stock or bond or piece of real estate, the title of that asset can be transferred in the name of the trust.

Items which do not have title, such as furniture, clothing, and jewelry, can also be transferred into a trust by an individual transferring their rights to the property to the trustee to be held for the benefit of the beneficiaries who are named in the trust. There are items which cannot be transferred into trusts. This is because the distribution of these items is determined by the beneficiary who is named in the individual policy, such as:

  • Life insurance policies;
  • Retirement accounts;
  • Pension plans; and
  • Health savings accounts.

Because of this, the named beneficiary listed for these types of policies must be the trustee in order for the assets from these types of items to be placed in the trust.

What Are Sham Trusts?

Sham trusts are invalid trusts. Sham trusts are trusts in which a settlor does not actually intend to distribute any assets but, rather, intends to create the impression that the assets have been disposed of.

The settlor in a sham trust will create this impression so that they can maintain actual control of the trust. A sham trust is a trust which is created for an unlawful purpose.

These purposes may include:

  • Tax evasion;
  • Intent to defraud creditors;
  • Unlawful hiding of assets; or
  • Other fraudulent purposes.

There are several ways settlors can retain control of a sham trust, including if they:

  • Are appointed the sole trustee;
  • Retain the power to override the decision of a trustee; or
  • Appoint a puppet trustee who is selected only for the purpose of giving effect to the wishes of the creator.

Sham trusts can be created for numerous illegal purposes. Typical types of sham trusts which are used for illegal purposes may include:

  • Spendthrift trusts which are created for the benefit of the creator;
  • Business trusts which are created to shield businesses from paying business taxes; and
  • Trusts created for charities that do not actually give charities any money.

A spendthrift trust is created in order to provide for the care of a beneficiary, in many cases, a minor. A lawful spendthrift trust can shield assets from creditors.

Typically, in a spendthrift trust, a creditor may only access the assets which remain in the trust after they have been used to provide for the care of the beneficiary. Spendthrift trusts will be considered sham trusts if they are created for the benefit of the creator instead of for the beneficiary.

The income a business makes is subject to both federal and state taxes. In order to avoid paying income taxes, an individual may create a trust but retain control of the trust assets.

In general, income tax is required to be paid on any income which is generated by trust assets. By keeping those assets in the hands of the creator, they can unlawfully avoid paying taxes.

Laws encourage charitable giving. In order to encourage this, an individual who creates a lawful charitable trust is given special tax treatment.

An individual who creates a trust from which charitable donations are made can receive income tax deductions. Charitable trusts will be regarded as sham trusts if, instead of collecting donations and using them for a charitable purpose, the creator keeps the donations and claims an income tax deduction for them.

How Do Courts Treat Sham Trusts?

A sham trust will be regarded as void by a court. This means that they will be treated as if they never existed.

Additionally, the individual who is creating or operating the sham trust may be prosecuted for crimes such as:

  • Tax fraud;
  • Tax evasion; and
  • Defrauding creditors.

Criminal penalties for these offenses may include jail time, criminal fines, or both. An individual who operated a sham trust may also be sued in civil court by the victims of the trust who suffered financial losses.

In most cases, an individual who unknowingly contributes to a sham trust will not be penalized. An individual who knew the trust was a sham and willingly participated, on the other hand, may be subject to criminal and civil penalties.

Do I Need an Attorney to Help with Sham Trust Issues?

It is essential to have the assistance of a trust attorney for any issues, questions, or concerns you may have related to a sham trust. If you have been charged with creating or operating a sham trust, it is very important to consult with an attorney because you may be facing criminal penalties.

If you believe you have been a victim of a sham trust, it is important to consult with an attorney as soon as possible. Your attorney can advise you of your rights, assist you with filing a lawsuit for the financial losses you have suffered, and represent you if you have to appear in court.

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