Proceed with caution
Trusts Marketed as Eliminating Income Tax (Proceed With Caution)
Some trusts are marketed as a way to stop paying income tax: move your business, home, and investments into a "pure," "constitutional," or offshore "asset protection" trust, and the income supposedly becomes untaxed and your personal expenses deductible. The IRS has warned against these arrangements for decades. When you keep control or benefit, the income is still yours to report, and a disallowed claim can add 20% to 75% in penalties to the tax owed.
Reviewed by Ebot Mbi, CPA, EA · Last reviewed October 9, 2026
Who it fits
- Owners who have been offered a trust that promises to end income tax on their business or wages
- Taxpayers who already moved assets into such a trust and need to correct their position
- Families who want legitimate estate, privacy, or asset protection planning
- Business owners looking for compliant ways to lower tax on business income
Who it's not for
- Anyone who wants to keep full control of assets and still shift the income off their own return
- Taxpayers looking to deduct personal living costs through a trust
- Anyone unwilling to report foreign trusts and accounts that the law requires to be reported
How it works
These arrangements typically layer several trusts. The owner transfers a business or home to a trust, often in exchange for "units," stays in control as trustee or through a friendly trustee, and keeps using the assets as before. Promoters claim the trust's income is not taxable, or that personal expenses such as a home or children's education become trust deductions.
Federal law says otherwise. Under the grantor trust rules, if you keep the power to control who benefits, can get the income or principal back, or hold certain administrative powers, the trust's income is taxed to you. If you are a U.S. person who transfers property to a foreign trust with U.S. beneficiaries, you are taxed on that income as well. Personal, living, and family expenses are not deductible regardless of who pays them.
The IRS also disregards trusts that lack economic substance. A trust that changes nothing about who controls and enjoys the assets is a sham for tax purposes. The IRS described these arrangements and their defects in Notice 97-24, and it continues to list abusive trust arrangements among its warnings to taxpayers.
Legitimate trusts do real work. A revocable living trust avoids probate but does not change income tax. An irrevocable trust such as a spousal lifetime access trust moves assets out of your estate, but the income is still taxed to you or the trust. A charitable remainder trust can spread out the tax on a large gain while providing income and a charitable gift. Your estate attorney drafts the documents; we handle the tax side.
For business income, the compliant tools are the ones in this library: entity choice, retirement plans, reasonable compensation, and the credits and deductions the Code provides.
Illustrative example
Illustrative: a business owner moves a business earning $400,000 a year into a marketed trust and stops reporting the income. Assume the federal tax he should have paid on it is $120,000.
- Tax owed when the IRS treats the trust as a grantor trust or a sham: $120,000
- Accuracy-related penalty at 20%: $120,000 x 20% = $24,000; total $144,000
- If the IRS proves fraud, the penalty is 75% instead: $120,000 x 75% = $90,000; total $210,000
- Plus interest from the original due date and any fees paid to the promoter
In this illustration, the claimed $120,000 saving becomes a bill of $144,000 to $210,000 before interest.
The rules
| Rule | Citation |
|---|---|
| Income of a trust is taxed to the grantor when the grantor keeps certain powers or interests. | IRC §§671–677 |
| A U.S. person who transfers property to a foreign trust with a U.S. beneficiary is treated as its owner for income tax. | IRC §679 |
| The IRS has identified abusive trust arrangements and explained why their claimed tax results fail. | IRS Notice 97-24 |
| Personal, living, and family expenses are not deductible. | IRC §262 |
| Understatements carry a 20% accuracy-related penalty, or 75% for fraud. | IRC §6662 and §6663 |
Watch-outs
- Foreign trusts carry their own reporting, including Forms 3520 and 3520-A, with steep penalties for missed filings even when no tax is due.
- Promoters of these arrangements face penalties too, but that does not reduce the participant's own tax, penalties, or interest.
- Correcting early, through amended returns, usually costs less than waiting for an examination.
- Be careful with any plan that promises to end income tax, makes personal expenses deductible, or requires you to give up nothing in practice.
What we do
We review any trust you have been offered or already set up, show how the income is actually taxed, and prepare corrected returns and required foreign trust filings where needed. Your estate attorney drafts the documents; we handle the tax side of legitimate trust planning and the compliant business strategies that replace these arrangements.
Questions
Are all trusts suspect?
No. Trusts are standard, legitimate tools for estate planning, probate avoidance, and charitable giving. The concern is with trusts sold as a way to stop paying income tax while you keep control.
Does a trust in another country change the answer?
No. A U.S. person who funds a foreign trust with U.S. beneficiaries is generally taxed on its income and must file additional information returns.
I already transferred assets to one of these. What now?
Get an independent review. Amended returns, foreign trust filings, and unwinding the structure are often needed, and acting before an examination generally helps.