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Trust Fraud and Forensic Accounting
It is currently estimated that there are over 53 million Senior Citizens in the United States and that number is expected to continue to grow into the future. Many of these Senior Citizens have amassed significant personal wealth and have consulted with legal counsel in protecting this wealth, as well as, planning on its transference to family members and others.
The vehicle of choice by estate and financial planners is a trust. A trust is a fiduciary arrangement that allows a third party, or trustee, to hold assets on behalf of a beneficiary or beneficiaries. Trusts can be arranged in many ways and can specify exactly how and when the assets pass to the beneficiaries.
Since trusts usually avoid probate, beneficiaries may gain access to these assets more quickly than they might to assets that are transferred using a will. Additionally, if it is an irrevocable trust, it may not be considered part of the taxable estate, so fewer taxes may be due upon the Trust grantor’s death.
Assets in a trust may also be able to pass outside of probate, saving time, court fees, and potentially reducing estate taxes as well. There are many types of trusts; a major distinction between them is whether they are revocable or irrevocable.
Also known as a living trust, a revocable trust can help assets pass outside of probate yet allows the grantor to retain control of the assets during their lifetime. It is flexible and can be dissolved at any time, should your circumstances or intentions change. A revocable trust typically becomes irrevocable upon the death of the grantor.
You can name yourself trustee (or co-trustee) and retain ownership and control over the trust, its terms and assets during your lifetime, but make provisions for a successor trustee to manage them in the event of your incapacity or death.
Although a revocable trust may help avoid probate, it is usually still subject to estate taxes. It also means that during your lifetime, it is treated like any other asset you own.
An irrevocable trust typically transfers your assets out of the grantor’s estate and potentially out of the reach of estate taxes and probate but cannot be altered by the grantor after it has been executed. Therefore, once the grantor establishes the trust, they will lose control over the assets and you cannot change any terms or decide to dissolve the trust.
An irrevocable trust is generally preferred over a revocable trust if your primary aim is to reduce the amount subject to estate taxes by effectively removing the trust assets from your estate. Also, since the assets have been transferred to the trust, you are relieved of the tax liability on the income generated by the trust assets (although distributions will typically have income tax consequences). It may also be protected in the event of a legal judgment against you.
When the grantor creates a trust, it is because the grantor intends that the assets will be handled and distributed as he or she intends. The terms of the trust should mirror the grantor’s intent.
The Trustee is the person delegated with the power, right, authority, and responsibility to administer and manage the trust property. A trustee has fiduciary obligations to beneficiaries including duties of care and loyalty with respect to the use, operation, management, and distribution of trust property.
The most important point a trustee must remember is that he or she must follow the terms of the trust on behalf of the beneficiaries. In other words, the interests of the beneficiaries must be placed before the interests of the trustee.
This includes both the current beneficiaries and any parties named by the trust to receive the remaining property (called remaindermen). These parties (individuals or organizations) receive trust assets upon the death of those entitled to income or principal now.
Responsibilities of a Trustee include:
• A trustee must keep accurate records that support income and payments made from the trust.
• Ensuring the timely filing of Federal and state income tax returns. Federal tax returns are not an adequate way to account for trust income and disbursements since the requirements for tax filing are different from the requirements for trust recordkeeping.
• Keeping trust administration costs reasonable.
• Not mixing trust assets with his or her own assets. They should be kept separate.
Some of the more common frauds involving trusts include:
• Commingling – The trustee mixes personal assets with trust property.
• Breaching the terms of the trust – Not following the trust’s requirements (for example, missing payments, under- or over-paying, failing to pay one or more beneficiaries the distributions to which they are entitled)
• Self-dealing – Taking advantage of the position as trustee, and acting in self-interest instead of those of the beneficiaries (for example, purchasing trust property at less than fair market value; receiving a commission, fee, or other compensation for arranging a loan secured by trust property; using trust property to pay for personal expenses) This usually occurs if the trustee is also a beneficiary. The trustee may be inclined to act in his or her best interest versus all the beneficiaries and remaindermen.
• Trust mismanagement – Failing to make prudent investments (note: the mere loss of decline in trust value does not necessarily constitute mismanagement) In some situations, trustees may use trust funds for themselves. A typical scenario would be a trustee who “borrows” money from the trust for his or her own purposes. Perhaps he or she is having financial difficulties and intends to return the money but is not able to pay it back.
• Failure to account – Failing to timely provide beneficiaries or the court with a proper accounting of income, expenses, and distributions. There may not be any intent to defraud or any self-interest involved. The trustee may just be lackadaisical or unable to effectively manage the trust.
• Embezzlement – The worst case would be when the trustee blatantly takes money from the trust with no intention of returning it.
If you suspect trust fraud, immediately consult a skilled, experienced trust and estate attorney and a forensic accountant.
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