Offshore asset protection is the set of legal tools that allow a person to safely place their assets outside of the reach of U.S. creditors. Offshore asset protection can include offshore trusts, foreign real estate, bank accounts, brokerage accounts, and personal items held at an offshore safe deposit box. Most people first think of offshore asset protection when they consider asset protection planning.
What Is Offshore Asset Protection?
Offshore asset protection is a legal strategy that involves moving assets to a foreign jurisdiction to protect them from creditors, lawsuits, and other legal claims. Offshore asset protection trusts are foreign trusts that US citizens can legally establish to hold and protect their assets. Because these trusts are created offshore (outside the US), they will be governed by the laws of the foreign jurisdiction rather than the laws of the US. The foreign jurisdiction will require a person seeking to go after the assets in an offshore asset protection trust within their jurisdiction to jump through several hoops in order to try to pursue enforcement.
Offshore asset protection includes the use of legal tools such as LLCs and trusts in jurisdictions that have debtor-friendly laws. There are several of these financial haven jurisdictions that cater to foreign investment. They do this by creating legal statutes dedicated to protecting the assets of investors.
Offshore asset protection trusts provide protection for most entities, including corporations, limited liability companies (LLCs), and limited partnerships. When a legal attack strikes, it is best to convert these domestic companies into foreign ones. This is because domestic judges have jurisdiction over domestic companies.
Benefits of Offshore Asset Protection
Offshore asset protection offers various levels of taxation, confidentiality, and other monetary advantages. The primary reason for most people to set up an offshore trust is to protect their assets with a highly secure financial structure in an offshore jurisdiction. Offshore asset protection trusts are the go-to asset protection tools recommended by most asset protection attorneys.
Other benefits of offshore asset protection include tax reduction, financial privacy, flexibility, estate planning and avoidance of probate, greater investment freedom, and protection against aggressive competitors, raiders, and adverse economic/political situations in today’s world.
Offshore asset protection trusts are not only for the wealthy. They are also for people who want to protect their assets from lawsuits, creditors, and other legal claims. Offshore asset protection trusts can be set up in a variety of jurisdictions, including the British Virgin Islands, the Cayman Islands, and the Cook Islands.
In summary, here are the most important benefits of offshore asset protection:
- Legal protection. Offshore asset protection makes it much more difficult for a U.S. creditor to collect on a monetary judgment. Foreign financial accounts are either impossible or nearly impossible for a domestic creditor to reach.
- Privacy. Offshore asset protection allows a U.S. individual to place their assets outside the searches of U.S. people, companies, and government entities.
- Diversification. Holding assets in multiple jurisdictions allows U.S. individuals to diversify their asset protection strategy. The judgment creditor is forced to engage in multiple jurisdictions, which is extremely expensive and time-consuming.
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Disadvantages of Offshore Asset Protection
Offshore asset protection has some key disadvantages. The biggest disadvantage is the cost. Establishing and maintaining an offshore trust or other offshore entity can be expensive. You will need legal and financial professionals to assist in creating the offshore structure. Offshore trustees and registered agents will charge annual fees. And offshore financial institutions will likely charge you to maintain your accounts.
In addition, offshore asset protection carries a perception of secrecy and tax avoidance. While it is legal to use offshore entities to protect your assets, some individuals and businesses have used these strategies to hide their assets and avoid paying taxes. As a result, some people may view offshore asset protection as unethical or even illegal, potentially damaging your reputation and public image.
Finally, offshore asset protection can be subject to political risks. If the country in which the trust is established experiences political instability, the assets may be difficult to access.
Offshore planning is less effective in bankruptcy than it is in state court collection cases. State courts have jurisdiction over assets located in their particular state. Bankruptcy courts have jurisdiction over assets worldwide. Transferring assets to foreign accounts owned by an offshore entity does not remove these assets from the reach of the bankruptcy trustee. The bankruptcy court may issue orders affecting title to assets located outside the U.S. A trustee may order the debtor to take affirmative steps to turn over the assets. The bankruptcy judge may hold a debtor in contempt subject to imprisonment if the debtor does not comply with the court’s turnover order.
U.S. citizens are subject to income tax on income earned anywhere in the world. Taxpayers must report all income earned by assets held in offshore financial accounts. Offshore asset protection planning will not reduce, avoid, or defer any U.S. taxation. Some U.S. businesses obtain a legitimate tax advantage by conducting active businesses wholly outside the U.S. Still, these tax strategies do not apply to individuals’ passive income from investments held outside the U.S.
In a divorce, both spouses must fully disclose, under oath, all their assets wherever located. Disclosure of U.S. financial accounts will reveal transfers of assets to offshore entities. All the spouse’s assets are considered in the court’s equitable distribution of marital assets. Therefore, whatever assets a spouse holds in an offshore jurisdiction will factor into the court’s division of U.S. assets. Generally, the more assets a spouse holds offshore, the fewer domestic assets will be awarded to that spouse in the equitable distribution of marital assets.
Many people believe that asset protection planning is based upon or involves hiding assets. They assume that creditors will not know about assets held in offshore entities run by offshore trustees. Because U.S. taxpayers report all offshore income, your tax returns will reveal offshore financial accounts which generate income. Offshore accounts may provide privacy and a lower “financial profile” in general business dealings. Still, once litigation commences, and certainly after a judgment is awarded, offshore accounts do not hide assets.
Not for Everyone
Many books and websites have been published to promote offshore planning for asset protection. Many experts, both attorneys and financial planners, promote complicated and expensive foreign-based asset protection entities. Many people are eager to accept offshore planning as the ultimate, albeit expensive, solution to their legal exposure.
