Ours is an international law firm, so offshore work has always been part of our practice.  Lately, however, we have been moving away from recommending offshore to our US clients.  

This article is broken into two parts mainly because the laws affecting US citizens and residents play a major factor in the analysis.  Citizens of foreign countries should review Part II of this series.

Offshore 

First of all, what do we mean by “offshore”?  Going offshore means to establish a (i) company or trust, and/or (ii) bank account in another country.  Sometimes clients maintain offshore accounts in a country where they have family, where they vacation, or where they have some other kind of connection.  That is still considered “offshore.”

But, let’s face it.  Normally, if we are talking about “offshore,” we are talking about countries that have laws favorable for asset protection.

To be sure, there have always been some good reasons to go offshore.  These days, it makes a difference whether the client is a “US person,” as defined in the US Tax Code, or a non-resident alien.  So, we will need to divide our analysis here into two parts.

A. Advantages of Offshore for US Persons

 Under the Tax Code, a US Person is _

• A citizen or residentof the United States
• A domestic partnership
• A domestic corporation
• Any estate other than a foreign estate
• Any trust if:
  • A court within the United States is able to exercise primary supervision over the administration of the trust, and
  • One or more United States persons have the authority to control all substantial decisions of the trust
• Any other person that is not a foreign person.

1.  Protection from Creditors.  One classic reason for going offshore is to put assets beyond the reach of creditors.  So, under the common scenario, the client is concerned about being sued by somebody.  If the plaintiff does sue and gets a judgment then, presumably, the plaintiff will go about trying to collect on the judgment by garnishing bank accounts, putting liens against vehicles, putting liens on real property, etc.

After all, the judgment is a just a piece of paper.  What really hurts is “execution of the judgment.”  That is where asset protection techniques come in handy.

As a safeguard, the client can (i) put cash in an offshore account, and (ii) create an offshore company or trust for purposes of re-titling assets such as vehicles and real propertry.  That way, when the piper comes calling, it will appear the client has nothing of value for the plaintiff to take.  This is sometimes called being “judgment proof.”

Now, you should be aware the plaintiff–once it becomes a judgment creditor–can engage in discovery, such as depositions, and try to find out about offshore assets.  The plaintiff would have to be somewhat skilled and know the right questions to ask.

If they do ask the right questions, you will answer the questions honestly.  Don’t perjure yourself because, even if the judgment-creditor finds out about the assets, it is still has a long way to go to actually get to them.

There are mechanism available in US law that would permit a creditor to go after your offshore account or “pierce the corporate veil” to get to assets held in the name of a company or trust.

More on Piercing the Corporate Veil

So, it is technically possible for the creditor to defeat your asset protection plan . . . but not practical at all.  Even if a US court enters an order permitting the creditor to garnish the offshore assets, the creditor still has to domesticate the judgment in the foreign court in order to enforce it.  That is not easy to do.

There are some jurisdictions that require creditors to post a $25,000 bond just to start the proceedings.  Then, the lawsuit will be painfully slow and difficult.

Countries that provide asset protection understand the game, and those governments do their best to make things difficult for creditors.

For purposes of protection against creditors–whether there is a real threat or you want to plan ahead just in case–offshore has been and continues to be a good solution.  In fact, it probably is still the best protection you can get.  As we will discuss, there are other solutions available, but there is nothing like having a friendly government behind you.   

There are additional advantages to going offshore, which may be somewhat secondary.

• The biggest advantage people think of when they think offshore is tax savings.  In fact, it usually is the case that there are greater opportunities to legally create tax efficiencies through the use of offshore structures.  That topic, as you can imagine, is far to intricate to deal with here.  As discussed below, however, new laws and treaties have changed the tax analysis significantly.     

More on Tax Planning

• Wealth protection is one of the few areas in which small countries, like island nations, can compete.  Going offshore helps developing countries and redistributes world finance.
• The additional tax and banking competition puts pressure on governments to keep rates down.
• Some offshore banks offer services that may not be readily available with US bank, so as anonymous bank accounts.

B. Disadvantages of Offshore for US Persons

For all the advantages discussed above, there are three main caveats to going offshore:

• cost,
• convenience and
• the “red flag” effect.

It would be an exaggeration to say the cost of setting up offshore is a huge factor.  Typically, establishing and maintaining a company, trust, or bank account offshore involves higher fees for registration, annual renewal, etc.  The costs are not prohibitive, however, and, presumably, you would not go offshore unless you have assets significant enough to warrant the extra measure.

Some clients ask just how much money is enough to consider going offshore.  In reality, that is a hard question to answer since (i) it depends very much on the client’s circumstances, and (ii) the value of money is so relative.

An additional cost consideration may be professional fees paid to lawyers, accountants, etc. for counsel regarding the offshore activities.  Again, those fees depend upon the level of expertise, how risk averse you are, etc.  Still, since offshore is a rather specialized area; it is probably true the cost of competent counsel will be higher than with domestic vehicles.

Convenience is another consideration.  Deposits have to be made electronically, which creates a trail, or else you have to get on a plane.  Face-to-face interaction is quite limited, unless you make frequent trips to the offshore location anyway.  Accessing your money is not a big problem since most offshore banks do provide bankcards and checks, but it is still not the same as having your money at the bank around the corner.

These days, the major disadvantage of going offshore is the possibility of drawing attention from regulators and the IRS.

