Volume IV, Number 2 – February 1995
© Donlevy-Rosen & Rosen, P.A.
OFFSHORE TRUSTS: A CLOSER LOOK
How and Why They Work To Protect Your Assets
PREFACE. The use of offshore trusts in asset protection planning was briefly discussed in Volume I, Number 4. In this issue we will take a more detailed look at how and why offshore trusts are used in asset protection planning, the tax consequences of utilizing an offshore trust in your planning, and the circumstances under which the technique may not be used.
BACKGROUND. Trusts have been used since the Crusades to protect assets. The trust concept and case law are deeply embedded in those jurisdictions whose laws are English common law based. Domestic trusts (those subject to US law) provide very limited asset protection for the settlor (creator) of such trusts if he or she is also a trust beneficiary. The various rules which culminate in this result are largely based upon a perceived public policy goal. In order to obtain any significant degree of asset protection for a settlor-beneficiary, we must look to an English common law based non-US jurisdiction with favorable trust protection laws.
THE OFFSHORE TRUST. The offshore asset protection trust (“APT”) is inherently more protective than a domestic trust for several reasons, not the least of which is its “foreignness”. Consider the thought processes of the creditor’s attorney contemplating an action to recover assets from a trust in a foreign country. He knows nothing of the country’s geography, laws, procedures, costs, or even their currency. These factors become immediate hurdles in a legal obstacle course upon which he is about to embark. Because of these geographical, legal, procedural, and financial hurdles, the APT is not an automatic target of litigation, as its domestic counterpart would likely be. The domestic trust and its trustees are subject to local (US) jurisdiction, and both are just as easily included in litigation (on some theory or another) as is the settlor – not so with the APT. The very fact that the APT is an offshore trust will have a significant deterrent effect on the creditor’s decision regarding whether or to what extent to pursue trust assets. Finally, the trust laws of certain foreign jurisdictions are far more specific and protective than our domestic trust laws. Therefore, if the creditor is (somehow) undaunted by the geographical, financial, and procedural hurdles of the APT obstacle course, he will be confronted with the brick wall of the foreign legal system as the final hurdle. Key among the factors making up this brick wall in a properly selected offshore jurisdiction are the fact that he will have to start his lawsuit all over again – from square one, because the foreign jurisdiction will not recognize his US judgment, he will have to utilize an attorney in the foreign jurisdiction, and that attorney will not be able to accept the case on a contingency fee basis (as US attorneys can), and he will likely be faced with an expired statute of limitations by the time the litigation reaches the foreign jurisdiction – game over!
TRUST VS. PARTNERSHIP. Why use an APT if the limited partnership provides so much protection? (See AP NEWS, Vol. IV, No. 1). First, not all assets can or should be owned by a limited partnership. For example, a subchapter S election would be lost if S corporation stock were transferred to a partnership. Similarly, the home mortgage interest deduction would be lost if property eligible for that deduction were owned by the partnership. These assets can, however, be directly owned by a properly structured offshore trust. Second, although a significant degree of protection is available through the use of the family limited partnership, we can never predict how a local court or jury will act. Sometimes a “result oriented” judge or jury will ignore the statute limiting the creditor’s rights against a partner in a limited partnership, and somehow pierce the partnership protection; this happened in two California cases. Effective asset protection planning must take such a possibility into account. Unfortunately, some planners stop short of going the “whole nine yards”, and utilize the limited partnership as the end all and be all of their asset protection techniques. An extremely effective strategy combines the limited partnership and the APT. Such a structure might be implemented, for example, with you as a 1% general partner in the limited partnership, and your APT as the 99% limited partner.
Remember: The general partner writes the checks and makes all decisions for the partnership, while the limited partner (the APT) is passive. In this manner, you can retain direct control of the assets held in your limited partnership in your capacity as general partner, keep the assets here in the US if you wish, and at the same time utilize the additional protection afforded by the APT through its ownership of the limited partnership interest. How does this work? If there is concern that an unrelenting creditor may convince a result oriented judge or jury to pierce the partnership, then the trust, as a limited partner, will cause the liquidation of the partnership and move the assets offshore – beyond the jurisdiction of a U.S. court. If the partnership is liquidated, and the assets moved offshore in this manner, you can dictate that all trust accounts and assets must have both your signature and the trustee’s signature in order for any transfer to take place. This technique provides the security blanket for those who wouldn’t feel comfortable if the trustee had the sole signature authority over their funds.
US TAX CONSEQUENCES. Some unscrupulous or ignorant promoters have been claiming the APT can offer certain tax advantages by “going offshore”. As far as a US citizen or resident is concerned, nothing could be further from the truth. Simply put: There are no legitimate income tax advantages available to a US citizen or resident using an offshore trust of any kind. In the author’s opinion, those that promote such advantages are either ignorant of the law, or just don’t care what it says. Beware: If you follow the advice of such a promoter YOU will pay for his ignorance. Ideally, an APT should be set up as a “tax neutral” trust. This means that your income, estate and gift tax picture does not change as a result of establishing the APT, although it can offer the unified credit and marital deduction estate planning benefits typically found in traditional living trusts.
ALWAYS AVAILABLE? The APT planning discussed in this issue may not be available to you once someone makes a claim against you.Advance planning is crucial to effective utilization of the APT. Don’t wait until you have been sued to protect yourself! At best, your planning options will be reduced, at worst, you will be totally exposed to the creditor’s claim.