An offshore trust lets you protect your assets by moving them outside U.S. jurisdiction. With an offshore trust, your assets are owned by an offshore trustee company for your benefit. A U.S. state court does not have jurisdiction over an offshore trustee.
- Offshore trusts protect your assets by removing them from U.S. jurisdiction.
- It takes 2-3 months to set up an offshore trust.
- Offshore trusts are not as effective for IRS debt, criminal restitution, and family support obligations.
How Does an Offshore Trust Work?
An offshore trust is defined as a legal arrangement where a person transfers assets to a trustee that is located in another jurisdiction. The trustee manages these assets in the foreign jurisdiction on your behalf. The terms and conditions governing the trust’s management and asset distribution are outlined in the trust agreement.
An offshore trust protects assets from U.S. civil judgments primarily because its assets and 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. Creditors do not have legal means to levy upon or interfere with administering an offshore trust’s assets.
An offshore trust has three roles: a settlor, a trustee, and a beneficiary.
- Settlor (or Grantor):
- The individual or entity that establishes the trust.
- Transfers assets into the trust, effectively relinquishing direct control to achieve specific objectives, such as asset protection or estate planning.
- Determines the terms and conditions under which the trust will operate, typically outlined in the trust deed.
- Appointed by the settlor to manage and administer the trust’s assets.
- Holds a fiduciary duty to act in the best interests of the beneficiaries and according to the terms of the trust deed.
- It can be an individual, a corporate entity, or a combination of both. A licensed trust company should serve in this capacity.
- Individuals or entities designated to benefit from the assets held in the trust. In most cases, this is the settlor.
- They can be explicitly named or fall within a defined class (e.g., “descendants of the settlor”).
- The trustee must manage the trust’s assets in their best interest.
Using Another Entity
Many offshore asset protection plans involve more than one legal entity. For example, a U.S. resident can combine 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 some LLCs being organized in the Cook Islands.
What Are the Benefits of an Offshore Trust?
The key benefits of an offshore trust are that it provides (1) asset protection, (2) privacy, and (3) estate planning.
First, an offshore trust is one of the most powerful ways to protect assets from creditors and domestic judgments. U.S. creditors rarely have the resources or desire to chase a judgment debtor’s assets outside of U.S. jurisdiction. Few collection attorneys know how to initiate collection proceedings against offshore assets.
Second, outside of litigation, the general public cannot determine the beneficiary of the offshore trust. This keeps financial affairs private.
Finally, offshore trusts can be used with general estate planning to ensure that your assets go to designated beneficiaries upon your death without probate. The offshore trust agreement can accommodate estate tax planning to minimize estate tax liability.
In summary, here are the most important benefits of an offshore trust:
Offshore trusts are a component of offshore asset protection planning. Assets and business 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 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 protect movable intangible assets such as bank deposits, marketable securities, small businesses, limited partnerships, and LLCs. These assets may be effectively moved beyond U.S. court jurisdiction by changing ownership to the foreign trustee of a foreign trust.
These trusts can be tailored to meet specific estate planning objectives, allowing for the seamless transfer of wealth across generations, often with minimized tax implications.
Offshore jurisdictions often have stringent privacy laws, ensuring that the trust details, beneficiaries, and assets remain confidential. This discretion can be a decisive factor for those seeking to maintain a low profile regarding their financial affairs.
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Offshore Trust Disadvantages
An offshore trust is not without its drawbacks. Here are the major ones:
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 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.
Establishing and maintaining an offshore trust often involves higher costs than domestic trusts. These include trustee fees, legal advisory costs, annual reporting expenses, and other administrative charges.
Once assets are transferred into an offshore trust, the settlor relinquishes direct control in most trust structures. While this is part of the protective nature of the trust, it can be discomforting for some.
How to Set Up an Offshore Trust
An offshore trust protects assets by placing them in a legal entity established in a foreign jurisdiction.
Here are the steps to creating an offshore trust:
- Complete the trustee application.
- Fill out the FATCA, W9, and Know Your Customer documents
- Draft and sign the trust documents.
- Open a bank or brokerage account in the trust.
- Transfer assets to the trust. This is called funding the trust.
Understanding Offshore Trusts
For most people, the Cook Islands is the best offshore trust country. It 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 in some situations.
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.
All offshore trustee companies perform a background check (referred to as a “know your customer” inquiry) on all grantors and beneficiaries of the offshore trust. The trustee company will use software and third-party investigators to verify your identity, investigate your current legal situation, and confirm the source of assets being transferred to the trust. Trustee companies do not want clients who may involve the company in government investigations or litigation, such as disputes involving U.S. government agencies or the Department of Justice.
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.
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.
The final step in offshore trust formation is 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.
How Are Offshore Trusts Taxed?
An offshore trust is not taxable in most cases. Offshore 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.
