In our house we have all the necessary supplies in the event of a terrorist attack — a flashlight, bottled water and a salami. What else could we need?

Religious School Tuition

The Tax Court said “no” to an attempt to claim part of the tuition and fees paid for a taxpayer’s children’s religious school education as a charitable contribution. The court rejected their argument that their payments were similar to the tax-deductible payments allowed by the IRS to Church of Scientology members for their “auditing and training” expenditures (M. Sklar, 125 TC, No. 14).

Delinquent Student Loans

The U.S. Supreme Court has ruled unanimously that the government can seize an individual’s Social Security benefits to pay any unpaid balances of old student loans. Sounds like they owed the money from the time they graduated college — until they retired on Social Security. Boy, those are really old loans!

Fraudulent Trusts

There are probably a few million trusts in existence, and certainly the vast majority of them are legitimate. You all know of the most common one, the Living Trust, used to avoid probate and publicity, along with a few other advantages. There’s also the Life Insurance Trust, many kinds of other Irrevocable Trusts, Charitable Trusts, etc.

However dishonest promoters, usually for very high fees, peddle fraudulent trusts to naïve, greedy or dishonest suckers, er, taxpayers. They promise huge tax savings that are supposedly far in excess of their fees. Many individuals fall for these offers and the naïve ones are frequently seduced by the word “trust.” After all, they have heard that all the rich people have trusts — so they must be legal and can legitimately save you taxes. Horse pucky!

The IRS has issued descriptions of the most common types of fraudulent trusts that not only don’t save you taxes, but will eventually get you embroiled with the IRS — with tax bills, penalties and interest charges up the wazoo! Of course by the time you find out, the promoter is long gone and living in a beach house in Malibu — under another assumed name — while peddling the next scam….

The IRS publicizes and explains the five most common and typical of these false trusts. None of these provide the slightest bit of tax savings, tax relief or any other legal benefits. They simply guarantee mucho trouble with the IRS and, in some cases, a possible trip to the slammer.

Business Trust. This involves the transfer of a going business to a trust that makes it appear that the taxpayer has given up control of his or her business. The reality is that through control of the trustees or other related entities, this is not true. The day-to-day activities of the business are under the same control as before. It is sometimes called a “constitutional trust,” or a “pure trust,” or an “unincorporated business organization.” It makes no difference, and it won’t work.

Equipment or Services Trust. This trust is formed to hold equipment that is rented or leased to the business, often at inflated rates. The business trust (see above) reduces its income by claiming deductions for payments to the equipment trust. Same pitfalls as the business trust and no overall tax relief.

Family Residence Trust. Taxpayers transfer family residence, including furnishings, to a trust that usually rents the residence back to the taxpayer. The trust then deducts depreciation and all the (personal) expenses of operating the residence — as a rental property operation. The personal expenses are not deductible by the trust — and why would we all not do this if it really worked?

Charitable Trust. Taxpayers transfer assets and/or income to this trust, which claims to be a charitable organization. This trust (or organization) then pays the personal, educational and recreational expenses on behalf of the taxpayers and/or other family members. The trust then claims the payments as charitable deductions on its tax returns. These so-called charities are often not qualified with the IRS and have no exemption letter. Even if by some miracle they were qualified — such deductions would never hold up.

Foreign Trust. These trusts are often located in select foreign countries that provide financial secrecy and impose little or no taxes on trusts. Typically, such abusive foreign trust arrangements enable taxable funds to flow through several trusts (or other entities) without payment of taxes. Then, those funds are distributed or made available to the original owner — supposedly tax-free. This is criminal tax fraud of the worst kind!

Of the five types listed, the foreign trust is probably not only the worst, but frequently involves the largest amounts of money being laundered. A variation on this theme is when the money first goes to the foreign bank, who then issues a credit card to the individual with the same dollar limit as the funds deposited. Then, that individual avoids the need to deposit large sums back into his or her bank account — and simply uses the credit card for any and all expenditures. However, as far as I know, it’s quite difficult to use those credit cards while residing in a federal prison….

This credit card ploy was so alarming to the IRS that some years ago they launched a special program just to track such individuals. They have had substantial success by first obtaining the records from many of these foreign banks and then tracking the credit card holders through those records. As far as I know, this special program is still in operation. Of course the rest of us taxpayers pay, indirectly, for all the taxes not paid by these crooks. Make no mistake about that!

False Trust Claims by Promoters — Badges of Fraud

Establishing a trust will reduce or eliminate income and or self-employment taxes. Truth: Taxes must be paid on income or assets held in trust, including income by the property held in trust. The responsibility to pay taxes may fall on the trust, or the beneficiary or the transferor — but someone must pay the taxes — and there ain’t no free lunch.

You will retain complete control over your income and assets with the establishment of the trust. Truth: Except for a revocable (e.g., Living) Trust, under legal arrangements for any Irrevocable Trust, you must give up significant control over income and assets. An independent trustee is designated to hold legal title to the trust assets, to exercise independent control over the trust, and to manage the trust.

Taxpayers may deduct personal expenses paid by the trust on their tax return. Truth: Non-deductible personal living expenses cannot be transformed into deductible expenses by virtue of assigning assets and income to a trust.