In practice, offshore planning is usually not the best asset protection tool. Most U.S. debtors can adequately protect themselves using the many exemptions provided by state law. However, in some circumstances, offshore asset protection may be the right option.
How to Set Up Offshore Asset Protection
Offshore asset protection uses legal entities in favorable foreign jurisdictions under the control of trustees or managers who are neither United States citizens nor persons having a business presence in the United States. The purpose of offshore planning is to move creditors’ judgment collection to jurisdictions beyond the reach of the United States courts. Offshore planning promises asset protection because certain countries do not recognize judgments rendered by U.S. courts. For judgment creditors to reach assets in such jurisdictions, a creditor must start over and institute a lawsuit against the defendant to establish a new judgment in the foreign court system.
The second purported advantage of offshore planning is that favorable offshore jurisdictions have a relatively short statute of limitations on fraudulent transfer claims. Domestic asset protection is often vulnerable to a creditor’s allegations that the debtor has transferred assets, or has converted one type of asset to another asset, to defraud or delay the creditor’s collection. Most states have a four-year statute of limitations, which means that a creditor’s attorney can attack asset transfers or conversions up to four years after the transfers. In favorable offshore jurisdictions, the statute of limitations for fraudulent transfer is only two years. The shorter statute of limitations makes it easier for debtors to delay collection until after the statute of limitations has expired to challenge asset protection transfers.
The most popular offshore legal tool is the offshore asset protection trust. The offshore trust resembles a typical U.S. trust except that the offshore trust is a “self-settled trust” where the settlor and the beneficiary are the same person. In addition to asset protection benefits, self-settled offshore trusts transfer assets between generations free of probate.
A more cost-effective offshore asset protection vehicle is the Nevis limited liability company. The Nevis LLC is simpler and less costly than an offshore trust, but it provides comparable asset protection. Nevis LLC law permits the U.S. owner to serve as manager, although the owners will most likely resign in favor of a foreign manager if the owner perceives future legal liability.
Best Offshore Asset Protection Jurisdictions
The Cook Islands and Nevis are the jurisdictions with the most favorable asset protection laws in the world. In particular, the Cook Islands trust is considered the world’s most effective and safest offshore asset protection structure. The Cook Islands have a long history of favorable case law that provides legal assurance that a U.S. debtor’s assets will be well protected under its laws.
Other than the Cook Islands, some people also form trusts and LLCs. A Nevis LLC is especially effective as part of an overall offshore asset protection structure. Unlike the Cook Islands, Nevis has a shorter statute of limitations for fraudulent conveyances, and Nevis requires creditors to post a bond in order to enforce a foreign judgment.
In summary, people often regard the Cook Islands as the best jurisdiction for offshore trusts and Nevis as the best jurisdiction for offshore LLCs.
Taxation of Offshore Entities
Any offshore asset protection requires IRS tax filings to report and disclose the ownership of foreign entities and money held, directly or indirectly, in foreign bank accounts, such as a Swiss bank account. The tax filings are informational, and offshore asset protection planning does not reduce or increase U.S. income tax liability.
Any type of offshore asset protection is complicated because of IRS reporting requirements applicable to foreign entities. People considering offshore asset protection should consult with a tax attorney or a CPA experienced in international tax law.
There are severe penalties for failure to comply with foreign entity reporting requirements. The tax reporting requirements are one of the reasons we usually try to accomplish asset protection with domestic tools under Florida exemptions before recommending more sophisticated offshore entities.
Limited Liability Companies
A single-member domestic limited liability company is by default a disregarded entity for tax purposes. The domestic LLC on the entity level reports nothing to the IRS and is not required to get a separate tax number. Any domestic LLC is a disregarded entity unless it elects a different tax status by filing Form 8832 with the IRS. A single-member foreign LLC established by a U.S. resident must file Form 8832 to claim a disregard entity status. If this form is not filed timely, the LLC may be treated as a C-corporation and subject to corporate taxation. In addition, after electing disregarded status, the offshore LLC must file information Form 8858. Offshore entities taxed as a partnership or corporation have different filing requirements.
U.S. taxpayers, domestic trusts, or domestic corporations must report any transfers to a foreign corporation by filing IRS Form 926. A U.S. taxpayer who directly or indirectly owns any interest in certain foreign corporations may have to file IRS Form 5471.
Any U.S. taxpayer that controls a foreign partnership must file Form 8865. A person controls a partnership if they hold more than 50 percent of the partnership interests. If no partner has a controlling share, then all partners with more than 10 percent partnership interest must file Form 8865. In addition, U.S. taxpayers who acquire or dispose of partnership interests in a foreign partnership must disclose the transaction to the IRS. Most foreign LLCs with two or more persons are foreign partnerships for tax purposes.
Reporting Foreign Bank Accounts and Financial Accounts
Most people who create offshore entities have the entity maintain a bank account outside the U.S. The people are required to notify the IRS about their offshore financial accounts by filing a form TDF90-22.1. Plus, U.S. taxpayers must disclose all offshore financial accounts for which they have signatory authority or for which they have control over a third party who has signatory authority by filing Form TDF90-22.1. For example, if you appoint someone to be a manager of your foreign LLC, and the manager maintains a financial account offshore, you must file a tax reporting form. The TDF90-22.1 form is due on or before June 30 of each year, and there are no extensions. Offshore accounts also must be disclosed on your 1040 income tax return in Part III of Schedule B. Willful non-compliance is a criminal offense.
About the Author
Jon Alper is an expert in offshore asset protection planning for high-net-worth individuals.
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