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Posted by Keith on March 21, 2007 at 11:04 pm  


A friend is encouraging me to prepare a “Constitutional Trust”. They say I can have the trust own my assets, including my paychecks, and that I can avoid income taxes this way. They also say it makes my assets safe from lawsuits, and that all I have to do is instruct the trustee and they will do whatever I say with the trust assets. Is this true?

Alara, Topeka Kansas

P.S. Do you get seasick?


No. Don’t do it. Don’t do it. Don’t do it. Did I mention not to do it? The “Constitutional Trust”, or “Rockefeller Trust”, or “INSERT NAME HERE Trust”, scams have been around for years, and they DO NOT WORK.

What’s more, I’ve seen instances where people were charged $25,000 or more for these less-than-worthless documents. I’ve also seen promoters of these scams go to prison, and I’ve seen their victims get hopelessly sideways with the IRS.

Here’s the deal: You can’t “give it away and keep it too.” Trust assets placed into irrevocable trusts must be beyond your ability to control directly or indirectly. If not, they are ignored for tax and liability purposes. No amount of legal-babble by the non-lawyers who promote these things will ever change that.

Meanwhile, Revocable Living Trusts (RLT), particularly in community property states such as Arizona (Kansas is a common law state), can be wonderful estate planning tools, where the grantors (or settlors) remain as trustees and control the assets during their lives. My law firm prepared hundreds of such documents. But an RLT is ignored for liability purposes, and has no affect on income taxation (although the proper use of credit shelter amounts at death may help minimize estate taxes).

I true irrevocable trust can also be a very helpful way to own, for example, insurance. By creating an irrevocable life insurance trust (ILIT) and by placing a (preferably) new policy in it, you may avoid both income tax on the death benefit, and estate tax upon your death. But you cannot be the trustee of such a trust. Usually you appoint a family member other than your spouse to serve as trustee. Again, you cannot “give it away, and keep it too!”

However, now let me contradict myself. You can establish an irrevocable trust that you manage as trustee for the benefit of the named beneficiaries. You have a fiduciary duty to manage the assets for their benefit, not your own. And let me further contradict myself: A few states, such as Alaska, now allow “Grantor Retained Irrevocable Trusts.” This is an asset protection device. However, generally, the assets must be administered by an institution located in that state.

And a final aside: The closest most people can come to “giving it away but keeping it too”, are the new 529 college savings plans. If junior doesn’t go to college you may reclaim your contributions and all the growth (you pay taxes and a 10% penalty on the growth only); but if you die before Junior goes to school, it is not considered part of your estate. That’s why some advisors are pushing the envelope and having their clients put hundreds of thousands of dollars into numerous 529 plans in multiple states. The theory is that a 10% penalty on the income tax you might owe is a heck of a lot better than a 50% estate tax (where the rates will go in 2011 unless Congress reaches some sort of estate tax compromise).

Alara, my best advice is this: Get thee to an estate planning attorney. Not just any attorney, but an estate planning attorney. Sit down with them, and have them recommend what works — and what will keep you out of trouble with the IRS! Oh, and tell your friend to stop recommending this scam. It will land them in jail!


P.S. Yes, sometimes!


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