When a U.S. resident establishes an offshore trust, the IRS is primarily concerned with whether the trust can be classified as a “grantor trust” or a “non-grantor trust.” This distinction is vital for tax purposes:
- Grantor Trusts: If the trust is deemed a grantor trust, it means the person who established the trust (the settlor or grantor) retains certain levels of control or benefits from the trust. In these situations, the U.S. grantor is taxed directly on the trust’s worldwide income, irrespective of whether the income is distributed to beneficiaries. The trust’s income is treated as the grantor’s personal income for tax purposes.
- Nongrantor Trusts: If the trust does not qualify as a grantor trust, it’s considered a non-grantor trust. This distinction means the trust itself is a separate tax entity. Generally, U.S. beneficiaries receiving distributions from such trusts might be subjected to a “throwback tax” on accumulated income when it’s distributed. This can result in significant tax implications for the beneficiaries.
U.S. Beneficiaries and Offshore Trusts: U.S. beneficiaries receiving distributions from a foreign trust must be wary of the tax consequences. They are generally taxed on distributions they receive, depending on the nature and source of the distribution. However, the rules determining the amount and type of taxable distribution are complex. Additionally, U.S. beneficiaries must report their involvement with foreign trusts.
Foreign Reporting Requirements: Aside from the direct tax implications, U.S. residents must adhere to a layer of reporting requirements if they have connections to foreign trusts. This includes the Report of Foreign Bank and Financial Accounts (FBAR) if they have a financial interest in or signatory authority over foreign financial accounts, including some types of trusts.
Tip: Make sure you fully understand the legal details of an offshore trust structure before moving transferring your assets. An asset protection plan is less effective when the judgment debtor does not fully understand all its legal components.
How to Protect Real Estate With an Offshore Trust
Although an offshore trust effectively protects financial assets, protecting U.S. real estate is more challenging. Financial assets and personal property may easily be moved offshore to be titled in an offshore trust or LLC. Real estate is fixed in its physical location and may not be transported to a foreign jurisdiction.
Florida and most states recognize a general legal rule that makes real estate subject to the laws and courts of the place where the real estate is physically located. Changing the real estate title to an offshore legal entity will not remove the property from the jurisdiction of the courts where the property lies.
To solve the challenge of protecting real estate, offshore trust structures can use a legal technique called equity stripping.
Equity stripping is a lending structure that “strips” the equity from the property. In an equity stripping plan, the property net-value, or equity, is encumbered by a foreign lender that acquires rights in the property that are superior to the interest of subsequent judgment creditor.
This plan essentially converts your equity, or profit, in your real estate to cash, and protects the cash in the offshore trust as long as you anticipate a legal problem in the U.S.
The most well-known jurisdiction for offshore trusts is the Cook Islands. Cook Islands trust laws allow you to use equity stripping to protect their domestic real property.
How Equity Stripping Works in an Offshore Trust
Here are the steps to protect real estate with an offshore trust:
- You establish the offshore trust.
- An offshore bank agrees to loan money to you.
- Loan proceeds are placed in the offshore trust’s account.
- You give a mortgage in favor of the offshore bank.
First, you establish an offshore trust. You and your family are the trust beneficiaries. A foreign individual or foreign trust company serves as the initial trustee. Moveable trust assets, such as cash and securities, are held in foreign financial institutions.
Second, the trustee of the offshore trust facilitates a loan from an offshore bank to you or to a Nevis LLC you have formed to hold an operating business or other assets. The loan amount and interest rate are based on the real estate equity and the type of real estate asset. The foreign bank typically will loan you at least 80 percent of the real estate’s equity.
Third, the loan proceeds are placed in your offshore trust’s financial accounts. The trustee typically uses the funds to purchase a Certificate of Deposit or similarly risk-free financial instrument. The interest earned is applied to pay the loan interest. In most instances, the interest rate charged by the bank for the loan is less than the interest you earn on the CD. Additional loan interest due, if any, is paid from the offshore trust.
Fourth, you or your Nevis LLC gives a mortgage in favor of the offshore bank to secure repayment of the loan. The bank records the mortgage in the county where the real estate is located. The mortgage serves as a protective blanket over the property. A judgment creditor would not benefit from a foreclosure on your real property because the foreign bank would be in the first position to either acquire the property or proceeds from its sale.
How to Unwind the Equity Stripping Structure
Once you no longer anticipate future legal issues, your offshore trustee may liquidate the C.D. and use the C.D. proceeds and other trust money to pay off the foreign bank’s mortgage. Title to the property may then be transferred back to your personal name or your domestic LLC.
Is Equity Stripping a Fraudulent Transfer?
Transactions that are found to be fraudulent transfers may be reversed by a U.S. judge. Remember that U.S. courts retain control over any real property in their jurisdiction. A U.S. court may reverse a title transfer or mortgage that they find is a fraudulent transfer designed to hinder or delay judgment creditors.