Taxpayers can depreciate their personal residence and furnishings and take them as deductions on their tax returns. Truth: Depreciation of a taxpayer’s residence and furnishings used solely for personal use is not deductible by virtue of assigning the residence to a trust.

Additionally, any of these actions should also sound your BS meter:

• Use of backdated documents.
• Lack of independent trustee.
• Use of post office boxes for trust addresses.
• Use of terms such as: “constitutional trust,” “sovereign trust” or “pure trust.”
• Unjustified replacement of trustee.
• Any attempt to prevent you from seeking independent and outside review of the documents and their ideas. Either by verbal assurances that such actions are not necessary — or by asking you sign a “confidentiality agreement” in which you promise not to seek any outside review or counsel. (This kind of written agreement was used by many of the national CPA firms when they were peddling their custom-designed tax shelters that were later ruled fraudulent.)
• If the salesman/promoter wears blue suede shoes.

Household Employees and Taxes

All our honest readers unfailingly pay any required employment taxes for their household employees. Right? However, for the few that are uninformed or don’t pay for other reasons, here is a brief summary of the law.

Social Security and Medicare Taxes:

• Required if you pay cash wages of $1,500 or more to any one household employee during the year.
• Unless those payments are to any employee who is under the age of 18 at any time during the year (except if it is this individual’s “principal occupation”). Or if the payments are to your spouse, or your child under the age 21, or your parent.

Federal Unemployment Tax:

• Required if you pay cash wages of $1,000 or more in any calendar quarter of the year.
• Unless these payments are to your spouse, or your child under the age of 21, or your parent.

State Unemployment Taxes:

• You still may have to pay these taxes, even if you are not liable for any of the previous taxes. The laws vary from state to state.

Tax Rate: Social Security and Medicare is 15.3%. You can either pay it all, or deduct one-half (7.65%) from your household employee’s pay. Federal unemployment tax is 0.8% of cash wages, but only on wages paid up to $7,000 a year.

Caution: If you do not file these payroll tax returns and make the required payments — there is no statute of limitations to protect you. Perhaps 20 years later, that household employee can retire and file a claim for social security benefits. Upon investigation, you could be hit with 20 years of those taxes, plus interest, plus penalties. Filing Schedule H with your personal tax return each year covers all the required federal taxes that you may owe. If there is no Schedule H attached to your annual Form 1040 — you have not paid any household employee taxes you may have owed for that year.

Auto Expense Reimbursements

The IRS ruled on what should have been an obvious answer for the employer. Could the employees be paid both the business mileage allowance (48.5¢ for 2007) and a reimbursement for fuel — both tax-free? Of course not! The (tax-free) business mileage reimbursement includes payment for gasoline costs. Naturally, the IRS ruling was that the additional fuel reimbursements were income to the employees and also subject to payroll taxes.

To refresh your memories, you must understand the difference between an “accountable plan” and a “nonaccountable plan” under IRS rules — and you can’t combine the two into one set of expense reimbursements as in the preceding. So this answer should have been predictable.

The New Bankruptcy Act and Homestead Exemptions

The various states all have laws regarding homestead exemptions that shield various amounts of equity in your principal residence against the claims of creditors.

• Prior law required you to live in a state for only 180 days to claim the homestead exemption. The new law increases the residency requirement to 730 days.
• Some states have very high homestead exemption limits and a few offer unlimited exemption. Under the new law, you are generally required to live in a state for 1,215 days before you can exempt more than $125,000 in homestead equity from creditors.
• “Fraudulent transfers” are considered transfers by the debtor with the intent to defraud creditors, as are certain transfers for less than “reasonable equivalent value.” Under prior law, the court could recover property transferred fraudulently within one year prior to the bankruptcy filing. The new law extends the general “look-back” period to two years.
• The new act also creates a special 10-year look-back period for certain transactions. Among them are transfers to self-settled asset protection trusts and conversions of nonexempt assets into homestead equity.

In the olden days, some individuals, before filing bankruptcy, converted all their assets into cash, say $10 million — and then invested the entire $10 million in a new principal residence in Florida (which has an unlimited amount of homestead exemption). Then they filed bankruptcy, claimed the unlimited homestead exemption — and the creditors got nothing! Later, they sold their home for $10 million or so and lived nicely on the tax-free cash they received — with no debt.

As you can see, the new law not only changed the residence requirements, but also has that new 10-year fraudulent transfer provision for “nonexempt assets converted into home equity,” that is exactly aimed at the kind of arrangement I just described.

(Most of the information in this section was supplied by the law firm of Valensi, Rose — Century City, CA.)

Where Would You Like to Live — Taxwise?

According to the Tax Foundation, the most “tax friendly” states overall are:

1. Alaska. No income tax, no sales tax — and refunds to individuals from state oil revenues. (Sometimes it’s a little cool there.)
2. New Hampshire. No income tax on wages, no sales tax, high property taxes.
3. Delaware. No sales tax, low individual income tax.

And the least “tax-friendly” states are:

1. Maine. High property tax and income tax.
2. District of Columbia. High income tax.
3. New York. Both state and local income tax and sales tax.

According to Forbes magazine, the most expensive housing in the country is:

1. Atherton, California (south of San Francisco in the “Silicon Valley”).
2. Santa Barbara, California (Oprah lives there).
3. Rancho Santa Fe, California.
4. Newport Beach, California.
5. Mill Neck, New York.