How to avoid revocable living trust cons and other tax scams

“Dirty Dozen Tax Scams” is an annual list published by the IRS, warning taxpayers that illegal schemes and scams will lead to significant penalties, and even criminal prosecution. Topping this year’s list is identity theft, whereby scammers look for ways to use a legitimate taxpayer’s identity and personal information to file a tax return and claim a fraudulent refund.

Other scams on the list include phishing — fake Web sites or unsolicited e-mails asking gullible taxpayers to provide their Social Security number and their bank information because they have purportedly won such prizes as the Irish Sweepstakes.

Of interest to homeowners on the list is the misuse of trusts. According to the IRS, “for years, unscrupulous promoters have urged taxpayers to transfer assets [including real property] into trusts. While there are legitimate uses in tax and estate planning, some highly questionable transactions promise reduction of income subject to tax . . . and reduced estate or gift taxes. Such trusts rarely deliver the tax benefits promised.”

Just what is a trust? There are a number of them, but the most common is the “deed of trust” — the mortgage document you sign when you get a home loan. There are also “testamentary trusts” which is spelled out in your Last Will and Testament and comes into existence when you die.

Here, however, the IRS is referring to “revocable living trusts.” This is created while you are living and is often referred to as an “inter vivos” trust — which is Latin for “between the living.” We use the word “revocable” because the person who created the trust has the right to change its terms, or even cancel for any reason, during his or her lifetime.

Living trusts are always “cocktail party” conversation topics. “I set up a trust and put my property in it and now I am set for life,” says one partygoer.

Let’s set the record straight: Contrary to popular belief — and despite what the scammers tell you — living trusts do not save on estate taxes, nor do they save on income taxes. Why? Because for ownership purposes, the trust is the legal property title holder, but for tax purposes, the property remains in the name of the person who set up the trust, called the “grantor.”

AARP, which has researched the matter, warns that “the greatest growth in sales of living trusts is to people who are least likely to need one. Living trusts are not the solution that salespeople make them out to be.”

How do you protect yourself? AARP says you should learn to spot the scams. Here are some suggestions. If the salesperson tells you that a living trust will preserve your legacy by helping you to avoid probate costs and estate taxes, that’s only partially true. Yes, if your home is in a trust, it will not have to be probated. But, according to AARP, “most people don’t need to worry about probate or estate taxes.” For example, if you and your spouse own property as tenants by the entirety, on the death of one spouse, the property automatically vests in the survivor. And in any event, even when probate becomes necessary, modern probate laws have reduced the pain and the costs of the process.