How an Offshore Trust Works

Offshore trusts are specialized legal arrangements that provide significant advantages for asset protection, estate planning, and privacy. They are established under the laws of a foreign jurisdiction that offers favorable conditions for safeguarding assets.

What Is an Offshore Trust?

An offshore trust is essentially a trust managed in a jurisdiction outside of the settlor’s country of residence. It is similar to a domestic trust in structure, but is governed by the laws of the country in which it is established.

This type of trust is used for asset protection as it can help shield assets from judgment creditors.

How Does an Offshore Trust Work?

An offshore trust can protect your assets by removing them from U.S. courts’ jurisdiction.

Offshore trusts are among the best-known offshore asset protection planning tools. They are “self-settled trusts,” which means the trustmaker and beneficiary are the same. The trustmaker appoints a trustee who is either a citizen of a foreign country or a trust company with no U.S. office or affiliation.

Offshore trusts are most effective when protecting movable intangible assets such as bank deposits, marketable securities, small business stock, limited partnership interests, and LLC interests. These assets may be effectively moved beyond U.S. court jurisdiction by changing ownership to the foreign trustee of a foreign trust.

Offshore Trust Provisions

Here’s what should be included in an offshore trust:

• The trust is irrevocable.
• The U.S. debtor is the grantor but never sole the trustee.
• The trust provides the trustee the discretion to withhold payment from the beneficiary.
• The trustee is typically a foreign trust company or financial institution rather than an individual.
• Sometimes, a friend or financial advisor of the U.S. debtor serves as a trust protector. The plan best uses a trust protector who is not located in the United States.
• The trust expressly states that the location of the trust (called the situs) governs trust provisions.
• The sole asset of the trust is a 100% ownership position in a foreign LLC or other entity that can be controlled by the debtor when not under creditor duress.

Benefits of Offshore Trusts

1. Provides the highest level of asset protection.
2. Removes your assets from oversight of state courts.
3. Allows you to distribute your assets properly upon your death.

Offshore trusts are one of the most powerful tools to protect assets from creditors and domestic judgments. U.S. private creditors very rarely have the resources or desire to chase a judgment debtor’s assets outside of U.S. jurisdiction.

Very few collection attorneys even know how to begin to initiate collection proceedings against assets located offshore.

Secondly, outside of litigation, the general public will be unable to find out the beneficiary of the offshore trust. This keeps financial affairs more private.

Finally, offshore trusts can be used in conjunction with general estate planning to make sure that your assets go to designated beneficiaries upon your death. At the same time, the trust agreement can accommodate estate tax planning to minimize the risk of any tax liability.

Structuring an Offshore Trust

The best offshore trust structure is when the trust owns a foreign LLC.

Most offshore LLCs are formed in Nevis, which for some time has been a favored LLC jurisdiction. However, recent changes to Nevis tax and filing requirements have led to LLCs in the Cook Islands.

For example, a U.S. person could form a Nevis LLC and transfer their business interests and liquid assets to the LLC. The person could next establish a Cook Islands trust using an offshore trust company as a trustee. The LLC issues membership interests to the trustee of the Cook Islands trust. The Cook Islands trust would own 100% of the Nevis LLC. The U.S. resident could serve as the initial manager of the Nevis LLC with the option of appointing an offshore manager should the person ever become under legal duress.

With this type of offshore trust structure, the Nevis LLC is managed by the U.S. individual when there are no anticipated lawsuits. Once a legal issue arises, the trustee of the offshore trust should remove the U.S. individual as manager of the Nevis LLC and then appoint a successor manager that is also offshore.

The plan diversifies control over two separate jurisdictions instead of putting all the assets in either the LLC or the trust.

Steps to Creating an Offshore Trust

There are five steps to creating an offshore trust:

1. Select a jurisdiction.
2. Pick a trustee.
3. Pass a background check.
4. Draft legal documents.
5. Transfer the assets.

1. Select a Jurisdiction.

The first step to forming an offshore trust is selecting a trust jurisdiction. In our experience, the Cook Islands offers the best combination of trustee regulation, favorable debtor laws, and positive litigation outcomes compared to other jurisdictions. Nevis, W.I., Bahamas, Belize, and some countries in Eastern Europe are also good options.

2. Pick a Trustee

A U.S. citizen must hire a person or company based in a foreign trust jurisdiction to serve as a trustee. Many people do not know which offshore trust trustees are reputable. U.S. citizens typically hire a domestic trust company, or a U.S. asset protection attorney to help them find an offshore trustee in a suitable jurisdiction.

3. Pass a Background Check

All offshore trustee companies perform a background check on all grantors and beneficiaries of the offshore trust. The trustee company will use software to verify your identity and investigate your current legal situation in the U.S. Trust companies do not want clients who may involve the company in investigations or litigation, such as disputes involving the U.S. government.

