What is an Offshore Asset Protection Trust?
Offshore asset protection is a legal, effective strategy that involves forming a trust or business entity in a favorable foreign jurisdiction, such as a Cook Islands trust or a Nevis LLC. These entities are placed under the control of trustees or managers who are not United States citizens and do not have a business presence in the United States. People with high liability risks, such as physician or business owners, use offshore asset protection to move legal battles with creditors to jurisdictions beyond the reach of the United States courts.
Offshore Asset Protection Using a Trust
The offshore asset protection trust is the best known tool of offshore planning. Specifically, the Cook Islands trust is widely accepted as providing being the best type of an offshore trust. The Cook Islands has favorable trust law and established, reliable trustee firms. People often refer to an offshore trust and a Cook Islands trust interchangeably.
An offshore trust is a trust agreement that is both administered and holds assets in a jurisdiction outside the United States. The offshore asset protection trust is typically a “self-settled trust” where the trustmaker and the beneficiary are the same. In an offshore trust, the trustmaker appoints a trustee who is either an individual citizen of a foreign country or a trust company with no U.S. office or affiliation.
An offshore asset protection trust may have additional people serving as trust advisers or trust protectors. Advisors and protectors help administer and protect the offshore trust and its assets while having no beneficial interest in trust property.
Offshore Trust Jurisdiction
An offshore trust protects assets from U.S. civil judgments primarily because the trust’s assets and its trustee are situated beyond the legal reach of U.S. state and federal civil courts.
U.S. judges have no authority to compel an offshore trustee to take any action with trust assets. U.S. courts also lack legal means to levy upon or interfere with the administration of assets titled in the name of an offshore trust.
For a Cook Islands trust, the legal system of the Cook Islands does not recognize or abide by U.S. judgments and court orders. In other words, even if a U.S. court ordered a foreign trustee to turn over assets, the offshore trustee would refuse to do so and ignore the order.
To levy or garnish offshore trust assets, a U.S. judgment creditor would have to file and re-litigate the underlying U.S. lawsuit in the Cook Islands and obtain a new foreign judgment. This is impractical and expensive.
Ten Things to Know About an Offshore Asset Protection Trust
There are ten things you’ll want to know about an offshore asset protection trust:
1. Offshore trusts are designed to place the trust assets and trust parties beyond the jurisdiction of U.S. courts enforcing a domestic civil judgment. Offshore trusts offer asset protection if the trust assets, the trustee, and the trust protector all are located outside U.S. court jurisdiction.
2. Offshore trusts are less effective in personal bankruptcy because bankruptcy courts have jurisdiction to affect your assets wherever they are located worldwide.
3. Offshore asset protection trusts are also less effective against IRS collection, criminal restitution judgments, and family support obligations.
4. Even if a U.S. court does not have jurisdiction over offshore trust assets, the U.S. court still has personal jurisdiction over you, the trustmaker, and the courts may try to compel you to dissolve a trust or bring back trust assets if you retain control over the assets or the trustee.
5. You, the trustmaker, will have to relinquish legal rights and control over your trust assets for an offshore trust to effectively protect these assets from U.S. judgments.
6. Selection of a professional and reliable trustee who will defend your trust is more important than your selection of an offshore trust jurisdiction. You should interview, and if possibly personally meet, prospective trustees of your offshore trusts.
7. You cannot change the beneficiaries, trustees, or terms of an irrevocable offshore trust.
8. Offshore trusts are treated as “grantor trusts” for tax purposes meaning that trust income, including capital gains, is treated as your personal ordinary income for U.S. tax purposes.
9. Most internet information about offshore trusts, including most advertising of offshore trusts, is published by document preparation companies that are not attorneys and that do not employ their own attorneys. If you “buy” an offshore trust package from a non-attorney company, you likely will not have effective asset protection.
10. Offshore trusts are complicated and expensive. Consult with an attorney to see if you can both control and protect your assets with more traditional U.S. based asset protection tools before considering offshore trust planning.
Offshore Asset Protection Strategies
A complete offshore asset protection strategy generally involves an offshore trust owning an offshore LLC.
For example, a U.S. person could establish a Cook Islands using an offshore trust company as trustee. The Cook Islands trust would own 100% of a Nevis LLC. The U.S. person could serve as initial manager of the Nevis LLC with the option of appointing an offshore manager should the person ever become under legal duress. The Nevis LLC would own the assets.
The benefits of this offshore asset protection structure include:
- Assets in the Nevis LLC and Cook Islands trust remain protected under the most favorable and well-tested foreign jurisdiction laws.
- The U.S. person maximizes leverage when dealing with domestic creditors.
- Assets in the Nevis LLC are managed by the U.S. person when there is no legal duress. Once the legal issue arises, the trustee of the offshore trusts must remove the U.S. person 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 eggs in one basket of either Nevis or the Cook Islands.
- It is very difficult and expensive for a creditor to succeed in a fraudulent transfer attack in the foreign jurisdictions.
Cook Islands Trust
Trust companies located in the Cook Islands are licensed and regulated by the Cook Islands government. Cook Islands law imposes strict procedures, qualifications on Cook Islands trust companies.
