Many individuals believe that assets held in trust for their benefit are exempt from the claims of their creditors, including the IRS. While this is generally true, there are exceptions, and the IRS may be able to levy on trust assets in certain situations.
Understanding Trusts and Spendthrift Provisions
A trust is a legal entity created to hold and manage assets for the benefit of beneficiaries. The trust is governed by a trust agreement, which outlines the terms and conditions of the trust, including the distribution of assets and the powers and duties of the trustee.
A spendthrift provision is a clause in a trust agreement that restricts the beneficiary’s ability to access or transfer the trust assets. This provision is designed to protect the assets from the beneficiary’s creditors, including the IRS.
Exceptions to Spendthrift Protection
While spendthrift provisions generally protect trust assets from creditors, there are some exceptions:
- Claims for support or maintenance: The IRS may be able to levy on trust assets to satisfy claims for support or maintenance of a child, spouse, or former spouse of the beneficiary.
- Claims of the U.S. government: The IRS has broader collection rights than most creditors and may be able to levy on trust assets to satisfy certain tax debts, even if the beneficiary is not the settlor of the trust.
Nominee Liability
The IRS may also be able to levy on trust assets if the trustee is deemed to be the taxpayer’s nominee. This occurs when the taxpayer retains control over the trust assets, even though they are legally held by the trustee.
Factors that may indicate nominee liability:
- The taxpayer pays for the maintenance of the trust property.
- The taxpayer uses the trust property as collateral for loans.
- The taxpayer pays state and local taxes on the trust property.
- The taxpayer continues to enjoy the benefits of the trust property.
IRS Levies on Trust Assets: A Case Study
In the recent case of U.S. v. Hovnanian, the IRS successfully levied on trust assets to satisfy the tax debt of the beneficiary’s parents. The court found that the parents, who were not beneficiaries of the trust, had retained control over the trust assets and were therefore nominees of the taxpayer.
This case highlights the importance of carefully structuring trusts to avoid nominee liability. It also demonstrates that the IRS may be able to levy on trust assets even if the beneficiary is not the settlor of the trust.
Protecting Assets from the IRS: Strategies
- Establish an irrevocable trust: In an irrevocable trust, the taxpayer cannot make any changes once the trust is established and, therefore, the IRS does not consider assets in an irrevocable trust to be owned by the taxpayer.
- Avoid nominee liability: Ensure that the trustee has full control over the trust assets and that the beneficiary does not retain any control or benefit from the assets.
- Seek professional advice: An experienced attorney can help you structure a trust to protect your assets from the IRS and other creditors.
While trusts can be an effective tool for asset protection, it is important to understand the exceptions to spendthrift protection and the potential for nominee liability. By carefully structuring your trust and seeking professional advice, you can increase the chances of protecting your assets from the IRS.
Frequently Asked Questions
Can the IRS take everything I own?
The IRS has broad collection powers, but they cannot take everything you own. The IRS is generally prohibited from levying on certain assets, such as your primary residence, retirement accounts, and Social Security benefits.
What happens if I can’t pay my taxes?
If you cannot pay your taxes, you should contact the IRS as soon as possible to discuss payment options. The IRS may be willing to set up a payment plan or offer other relief options.
Can I go to jail for not paying my taxes?
In most cases, you will not go to jail for not paying your taxes. However, the IRS can file a lawsuit against you to collect the debt, and you could be held in contempt of court if you fail to comply with a court order.
What should I do if I am being audited by the IRS?
If you are being audited by the IRS, you should contact a tax attorney or accountant for assistance. An experienced professional can help you understand the audit process and protect your rights.
Irrevocable Trusts vs. Revocable Trusts
As long as the person creating the trust is mentally competent, it is possible to change or dissolve it at any moment. They do have the advantage of enabling their creator to revoke them and take back any assets held in the trust before they pass away. But unlike irrevocable trusts, these trusts do not provide the same defense against lawsuits or estate taxes.
Government agencies that use revocable trusts will take into account that any property held in one is still the property of the trust’s creator and may be included in their estate for taxation or eligibility for government benefits. Once a revocable trusts creator dies, the trust becomes irrevocable.
SECURE Act Rules
Distributions from retirement accounts held in an irrevocable trust could previously be taken by certain non-spousal beneficiaries over the course of their life expectancy. Nevertheless, some beneficiaries might discover that they have to accept the entire distribution by the end of the tenth calendar year after the grantor’s passing under the terms of the SECURE Act.
Again, when using an irrevocable trust, it’s important to seek the advice of a tax or estate attorney because the tax implications of this can be complicated and may change with the passing of new laws.