New laws and treaties aimed, ostensibly, at preventing terrorism and money laundering create onerous reporting requirements and scary penalties.  Most people know US banks are required to report deposits or purchase of negotiable instruments of more than $10,000 pursuant the Bank Secrecy Act.

For offshore concerns, you will want to be well-versed–or work with a professional who is well-versed–with the Foreign Account Tax Compliance Act (FATCA).

FATCA was enacted by Congress specifically for the purpose of obtaining information about the offshore accounts of US citizens and residents.

There is much discussion among experts as to how successful the program has been and whether or not it is likely to endure.  Nonetheless, for the moment, at least, the act is in effect and the majority of foreign banks are already in compliance with the reporting requirements.

It might be naivete, but I truly do not believe the majority of clients with whom we consult are looking to evade taxes.  They may want to legally use offshore tax planning to minimize taxation, but they do not want to break the law.  Okay, so what’s the problem?

The problem is the extra layer of headaches and possibility of unwittingly violating some aspect of the complex and constantly-changing regulatory landscape.

For clients who have a lot to lose, it is getting harder and harder to justify going offshore.  The current environment is someowhat akin to a witchhunt.

For US citizens and residents, other available options have to be examined carefully before deciding to go offshore.

Domestic Trust

The use of certain types of trusts has always been an important part of asset protection.  To be sure, there are many, many types of trusts–such as trusts for estate planning, land trusts, etc.–so we should first describe some of the key features of what we will generically call an “asset protection trust.”

The basic concept of an asset protection trust is to create an entity that is entirely separate from you and your estate.  We want the trust to be, for all legal purposes, just like another person.  That way, if creditors come after you personally, they will never have any claim against the trust.

Be aware that certain things have to be done in a very specific way in order to accomplish the goal of separating yourself (as a grantor) from the trust.  Do not think that happens automatically.  On the contrary, it requires a good deal of expertise to pull this off effectively.

A. Advantages of an Asset Protection Trust

1. Confidentiality.  Like going offshore, establishing a trust can provide a great deal of privacy.  Unlike a company, which has to be registered with the Department of State, there is no requirement to register a trust anywhere.  There may be some advantages in recording what is called a Certification of Trust, which is an extremely limited summary of the trust document, but there is absolutely no legal requirement to do so.

The trust document, and therefore the trust itself, exists completely outside the public record.  You might be the only one who even knows about it.

So, when it comes to confidentiality, going offshore and establishing a trust are equally good protection.  As described above, the only way a creditor could even find out about the trust, and the assets held therein, would be to obtain a judgment, engage in post-judgment discovery, and skillfully ask the right questions.  Otherwise, you will simply appear to be judgment-proof.

2.  Execution of Judgment; Piercing the Corporate Veil. As discussed earlier, even if the creditors find out about the trust assets, they still have to take some extra measures in order to get to them.  As with offshore assets, that is not so easy to do.

First, it is worth mentioning there is absolutely nothing illegal about asset protection of any kind, whether going offshore or creating an asset protection trust.  Perhaps there is some social stigma attached, but asset protection is really just an intelligent thing to do.  Judges know that, and the courts have largely been very reluctant to pierce through asset protection techniques.

If your asset protection trust is set up correctly, it will not be easy for creditors to pierce.  They have the burden of proving your intent, and one’s state of mind is a difficult thing indeed to prove.

More than likely, your creditors will tire of the expense and trouble of trying to get to the trust assets.  Generally, the “throwing good money after bad” analysis kicks in at some point.  And, even if they do stay in it to the bitter end, the chances are they will lose.

So, the trust is very good protection, although not entirely as good as offshore.  The fact that the offshore assets are in another country is a distinct advantage over the domestic asset protection trust.

3.  Estate Planning.  Trusts are typically used as vehicles for succession planning, so you can easily get a double-benefit from your asset protection trust.  In fact, estate planning and asset protection are so closely related that you will almost certainly end up accomplishing both at the same time.
4.  Costs.  The cost analysis goes in favor of the trust for the following reasons:

• there are no fees related to registration or renewal of a trust;
• you get more bang for you buck by accomplishing both estate planning and asset protection at the same time, and
• you do not have to look for professionals specialized in compliance with the new regulatory schemes.

5.  Convenience.  You can have your trust account at the local bank, so that is more convenient than dealing with an international bank.  That said, you will need to appoint a trustee who is someone other than yourself, so that will potentially create some inconvenience.

Our firm has gotten very good at streamlining the process of both offshore services and asset protection trusts so, ultimately, the convenience analysis is pretty much a draw.  Perhaps the trust is slightly more convenient, but the difference is negligable.

6.  Risk Exposure.  This is the elephant in the room.  The new regulations (and penalties) are the single factor that has most impacted the advice we give clients.

Simply put, it is hard to tell our US clients to take on the additional risks and complications related to offshore regulations in order to gain the relatively minor advantages they cannot readily achieve through a domestic trust.

It may be the case that some corporations and large estates can legally pick up enough tax savings through offshore structures to justify the compliance headaches.  It is no secret that certain US companies have received a lot of media attention for doing just that.

For most clients who walk through the door, though, it is just not worth it.  For the time being, stay domestic and learn more about some of the very innovative developments with:

• Asset Protection Trusts
• Annuities
• Self-Directed IRAs
• Insurance Products

~ Jeff Harrington, Esq.