In recent years, the government has continued to ramp up its investigatory efforts concerning trust arrangements that it deems abusive for tax purposes. These investigations have included so-called “section 643(b) trusts” and other trust schemes that lack economic substance. In many instances, these probes have resulted in criminal indictments against the promoters of the schemes—i.e., those marketing and making a profit from them. However, a recent indictment filed on August 21, 2024, cautions that the government may also choose to target individual taxpayers who participated in some of these abusive trust arrangements.

The Ulibarri Indictment

On August 21, 2024, an indictment was filed against Ryan Ulibarri in the U.S. District Court of Colorado. The following facts are taken solely from the indictment and are therefore only allegations at this stage of the proceeding.

According to the indictment, Ulibarri hired Larry Conner to assist him in setting up three different trusts and a private foundation. In exchange for a significant fee, Conner drafted the trust documents and advised Ulibarri that these trusts would be characterized as non-grantor trusts for federal income tax purposes. The three trusts consisted of a “business trust,” a “family trust,” and a “charitable trust.” Notably, Conner was later indicted in 2023 for marketing this specific type of transaction to other parties.

How The Structure Purportedly Worked

Ulibarri is a dentist. Prior to the trust arrangement, he had substantial income from his dental practice, all of which was earned through an S corporation. For federal tax purposes, S corporations generate flow-through income that its owners report separately on their tax returns. Absent the trusts, Ulibarri was required to report and pay tax on the S corporation’s income.

After the trusts were created, however, Ulibarri assigned 90% of his interest in the S corporation to the business trust. With the business trust owning 90% of the S corporation, it now had an obligation to report and pay tax on this income. And, each year, the business trust filed a trust income tax return (Form 1041), reporting income from the S corporation.

In addition to the income, the business trust claimed deductions. These deductions included, for example, an income distribution deduction for amounts the business trust distributed to the family trust. At the end of each year, the business trust reported no taxable income, primarily because of the income distribution deduction.

Generally, this would be no problem for tax purposes. When a trust distributes taxable income to its beneficiaries, the beneficiaries must report the income and pay taxes on it. Indeed, that is why the trust tax provisions allow a deduction for the income distribution deduction at the trust level.

Here, the family trust reported the income distributions it received from the business trust. In addition, it claimed deductions to reduce this income, including personal deductions (i.e., Ulibarri’s mortgage payments, personal credit cards, etc.) and an income distribution deduction for amounts the family trust paid to the charitable trust. At the end of each year, the family trust reported no taxable income as a result of these deductions.

In turn, the charitable trust also reported as income the amounts it received from the family trust. Unlike the other trusts, though, the charitable trust claimed a charitable contribution deduction for amounts it paid to the private foundation. Because the charitable trust distributed out all the remaining income it received from the family trust to the private foundation, the charitable trust never reported taxable income.

In sum, Ulibarri used the Conner transaction as a means to report only 10% of the S corporation’s income on his own return with the remaining 90% as tax-exempt. In addition, he allegedly claimed personal expenses as deductions against the income, which federal tax law does not allow.

The Private Foundation

The indictment indicates that Ulibarri also sought and received tax-exempt status for the private foundation. In general, tax-exempt private foundations do not pay income taxes, although they are required to file Forms 990-PF to report their activities to the IRS.

Because private foundations are tax-exempt, there are strict rules relating to the usage of the foundation’s funds. Specifically, if the private foundation does not use the funds to further its tax-exempt status, the foundation can lose its tax-exempt status altogether. Moreover, certain persons responsible for operating the private foundation can incur significant penalties for these types of transactions.

According to the indictment, Ulibarri used the private foundation’s funds for personal expenses, including sporting event tickets. He also caused the private foundation to loan its funds back to his dental practice—i.e., the funds that originated from the dental practice circled back, after going through the trusts, to the dental practice.

In effect, the government’s primary concerns with the arrangement relate to the personal expense deductions, the usage of private foundation funds for personal purposes, and the economics of the transaction—i.e., the circling back of money to its origin without the payment of taxes.

The Criminal Charges

For his participation in the above transactions, the government seeks six counts of tax evasion under section 7201. Section 7201 makes it a felony for any individual to “willfully attempt in any manner to evade or defeat any tax” or tax payment obligation. According to the indictment, Ulibarri is criminally liable under section 7201 because “the trusts and private family foundation . . . were sham entities devoid of economic substance and served no legitimate business purpose” with Ulibarri retaining complete control of all the income and assets of the trusts and private foundation.

Because Conner allegedly sold this specific type of trust arrangement “nationwide,” it would seem likely that we may see additional indictments against taxpayers who participated in these transactions. It also demonstrates that the government may be willing to go after taxpayers who participated in other abusive trust arrangements that did not involve Conner.

Conclusion

Although it is relatively uncommon for the government to bring a criminal case against a participant of an abusive trust arrangement, the recent Ulibarri indictment should serve as a warning that this is not always the case. Taxpayers who participated in these types of transactions should certainly consider consulting with a tax professional to determine what steps can be taken to mitigate any criminal and civil exposure, bearing in mind that the statute of limitations for most criminal tax cases is generally 6 years.

A copy of the indictment can be found here.


This article was originally published on Forbes.com on August 27, 2024.