A trust is a legal device for a person (known as a settlor) to distribute assets to one or more beneficiaries. To create a trust, the settlor first puts assets into the trust. An individual named a trustee then manages the trust and distributes the assets. The trustee does so in accordance with the wishes of the settlor who intended to create the trust.
A sham trust is an invalid trust. A sham trust is a trust in which the settlor does not actually intend to distribute the assets, but rather, wishes to create the impression that the assets have been disposed of. The settlor creates this impression so the settlor can maintain actual control of the trust. Sham trusts are created for unlawful purposes. These purposes include tax evasion, intent to defraud creditors, or other fraudulent purposes.
Understanding some basic terms about trusts is helpful to understand what a sham trust looks like.
A trust that a settlor intends to create is known as an express trust. To create a valid express trust, the trust creator distributes property or funds into the trust. The property is then managed by a trustee, who holds the property, or res, “in trust” (i.e., holds legal title to the trust). The trustee holds the property in trust subject to the rights of the beneficiaries, who are the individuals entitled to the trust property.
In addition, for the trust to be valid, the trust must be created for a lawful purpose.
A sham trust is one that is created for an unlawful purpose. Unlawful purposes include tax evasion, defrauding of creditors, and unlawful hiding of assets.
A sham trust is created in such a manner that the settlor (often called a “creator” with respect to a sham trust) retains ultimate control over the assets. There are various ways a settlor can retain ultimate control. These include:
- Being appointed the sole trustee;
- Retaining the power to override the decision of a trustee; or
- Appointing a “puppet” trustee who is selected simply to give effect to the creator’s wishes.
Sham trust can be created for a number of illegal purposes. Typical sham trusts that are used for illegal purposes include:
- Spendthrift trusts created for the creator’s benefit. A valid spendthrift trust is created to provide for the care of a beneficiary (often a minor). Lawful spendthrift trusts can shield assets from creditors. In a typical spendthrift trust, creditors may only access the assets that remain in the trust after assets have been used to provide for the beneficiary’s care. A spendthrift trust will be regarded as a sham trust if the spendthrift trust is created for the benefit of the creator, as opposed to the beneficiary. This sham trust works to defraud creditors of money they might be entitled to were the spendthrift trust lawful;
- Business trusts created to shield businesses from paying business taxes. The income of a business is subject to state and federal tax. To avoid paying business income tax, a creator can create a trust that gives the impression of being a legitimate trust. However, in fact, the creator retains control of the trust “assets.” Generally, income tax must be paid on any income generated by trust assets. Keeping those assets in the hands of the creator allows for unlawful evasion of taxes; and
- Trusts created “for charity” that do not actually give charities any money. The law encourages charitable giving. To encourage this giving, individuals who create lawful charitable trusts are given special tax treatment. Individuals who create trusts from which charitable donations are made, receive income tax deductions.
- A charitable trust will be regarded as a sham if the creator of the trust, instead of collecting donations and using them for charitable purposes, pockets the donations and claims the income tax deduction. This “pocketing” is illegal; it serves both to defraud both people who made what they thought were legitimate donations, as well as the tax authorities.
Sham trusts are regarded as void by courts. This means they are treated as if they never existed. In addition, individuals creating or operating sham trusts may be prosecuted for crimes that include tax fraud, tax evasion, and defrauding of creditors. Criminal penalties can include fines, as well as jail time. Individuals who have been found to operate sham trusts may also be sued in civil court by victims of the trust who suffered financial loss.
Typically, individuals who unknowingly contribute to sham trusts will not be penalized. Individuals who knew that a trust was a sham, and were willing participants in the sham, may be subject to civil and criminal penalties.
If you have been charged with creating or operating a sham trust, you should consult with an experienced criminal defense attorney. A lawyer in your area can defend you against the charges and represent you in court. If you believe you have been defrauded or deceived by a sham trust, you should consult with a qualified estate attorney as soon as possible. Your attorney can advise you as to what your rights are; can assist in preparing a lawsuit for financial losses you may have suffered; and can represent you in court.