You must disclose pending litigation and investigations as part of the background check. The trustee company may require that the trust documents carve out an exception for any pending litigation, and the trustee will not defend the trust against claims by the plaintiff in that matter.

Most people pass the background check without issue.

4. Draft Legal Documents

Your domestic asset protection attorney will work with the offshore trustee company to draft the offshore trust agreement. If you include other entities in the structure, such as a Nevis LLC, the attorney will also draft the agreements for those entities.

The trust agreement can be customized based on your asset protection and estate planning goals.

5. Transfer Assets

The final step in offshore trust formation transferring assets to the trustee of the offshore trust. If the trust owns an offshore LLC which will be owned by the offshore trust, then the trustmaker’s personal assets will be transferred to the LLC rather than the offshore trust.

The offshore trust structure works best when the trust assets are held offshore. The trustee company can assist in opening financial accounts for the trust or its wholly-owned LLC that are located in foreign jurisdictions.

Choosing an Offshore Trustee

Trustee selection is the most important part of offshore trust asset protection. The offshore trustee controls the trustmaker’s assets. The trustee must be competent, responsive, and trustworthy.

The offshore trustee can be a bank, a trustee company, or an individual in another country.

The trust plan works best when the trustee is a professional or a well-established and secure business, and most importantly, is willing to defend the offshore trust against attacks initiated by U.S. creditor collection. A person considering an offshore trust should investigate, and if feasible, personally meet with, a prospective foreign trustee before appointing them as trustee of their offshore trust.

There are reputable and experienced companies serving as trustees of offshore trusts. These companies carry insurance policies issued by well-known insurance companies that insure their customers against loss from negligence and criminal acts of the trustee’s agents and employees. Some trust companies are also audited by national U.S. accounting firms, and they offer the audit results and their insurance certificates to prospective offshore trust clients.

Keeping Control of Assets in an Offshore Trust

Most people would like to retain control of their own assets held in their offshore trust by having the power to remove and replace the trustee.

Retaining the power to change an offshore trustee creates legal risks. A U.S court may not have direct authority over assets held offshore, but the court does retain personal jurisdiction over the trustmaker who resides in the United States.

A judge could order the debtor to exercise their retained rights to substitute a creditor agent for the current offshore trustee. Therefore, offshore trust asset protection works best if the trustmaker has no control over trust assets or other parties to the trust. The trustmaker should not retain any powers that they could be forced to exercise by a U.S. court order.

Some trustee companies permit the trustmaker to reserve primary discretion over trust investments and account management in the position of trust advisor.

This arrangement gives the trustmaker some control over assets conveyed to the trust, and the trustmaker can give up rights if they are threatened with legal action, leaving the offshore trustee in sole control. Another option is for the trustmaker to name a trust protector who is not subject to U.S. court jurisdiction. The trust protector can remove a trustee who is not responsive or who is not taking good care of trust assets.

Offshore Trusts for Florida Residents

Offshore trusts provide enhanced asset protection for Florida residents. However, Florida residents often have access to strong, less expensive techniques provided by state law. Florida residents should consider an offshore trust only when state-level protections are insufficient.

Contempt Orders with Offshore Trusts

The possibility of turnover orders and civil contempt charges is a significant risk in offshore asset protection. Debtors relying on offshore trusts should consider the possibility of a domestic court order to bring back assets transferred to a debtor’s offshore trust.

The impossibility of compliance is a defense to civil contempt. A court will not imprison someone for failure to do something that can’t be done. In instances when a court orders a debtor to unwind an offshore trust plan, the debtor can claim that compliance is impossible because the trust is under the control of an offshore trustee.

But it’s not as simple as invoking an impossibility defense and saying, “I can’t.” Some recent court decisions treat a transfer of assets to an offshore trust as an intentional act of creating an impossibility. The courts then disallow the impossibility defense to the contempt order because the impossibility is of the debtor’s own making.

Offshore Trust Taxation

Offshore trusts are taxed as grantor trusts. They do not reduce or avoid U.S. income taxation.

A grantor trust is a trust whose taxable income is reported by the grantor so that the trust is disregarded for U.S. tax purposes. The trustmaker must report all trust income, including capital gains, on their personal tax return as ordinary income. This taxation treatment applies regardless of whether the assets themselves are in the United States or offshore.

In addition, there are IRS reporting requirements for trustees and beneficiaries of offshore trusts. In 1996, Congress imposed substantial penalties for failure to report offshore trust financial information. A trustmaker must work with a CPA experienced with foreign trust reporting and taxation.

Frequently Asked Questions

Below are answers to some commonly asked questions about offshore trusts.