How an Offshore Asset Protection Trust Works
An offshore asset protection trust is a legal structure created in a jurisdiction 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.
An offshore trust is one of the best-known offshore asset protection planning tools. Most often, an offshore trust is a “self-settled trust” where the trustmaker and the beneficiary are the same. 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.
Requirements for Offshore Trust
Here are the seven requirements for an offshore asset protection trust:
- The trust must be irrevocable.
- The U.S. debtor cannot be the trustee.
- The trust must provide the trustee the discretion to withhold payment from the beneficiary.
- The trustee must be a foreign trust company or financial institution rather than an individual.
- If using a trust protector, the trust protector cannot be located in the United States.
- The trust must state that the location of the trust (called the situs) governs trust provisions.
- The trust must own the assets either directly or through a foreign entity such as an LLC that the debtor can control when not under legal duress.
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A Cook Island offshore trust provides several advantages to a U.S. judgment debtor, including:
- Asset protection. 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.
- Confidentiality. Outside of litigation, the general public will be unable to find out the beneficiary of the offshore trust. This keeps financial affairs more private.
- Estate planning. 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.
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.
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.
Cook Islands Asset Protection Trust
The most well-known version of an offshore trust is the Cook Islands asset protection trust. The use of offshore asset protection trusts began in the Cook Islands in the 1980s and 1990s after the Cook Islands developed an extensive statutory framework to protect trust assets from creditors. Since then, other jurisdictions such as Nevis, Belize, and the Bahamas, have enacted similar statutes.
An offshore asset protection trust involves unrelated third parties serving as trustees, trust advisers, or trust protectors. The trustee has the responsibility and the trust powers to administer the offshore trust and its assets, but they have no beneficial interest in trust property. A trust protector can be given the power to change trustees, reallocate beneficial interests, or direct the investment of trust assets. Advisors may be foreign or U.S. persons who have the authority to direct the investment of trust assets.
An offshore trust protects a U.S. debtor’s 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. Creditors do not have legal means to levy upon or interfere with the administration of an offshore trust’s assets.
To levy or garnish offshore trust assets, a U.S. judgment creditor would have to re-litigate the underlying U.S. lawsuit in the foreign courts and obtain a new foreign judgment. This is difficult, expensive, and rarely done.
What is a Cook Islands Trust?
A Cook Islands trust is an offshore trust that is created under the laws of the Cook Islands using a Cook Islands trustee. The Cook Islands are located in the South Pacific (same time zone as Hawaii). Cook Islands trust companies are licensed and regulated by the Cook Islands government. Cook Islands law imposes strict procedures and qualifications on Cook Islands trust companies.
The Cook Islands were actually the first jurisdiction that 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.
Example of Cook Islands Asset Protection 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.
Tip: Make sure you fully understand the offshore trust structure before moving forward with it. An asset protection plan is less effective when not understood by the judgment debtor.
How to Set Up an Offshore Trust
Here are the 5 steps to forming an offshore trust:
- Select a jurisdiction with favorable offshore trust laws.
- Pick a trustee company to serve as trustee of the offshore trust.
- Provide all required documents for the trustee’s due diligence.
- Draft the offshore trust document with your attorney.
- Fund the trust by transferring domestic assets to the offshore accounts.
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.
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.
Important: A federal court, particularly a bankruptcy court, is more likely to disallow the impossibility defense.
Example of Debtor Held in Contempt
Most offshore asset protection plans, and similarly complicated domestic plans, do not hold up if a motivated creditor pursues its attacks through a vigorous legal challenge. Most appellate courts will not sustain the promised protection of offshore planning.
One example is an order from a Minnesota appeals court. The Fannie Mae corporation obtained a money judgment against the debtor. The debtor had transferred over $7 million to an offshore trustee. The trustee then transferred the same money to a foreign LLC of which the debtor was the sole member.
The court ordered the debtor to bring back the money to pay the Fannie Mae judgment. The debtor wrote a letter to the offshore trustee asking the trustee to turn over the funds. The offshore trustee refused, and he said that the money had been invested in the LLC.