For example, if you would transfer legal title to your U.S. real estate to your offshore trust without receiving anything of value in return, a U.S. court would likely reverse the transaction if your transfer appeared to be done to avoid judgment collection.
One effective defense to a fraudulent conveyance allegation is the receipt of reasonably equivalent value for the transfer. A simple example is when you sell an asset and receive reasonable amounts of money in consideration for your transfer of the asset to a buyer.
In offshore equity stripping, the debtor is transferring a security interest in real estate (the mortgage), and the debtor is receiving cash based on the property value. The equity stripping plan should not be unwound as a fraudulent transfer because the property owner is receiving money in exchange for the creation of mortgage security in favor of the lender. The transaction is a typical commercial mortgage loan transaction, the main difference being that the lender is a foreign bank.
How Much Does Equity Stripping with an Offshore Trust Cost?
Offshore equity stripping first requires an underlying offshore asset protection trust. That requires separate legal and trustee fees. The costs of equity stripping through the offshore trust are comparable to other commercial loans through U.S. banks. These costs include:
- Lender origination fees (points) in the range of one to two percent.
- Lender annual administration fees.
- Mortgage interest if mortgage payment exceeds interest earned.
- Legal fees.
- Mortgage recording fees and taxes where the property is located.
Offshore Trust Bank Accounts
An offshore trust can have a bank account. It’s common for offshore trusts to have bank accounts in the jurisdiction where the trust is established or in other foreign jurisdictions to hold and manage the trust’s assets.
One of the primary reasons for establishing an offshore trust is to provide asset protection. Holding assets, including cash, in a bank account in the trust’s name can help shield those assets from potential creditors or litigants in the settlor’s home country.
Significant reporting requirements are associated with foreign bank accounts for U.S. persons (and residents of many other countries).
The choice of bank and jurisdiction can affect the trust’s confidentiality, asset protection, and ease of managing the trust’s assets. Selecting a jurisdiction and bank with a strong reputation for stability, confidentiality, and adherence to international financial regulations is essential.
Should You Set Up an Offshore Trust?
An offshore trust can be extremely helpful for people seeking a high level of asset protection. An offshore trust can completely safeguard trust assets from domestic creditors and U.S. courts.
Offshore trusts are expensive and not for everyone. For many people, a domestic asset protection plan will be as effective for much less money. However, for some people facing difficult creditor problems, an offshore trust is the best option to protect significant assets.
Frequently Asked Questions
How much does it cost to set up an offshore trust?
An offshore trust typically costs between $15,000 and $25,000, which normally includes the first year of trustee expenses. The trustee will charge annual fees. Customizing the trust, such as having a trust protector or specialized estate planning provisions, will increase the costs.
A Cook Islands costs slightly more than an average offshore trust: typically $15,000 to $35,000. These numbers include legal fees plus the initial fee with the Cook Islands trustee company.
What’s the Best Place to Form an Offshore Trust?
For most people, the Cook Islands is the best place to form an offshore trust. Other offshore trust jurisdictions include Nevis, the West Indies, and Hungary. Each of these countries has trust statutes favorable for offshore asset protection.
There are subtle legal differences among offshore trust jurisdictions’ laws, but they have more features in common. The trustmaker’s choice of the country depends mostly on where the trustmaker feels most comfortable placing assets and the trustmaker’s current legal situation.
How are Offshore Trusts Taxed?
Tax treatment of foreign offshore trusts is very specialized. You should talk to a CPA experienced with offshore trust taxation to better understand the tax consequences of an offshore trust, especially if the offshore trust will generate income or own a business.
How safe is an Offshore Trust?
An offshore trust is a safe asset protection tool when the trust county thoroughly regulates its trustee companies. For example, in the Cook Islands, offshore trust companies must comply with local laws regarding trust management and privacy. Many offshore trust companies are insured by reputable U.K. institutions.
Can Someone Set Up an Offshore Trust If They Already Have a Judgment?
Most Cook Islands trustee companies will not accept new offshore trust clients already subject to a civil judgment. On the other hand, if a person is a defendant in a lawsuit but not yet subject to a judgment, the trustee will “carve out” or make an exception to their trust protection for any future judgments related to existing litigation.
People with existing civil judgments may find protection through trusts in the European Union or elsewhere. For example, Hungary has trust laws designed with asset protection benefits, and Hungarian trustee companies do not typically refuse or make exceptions for clients with current civil judgments.
Can a Judge Order You to Bring Back Offshore Trust Assets?
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. 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 transferring 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.
How long does it take to set up an offshore trust?
About 2-3 months. You have to file an application with the offshore trustee and pass a background check. Then, you’ll sign the trust agreement and transfer assets to the trust.
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