QUESTION
We have an issue involving trusts and anti-money laundering. Our bank serves its customers through five branches. I am the AML officer, and we have a Compliance Manager.
It was our understanding that trusts are not used to launder illegal funds. But, recently, we have a new customer account owned by a trust. Based on our review, we believe we should file a Suspicious Activity Report. We think the trustee is directly involved in transactions that would require us to file a SAR.
We want to know more about trusts in connection with possible AML requirements. Also, please let us know about some risk factors to consider.
What are the features of trusts and the impact on upholding AML monitoring?
And what are some risk factors relating to abusing trusts in money laundering?
ANSWER
The Financial Action Task Force (FATF) recognizes the misuse of trusts for money laundering as a global problem. I will provide an overview of trust activities that evince vulnerabilities for money laundering crimes. My answer is perforce somewhat cursory because of the intricate legal and regulatory compliance risks associated with this aspect of AML compliance.
The FATF has identified characteristic AML and Counter Terrorist Financing (usually referred to with the acronym “CFT”) vulnerabilities of trusts that include
(1) problematic relationships among the settlor, trustee, and beneficiary of a trust;
(2) use of specific trust provisions to obscure relevant facts; and
(3) use of trusts to take advantage of jurisdictional differences.
In the United States, a trust is a legal arrangement created and governed under state law (whether statutory or common law) of the jurisdiction in which it was formed. A trust is generally a relationship created by an arrangement between the grantor and the trustee, under which the trustee assumes fiduciary obligations to the trust’s beneficiaries.
The legal title to any property held in trust is controlled by the trustee, who is then charged with the responsibility of administering that property for the benefit of one or more beneficiaries. The beneficiaries of the trust may receive the economic benefits from the trust property but generally have no power over the investment or distribution of that property. The duties, powers, and responsibilities of these parties are determined by the law of the jurisdiction of formation of the trust and by the trust agreement.
Central to trust law is a set of fiduciary duties or obligations imposed on every trustee, one effect of which is to require that the trustee have and maintain information about other parties relevant to the trust, including co-trustees, the grantor, and the beneficiaries of the trust. However, several states have recently enacted or proposed trust legislation that may run counter to conventional trust law in some ways. This includes, for instance, the formation of a domestic asset protection trust (DAPT) similar to those in South Dakota and Wyoming.
Many people are unaware of the fact that Federal law does not regulate trusts. Rather, federal law applicable to trusts is primarily directed toward the taxation of trust income. U.S. trusts are taxed on U.S. and foreign source income, and foreign trusts are taxed only on U.S. source income.
A trust with income generating a U.S. tax liability is required to file an annual income tax return with the IRS and may be required to file an income tax return with a state, if applicable. That return will disclose the identifying information and tax identification number of each beneficiary who received taxable income from the trust during that year.
A foreign trust with no U.S. source income need not file an annual income tax return with the IRS and therefore need not disclose its beneficiaries to the IRS. A trust formed under U.S. law may be treated as a foreign trust for tax purposes if a non-U.S. person has control over one substantial decision of the trust (i.e., a non-U.S. protector with authority to decide whether to replace a trustee).
Under reciprocal Foreign Account Tax Compliance Act intergovernmental agreements, the IRS is not required to automatically exchange information on accounts maintained by U.S. financial institutions – including accounts held by foreign trusts – if the account does not receive income during the year or receives only foreign source income.
So, given the foregoing outline, would it not be appropriate for trustees to be subject to the Bank Secrecy Act (BSA)?
The answer may surprise you: trustees (except for trust companies) are not subject to the BSA.
When misused, trust and asset management accounts can conceal the sources and uses of funds – and the identity of beneficial owners.
Some factors that may serve as indicia of a higher risk that a trust is being used for inappropriate purposes include
(1) unusual account relationships and circumstances,
(2) questionable assets and sources of assets,
(3) and other potential risk areas, such as offshore accounts, private investment companies, and funds transfers to or from offshore accounts.
There are numerous AML incidences where trustees have been caught abusing trusts. For instance, in October 2021, six defendants were charged with conspiring to defraud the IRS and other fraud offenses from at least January 2015 through September 2018. According to the superseding indictment, as part of the tax fraud scheme, the conspirators allegedly filed fraudulent individual tax returns and other tax documents that reported false withholdings from mortgage lenders and then claimed substantial refunds from the IRS. After processing the false returns, the IRS allegedly issued over $1 million in refunds. To prevent the IRS from recovering the fraudulently obtained refunds, the conspirators allegedly created trusts, opened new bank accounts in the name of business entities and the trusts, and transferred the criminal proceeds between the accounts to conceal the funds from the IRS.[i]
To date, the available evidence does not indicate that trusts established within the United States are frequently used for money laundering purposes. They are used for tax avoidance purposes by both U.S. and foreign persons. While that is distinct from money laundering, it still is of interest to the Treasury Department.
Where trusts were identified as being used to launder money, they relied on strawman trustees (trustees willing to act illegally) to provide a clean name for the trust documents. The U.S. government is seeking to expand its understanding of whether and how U.S. trusts are misused for illicit purposes in the United States.
Chairman & Managing Director
[i] “Six
Defendants Charged with Conspiring to Defraud the IRS and Other Fraud
Offenses,” (October 15, 2021), US/DOJ, District of Hawaii,
https://www.justice.gov/usao-hi/pr/six-defendants-charged-conspiring-defraud-irs-and-other-fraud-offenses
