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OFFSHORE ASSET PROTECTION TRUSTS | Trust Diagrams | Create Trust Worksheets

The ultimate wealth protection strategy is the Offshore Trust. In 1989, the Cook Islands passed the International Trust Act and since then several other offshore jurisdictions have followed suit, including the Bahamas, Bermuda, Cayman Islands, Nevis, St. Lucia and Turks & Caicos. Similar to the U.S. states which have enacted DAPT statutes, these foreign jurisdictions have enacted debtor-oriented statutes which recognize self-settled spendthrift trusts. In other words, even though the trust is structured to permit distributions to the settlor, the trust assets are protected against the settlor's creditors (see sources of liability).

An attack may still be made in the offshore jurisdiction for certain reasons, if brought within the appropriate statute of limitations period. Many of these jurisdictions, however, provide for a very short period in which to bring a challenge. If a challenge were brought within that period, a transfer could be upset, if it were proven that the transfer were made to hinder existing or reasonably forseeable creditors. If so, the offshore jurisdiction court could disregard the trust and allow the creditor to attach the trust assets transferred. Each jurisdiction has its own version of such a statute of limitations.

For example, assume that John is a Chicago pediatrician who establishes a Bahamian trust in 2002. In 2006, John is sued for $2 million. The lawsuit alleges malpractice in the treatment of plaintiff's child in 2003. John's liability insurance has a $1 million limit per claim. Before John expends much time or money defending the lawsuit, his attorney contacts the plaintiff's attorney and informs him that:

  • Most of John's nonexempt assets are in an Offshore Asset Protection Trust (OAPT) settled in the Bahamas.
  • The Bahamian courts will not recognize a judgment obtained in the U.S.
  • To reach the assets of the trust, the plaintiff will have to travel to Nassau, hire a Bahamian attorney at great expense, and litigate the claim, not on its merits, but on the basis of the Bahamian fraudulent transfer statute of limitations.
  • That the statute of limitations for bringing such an action (2 years in the Bahamas) expired in 2004 (two years from the transfer) and any such claim would be barred under Bahamian law.

The assets held by an offshore trust are out of the reach of the U.S. courts. There is no full faith and credit issue involved with these foreign jurisdictions. Therefore, creditors will have to assert their claims in the foreign jurisdiction under the laws of that country. Those laws are slanted in favor of the trust settlor. The obvious difficulties in collecting a claim against those assets will encourage even the most aggressive creditors to settle their claims on terms favorable to the debtor.

SELECTING THE PHYSICAL LOCATION OF THE OAPT'S ASSETS-FLPs and LLCs

There is no rule requiring that the assets held by an OAPT be physically located in the same country as the OAPT. Therefore a settlor might well have an OAPT in a jurisdiction with very favorable laws and instruct the offshore trustee to open an account in another location (e.g., London, Grand Cayman, Las Vegas) where the OAPT'S assets will be physically located (and visited). Often settlors create family limited partnerships or limited liability companies and the offshore trustee holds the partnership or membership interests while the underlying assets owned by the FLP or LLC are held physically in another location.

THE OAPT SHOULD PROVIDE FOR A TRUST PROTECTOR

The trust Protector should be given the power to veto actions of the trustee and to replace the trustee for any reason. The Protector should not be given the power to appoint himself as trustee or co-trustee. The Protector, however, should be given the authority to appoint a successor Protector.

OAPTs ARE INCOME TAX-NEUTRAL

OAPTs are grantor trusts for income tax purposes because they have U.S. beneficiaries. Because they are grantor trusts they are income-tax neutral. The trustor will pay U.S. income tax on the income earned by the offshore trust. This is the case even if the income is accumulated or distributed to beneficiaries other than the trustor (e.g., spouse or children).

OAPTs ARE TREATED LIKE DOMESTIC TRUSTS FOR ESTATE, GIFT, AND GENERATION-SKIPPING TRANSFER TAX PURPOSES

Transfers to grantor-trust OAPTs are incomplete gifts for tax purposes as typically drafted. A gift is incomplete to the extent that a reserved power gives the settlor the power to name new beneficiaries or to change the interests of the beneficiaries, provided that the power is not limited by an ascertainable standard. Therefore, OAPTs contain a provision giving the settlor a special power of appointment over the trust's assets either during settlor's lifetime, or upon settlor's death. The settlor is allowed to appoint the trust assets to anyone other than himself, his estate, or his creditors. Since the document contains this special power of appointment, the settlor's transfers to the OAPT will be incomplete gifts. Accordingly, there will be no gift tax consequences arising from the transfers. Also, since the settlor retains a special power of appointment over the OAPT's assets, the assets will be included in the settlor's gross estate for estate tax purposes.

The highest level of asset protection available is with a foreign situs-offshore trust.

Contact us to discuss establishing an Offshore Asset Protection Trust or use the OAPT Create Trust Worksheets to assist us with your wishes.