The Cook Islands was actually the first jurisdiction the enacted favorable trust laws enabling U.S. residents to protect assets. When the Cook Islands enacted the International Trusts Amendment Act of 1989, it became the premier offshore trust jurisdiction. The law affords the utmost asset protection, while still maintaining flexibility and privacy for U.S. trust-makers. Cook Islands trust companies are reputable, experienced, and thoroughly competent.
The Cook Islands are located in the South Pacific—same time zone as Hawaii.
Types of Assets
Offshore asset protection trusts, such as a Cook Islands trust, are most effective when protecting financial assets, such as securities, LLC interests, and cash. Offshore trusts are not as effective when protecting real estate property located in the U.S.
Financial assets can be moved to an offshore financial company, but real estate cannot. Generally, real estate remains subject to the powers of the courts of the jurisdiction where the property is located.
Even if a debtor re-titles U.S. real estate in the name of an offshore trust, a U.S. court likely will still be able to affect the debtor’s equity and the property title because the property remains within the U.S. court’s geographical jurisdiction.
Instead, some debtors title U.S. real estate in an LLC or partnership owned by their offshore trust. Even this may not always work. Most courts will still impose collection remedies against the underlying U.S. real property.
A Cook Islands trust typically holds trust cash deposits at foreign banks that have no branches within the United States. The offshore trust may also hold securities at foreign financial institutions.
The trustmaker does not have direct access to the bank account, but he or she can request distributions from the offshore trustee. It is possible for the trustmaker to direct investments of foreign securities accounts titled in the name of the trust.
Most people prefer to retain control of their own assets held in their offshore trust by having the power to remove and replace the trustee. 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 U.S.
While a judgment creditor cannot levy directly on offshore trust assets, a creditor may ask the U.S. court to force the trustmaker to bring back to the U.S. offshore assets or to dissolve the trustmaker’s offshore trust.
Some U.S. judges have ordered a trustmaker to replace an offshore trustee or trust protector with someone selected by the creditor, or even to have the trustmaker direct the offshore trustee to send back trust assets to the United States.
Therefore, offshore asset protection trusts work best if the trustmaker has no control over trust assets or other parties to the trust. The trustmaker should not retain any powers that he could be forced to exercise by a U.S. court order.
Some trustee companies permit the trustmaker to appoint a U.S. based co-trustee with primary authority and responsibility to oversee trust investment and account management. This arrangement gives the trustmaker some controls over assets conveyed to the trust until the trustmaker is threatened with legal action when he can resign leaving the offshore trustee in sole control.
As a practical matter, the selection of a trustee is the most important decision in forming an offshore trust. The offshore trustee controls the trustmaker’s assets. The offshore trustee can be a bank, a trustee company, or an individual in another country.
The trust plan works best where the trustee is professional, reliable, and most importantly, is willing to defend the offshore trust against attacks initiated by creditor collection. A person considering an offshore trust should investigate, and if feasible, meet with personally, a foreign trustee before appointing them as trustee of their offshore trust.
A Cook Islands trust is especially vulnerable in bankruptcy. A bankruptcy debtor is responsible to surrender assets and any interest in assets wherever held. Bankruptcy courts have worldwide jurisdiction and are not deterred by foreign countries’ refusal to recognize general civil court orders from the U.S.
A U.S. bankruptcy judge may compel the bankruptcy debtor to do whatever is required to turn over to the bankruptcy trustee all of the debtor’s assets wherever located throughout the world, including the debtor’s beneficial interest in an offshore trust. Bankruptcy debtors who have refused such orders have been held in contempt and have been incarcerated.
How an Offshore Account Works
Many people believe that they can protect cash deposits from their creditors simply by opening an offshore bank account. If their money is an account at a bank with no U.S. branches or offices, a creditor will have difficulty garnishing the debtor’s bank account.
However, it is now very difficult for a U.S. citizen to open a foreign bank account. In practice, the easiest way to deposit money in a foreign bank is to first establish an offshore LLC or offshore trust. Then, the debtor can have a foreign LLC manager or trustee open the account in the name of the foreign entity. Foreign managers and trustees have relationships with banks that enable them to open accounts on behalf of their U.S. clients.
Offshore asset protection trusts will not reduce or avoid U.S. income tax. This is a common misconception. We do not recommend offshore trusts and offshore asset protection as a way to impact your tax liability.
Generally, a foreign irrevocable trust will be treated as a “grantor trust” regardless of whether the trustmaker reserved any powers associated with domestic grantor trusts. 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 as ordinary income all trust income, including capital gains, on his personal tax return.
This taxation treatment applies regardless of whether the assets themselves are in the Unites States or offshore.
In addition, there are substantial 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.
Is Offshore Asset Protection Worth It?
As offshore trusts have become more and more popular for asset protection, many clients wonder if offshore protection is worth it.
Offshore asset protection is not for everyone, and often a domestic asset protection plan will work just fine and for much less money. But for some people facing certain legal issues, it does remain the gold standard of asset protection. Before committing to an offshore plan, you should go over your particular circumstances with an asset protection attorney.
What to Do Next
We help people go through their assets and income and determine what is at risk of collection from a judgment creditor. We then develop a plan to protect any exposed assets from collection. If you’re interested in protecting your assets from monetary judgment creditors, contact us or schedule an appointment online.