The court held the debtor in contempt of court. The court found that despite the refusal by the offshore trustee, the debtor still had the ability to access the funds as the sole member of the LLC. The court considered other evidence of the debtor’s motives to shield the money and his previous access to the offshore trust assets.
For every case involving offshore planning that is fully litigated in court decisions and appeals, there are many more instances that are resolved by the parties before a court decision. Even though a creditor may eventually penetrate an offshore asset protection plan, the collection process is very time-consuming and expensive. Most collection cases involving offshore planning and similarly complex asset protection plans are settled before they are decided by an appeals court. Most creditors make the business decision to accept part of their judgment award in settlement rather than engage in multi-year litigation efforts against a debtor’s complicated asset protection involving offshore entities.
This case described above did not involve an ordinary creditor. Fannie Mae has more resources than typical judgment creditors. Many other court decisions finding debtors in contempt for their offshore trust planning involved federal agencies with even more time and legal resources. Private creditors, even larger private corporations, are more amendable to settle collections against debtors with complicated and effective asset protection plans. There is no asset protection plan that can deter a highly motivated creditor with unlimited money and patience, but a well-designed offshore trust often gives the debtor a favorable settlement.
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.
Is Offshore Asset Protection 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 $1,000 to $5,000 per year plus hourly rates for extra services.
Offshore asset protection is 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.
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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.
Key Points About Offshore Trusts
There are ten important considerations regarding offshore asset protection trusts:
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.
2. Offshore trusts are less effective in personal bankruptcy because bankruptcy courts have jurisdiction over a debtor’s assets wherever they are located worldwide.
3. Offshore asset protection trusts are 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 the trustmaker. The courts may try to compel a trustmaker to dissolve a trust or bring back trust assets.
5. The trustmaker must be willing to give up legal rights and control over their 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 an offshore trust is more important than selecting an offshore trust jurisdiction. Trustmakers should interview, and if possible, personally meet prospective trustees of their offshore trusts.
7. Offshore trusts are irrevocable. The trustmaker 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 the trustmaker’s 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. People who “buy” an offshore trust package from a non-attorney company will likely not have effective asset protection.
10. Offshore trusts are complicated and expensive. Most Florida residents can achieve asset protection with traditional asset protection tools.
Important Court Cases
In re Lawrence, 279 F. 3d. 1274 (11th Cir. 2002): Civil Contempt Can Defeat Offshore Trust Plan
A bankruptcy court may use powers of civil contempt to compel a debtor to repatriate assets from an offshore trust established to defraud creditor collection. Bankruptcy courts have jurisdiction over debtor’s foreign assets. The alleged impossibility of the debtor’s compliance with a court order is not a viable defense when the debtor created the impossibility.
But see a different result with a more favorable outcome of an offshore trust plan:
- In re Rensin, 600 B.R. 870 (Bankr. S.D. Fla. 2019)
Frequently Asked Questions
Below are answers to some commonly asked questions about offshore trusts.
How does an offshore trust work?
An offshore trust works by transferring legal title of a person’s assets over to a trustee of a trust located outside the United. Both the assets and the trustee will be outside the jurisdiction of a U.S. civil court. A civil creditor would have to spend a lot of time and money pursuing the offshore trustee—and even then, there is no guarantee of success.
Ultimately, having assets in an offshore trust provides the U.S. debtor substantial leverage in the settlement of a civil money claim. Offshore trusts do not work as well in bankruptcy proceedings or for liabilities other than monetary judgments. Learn more about overall asset protection planning.
How much does it cost to set up an offshore trust?
An offshore trust typically costs between $12,000 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, will increase the costs.
What’s the best place to form an offshore trust?
There are many academic publications and articles discussing the relative merits of various offshore trust jurisdictions. Common offshore trust jurisdictions include the Cook Islands, Nevis, the West Indies, and Hungary. Each of these countries has trust statutes that are 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 country depends mostly on where the trustmaker feels most comfortable placing assets.
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.
About the Author
Jon Alper is an expert in asset protection planning for individuals and small businesses.