Recent Government actions suggest that third-party promoters and potentially hundreds of taxpayers may be entering into abusive trust arrangements aimed at unlawfully eliminating or deferring federal income taxes. Specifically, on August 9, 2023, IRS Chief Counsel issued a Memorandum on a trust arrangement known as a “section 643(b) trust.” In the Memorandum, Chief Counsel urged IRS examiners to aggressively challenge the trusts. And, the very next month, on September 26, 2023, the United States Department of Justice (DOJ) made a public announcement that a federal grand jury had indicted two individuals for conspiracy to defraud the United States and aiding and assisting in the preparation of false income tax returns. According to the indictment’s allegations, the third parties had participated in a “nationwide, illegal, abusive-trust tax shelter fraud scheme.”

Taxpayers who entered into an abusive trust arrangement may wonder what steps the Government may take next or what is meant by the mandate to aggressively challenge such transactions. For these purposes, they should look no further than the now-defunct Aegis trust arrangements that proliferated throughout the 1990s and 2000s. 

The Aegis Trust Scheme and IRS Notice 97-24

Approximately three decades ago, the Government became aware of a company known as The Aegis Company (Aegis), which was selling trust packages to approximately 650 individuals for between $10,000 to $50,000. According to federal court decisions on the Aegis trust, Aegis promised its clients that they could avoid federal income tax by using a multi-trust system consisting of a business trust, an asset management trust, and a charitable trust. With this arrangement, Aegis claimed its clients could obtain significant tax benefits even though they effectively controlled the assets and income of the trusts.    

The IRS eventually became aware of the Aegis trust scheme and quickly ramped up criminal investigations of the promoters and, in some instances, the clients who had participated in the trust arrangement. Many of the promoters and clients were sentenced to prison time for their participation in the scheme. Even those who were lucky to escape prison time were nevertheless ensnared in lengthy and expensive IRS examinations related to the trust income tax returns. Based on only a sample of federal court decisions, most (if not all) of these individuals were required to pay income tax, interest, and penalties back to the Government at the end of the examination. 

Given the widespread abuse in the Aegis trust scheme, the IRS chose to warn taxpayers of the scheme and similar abusive trust arrangements when it issued Notice 97-24 in April 1997. The Notice cautioned taxpayers to be wary of third parties who promised tax benefits with no meaningful change in the taxpayer’s control over the assets and income associated with the trusts. Perhaps another IRS Notice will be released with more details on what trust arrangements they consider to be abusive.

IRS Website on Abusive Trust Arrangements

The IRS eventually went digital with its warnings. It now maintains a designated website that echoes the cautions made in Notice 97-24. The website is useful in that it provides examples of what the IRS views as abusive trust arrangements. It also warns taxpayers to scrutinize “too good to be true” statements made by third parties regarding trust arrangements.    

IRS Chief Counsel Memorandum

On August 9, 2023, IRS Chief Counsel issued a Memorandum on a trust it referred to as a “non-grantor, irrevocable, complex, discretionary, spendthrift trust,” or a “section 643(b) trust.”  In the Memorandum, IRS Chief Counsel indicated that it was aware that third-party promoters had been selling these trust arrangements to taxpayers on the basis that such taxpayers would not pay federal income tax under section 643(b) of the Code.  More on this Memorandum can be found here.

DOJ Indictment

Shortly after the IRS Chief Counsel Memorandum, on September 26, 2023, the DOJ announced that a federal grand jury had indicted two individuals for conspiring to defraud the United States and assisting in the preparation of false income tax returns. The DOJ press release states:    

According to the indictment, since 2017, Timothy McPhee of Estes Park, Colorado, and Larry Conner of Frisco, Texas – along with others – promoted and sold an abusive-trust tax shelter to clients nationwide for fees ranging from approximately $25,000 to $50,000. The indictment alleges that MacPhee and Conner instructed clients to assign their income to a series of sham trusts to make it appear as if the income was no longer owned or controlled by the client. However, this paper trail was allegedly false as the clients continued to benefit from and control the income assigned to the sham trusts. McPhee and Conner’s promotion and sale of the tax shelter allegedly resulted in tens of millions of dollars in federal income taxes not being paid to the IRS.

Parting Thoughts

Not all trust arrangements are abusive. But, as the IRS Chief Counsel Memorandum and DOJ press release show, the Government will scrutinize trust arrangements that lack economic substance and were entered into solely to reduce or eliminate federal income tax. Further, what is “too good to be true” is often hard for a non-tax person to identify despite the Government’s public cautionary statements. Taxpayers who have entered into trust arrangements should certainly be mindful of the Government’s recent focus on these types of arrangements and seek advice from a tax professional.