How an Offshore Trust Works

What Is an Offshore Trust?

An offshore trust is a foreign legal structure created outside the United States that protects assets from domestic creditors. While not required, typically the offshore trust only holds assets outside of the United States as well. The most popular form of an offshore trust is the Cook Islands asset protection trust, which is a trust in the Cook Islands designed to protect all trust assets from U.S. creditors.

How Does It Work?

An offshore trust can protect your assets because it removes the assets from the jurisdiction of U.S. courts.

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.

To best protect assets from U.S. creditors, an offshore trust should include:

• 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.

Offshore Asset Protection

Offshore trusts are a component of offshore asset protection planning. Offshore asset protection is an asset protection tool that involves forming a trust or business entity in a favorable legal jurisdiction outside of the United States. Offshore assets 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 significant assets and higher risks of legal liability can employ offshore asset protection to move legal battles with creditors to jurisdictions beyond the reach of United States courts.

Benefits of Offshore Trusts

An offshore trust provides several advantages to a U.S. judgment debtor. First, 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.

In summary, here are the three most important benefits of an offshore trust:

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

Asset Protection

Offshore trusts are a component of offshore asset protection planning. Offshore asset protection is an asset protection tool that involves forming a trust or business entity in a favorable legal jurisdiction outside of the United States. Offshore assets 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 significant assets and higher risks of legal liability can use offshore trusts to move legal battles with creditors to jurisdictions beyond the reach of United States courts.

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.

Protecting Real Estate

On the other hand, offshore trusts are not as effective in protecting real estate located in the U.S. In general, real estate is 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 or an offshore LLC, a U.S. court will still have jurisdiction over the debtor’s equity and the property title because the property remains within the U.S. court’s geographical jurisdiction.

Offshore planning may protect U.S. property if the property is encumbered by a mortgage to an offshore bank. Offshore banks typically pay higher CD rates than U.S. banks. A prospective debtor can borrow funds from an offshore bank, hold the funds offshore in a CD, and secure the loan with a lien on the property. The CD interest would cover most of the loan expense. Alternatively, the loan proceeds may be held at a U.S. bank that is immune from garnishment, albeit earning lower interest rates but with more convenient access to the money.

Structuring an Offshore Trust

Many offshore asset protection plans involve more than one legal entity. For example, a U.S. resident can establish an offshore trust and a U.S. limited partnership or an offshore limited liability company.

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.

What Is the Best Offshore Trust Jurisdiction?

It is more important to select the best trustee than the best offshore trust jurisdiction. In fact, 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.

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 Trust Bank Accounts

Many people believe they can protect cash deposits from creditors by opening an offshore trust bank account. People assume that a judgment creditor cannot garnish their accounts at a bank with no U.S. branches or offices.

However, it has become difficult for a U.S. citizen to open a foreign bank account in their own name. Most reputable foreign banks do not accept U.S. citizens as individual bank customers. Secret bank accounts do not exist because of treaties between the U.S. and most countries following 9/11.

The way to deposit money in a foreign bank is to first establish an offshore LLC or offshore trust. Then, the debtor requests the foreign LLC manager or offshore trustee to 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 trustees usually maintain their client’s financial accounts at E.U. institutions that have no U.S. branches. E.U. financial institutions can purchase U.S. marketable securities and maintain bank accounts in U.S. dollars. The trustmaker does not have direct access to offshore trust financial accounts, but they can request distributions from the offshore trustee

Turnover and 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 asset protection trusts will not reduce or avoid U.S. income taxation. This is a common misconception. Offshore trusts are not an effective income tax planning vehicle.

Generally, a foreign irrevocable trust will be treated as a “grantor trust” for taxation purposes 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 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.

Are Offshore Trusts Worth it?

Offshore trusts are not cheap. Increasingly invasive “know your customer” (KYC) regulations have made establishing offshore entities more difficult. An offshore trustee usually investigates potential U.S. clients more fully than the U.S. client investigates possible offshore trustees. The increased scrutiny and KYC “red tape” have caused U.S. attorneys to increase their legal fees to establish an offshore trust plan.

After paying to set up the trust and conveying assets to the trustee, the trustmaker will incur annual administration fees. Trustee companies charge annual fees in the range of $3,500 to $5,000 per year plus hourly rates for extra services.

Offshore trusts are not for everyone. For most people living in Florida, a domestic asset protection plan will be as effective for much less money. But for some people facing difficult creditor problems, the offshore trust is the best option to protect a significant amount of assets.

Offshore Trusts and Bankruptcy

Debtors may have more success with an offshore trust plan in state court than in a bankruptcy court. Judgment creditors in state court litigation may be intimidated by offshore asset protection trusts and may not seek collection of assets in the hands of an offshore trustee. State courts lack jurisdiction over offshore trustees, which means that state courts have limited remedies to order compliance with court orders.

An offshore trust does not work as well if the U.S. debtor files bankruptcy. A bankruptcy debtor must surrender all their assets and legal interests in property wherever held to the bankruptcy trustee. 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 the debtor’s assets 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 incarcerated.

Frequently Asked Questions

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