How Does an Offshore Trust Work?

An offshore trust is a legal tool that allows an individual to safely protect their assets from creditors by placing them in another country. An offshore trust works by transferring ownership of the assets to a foreign trustee outside the jurisdiction of U.S. courts. While not required, typically the offshore trust only holds assets located outside of the United States.

The best offshore trust jurisdiction is the Cook Islands. Cook Islands trusts can be designed to protect all trust assets from U.S. civil creditors.

An offshore trust is one of the most well-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

The most important requirements for an offshore trust include:

1. The trust must be irrevocable.
2. The U.S. debtor cannot be the trustee.
3. The trust must provide the trustee the discretion to withhold payment from the beneficiary.
4. The trustee must be a foreign trust company or financial institution rather than an individual.
5. If using a trust protector, the trust protector cannot be located in the United States.
6. The trust must state that the location of the trust (called the situs) governs trust provisions.
7. 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.

What Are the Benefits of an Offshore Trust?

An offshore trust provides several advantages to a U.S. judgment debtor. First, 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.

Secondly, outside of litigation, the general public will be unable to find out the beneficiary of the offshore trust. This keeps financial affairs more private. Finally, 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.

In summary, here are the three most important benefits of an offshore trust:

• Provides the highest level of asset protection.
• Removes your assets from oversight of state courts.
• Allows you to distribute your assets properly upon your death.

Asset Protection

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 use offshore trusts 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.

Structuring an Offshore 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.

Disadvantages of an Offshore Trust

Although offshore trusts offer many benefits, there are several disadvantages to consider:

1. Legal complications: Offshore trust laws can be complex and vary significantly by jurisdiction. This complexity can make it challenging to ensure that the trust is properly established and managed, which may cause legal difficulties.
2. Regulatory scrutiny: Offshore trusts have become a target for regulatory scrutiny in recent years due to their association with tax evasion and other illegal activities. This can increase reporting requirements and the risk of sanctions or penalties if the regulations are improperly followed.
3. Reputation risks: Due to their association with tax evasion and other illicit activities, offshore trusts can carry a stigma that could harm your reputation.
4. Cost: Establishing and maintaining an offshore trust can be expensive.
5. Limited control: When assets are placed in an offshore trust, control over those assets is generally handed over to the trustee. This can be a disadvantage if you need to access or decide how to manage those assets.
6. Potential for fraud: Offshore jurisdictions are often less regulated than domestic ones, increasing the risk of fraud or mismanagement by the trustee.
7. Changes in legislation: Offshore jurisdictions are subject to changes in their tax and legal regulations. There is always a risk that changes in legislation could make offshore trusts less attractive or even unfeasible.
8. Access to funds: Depending on the terms of the trust and the laws of the jurisdiction in which it is established, it may not be easy to access funds in an offshore trust. This could be an issue if you need to access those funds quickly.

How to Set Up an Offshore Trust

For more situations, there are five steps to creating an offshore trust:

1. Select a jurisdiction with favorable offshore trust laws.
2. Pick a trustee company to serve as trustee of the offshore trust.
3. Provide all required documents for the trustee’s due diligence.
4. Draft the offshore trust document with your attorney.
5. Fund the trust by transferring domestic assets to 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.

What Is the 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.

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.

Are Offshore Trusts 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 trusts are 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.

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.