Can an Offshore Trust Protect Assets in Divorce?

We often receive client inquiries about protecting their assets in divorce.

Divorce can lead to civil judgments against a spouse to fund various financial needs of a former spouse and children. Judges may order a spouse to pay money for ongoing alimony, additional money for child support, and still more money to equitably divide marital assets.

Alimony and support judgments, in particular, are enhanced judgments because Florida law gives spouses extra powerful remedies to collect alimony and support.

Standard asset protection planning is effective in defending and negotiating civil money judgments, including property division in divorce. However, spouses have more powerful remedies to collect alimony and support. Many standard Florida asset exemptions do not effectively shield the collection of alimony and support.

For example, a court can order payment from otherwise exempt assets such as retirement accounts and annuities. Courts can garnish up to 40% of your salary to satisfy alimony judgments.

We have found that, other than Florida homestead, offshore trusts are the best asset protection tool against typical civil judgments.

Understanding Offshore Trusts

An offshore asset protection trust is a customized irrevocable trust established in a foreign country. The offshore trust protects assets from potential creditors, lawsuits, or financial risks. Offshore trusts work best in protecting financial assets and intangible property (e.g., LLC membership interest; it is more difficult to use offshore trusts to protect real estate.

Offshore asset protection trusts offer stronger protection than domestic trusts because they are governed by laws that make judgment collection difficult.

The Cook Islands and Nevis today are the most popular offshore trust jurisdictions. There are reputable trust companies in each country that can serve as your offshore trustee.

How Does an Offshore Trust Work?

An offshore asset protection trust functions by transferring your assets into the trust. The trust assets are invested and administered by a foreign trustee.  Once assets are transferred, they are no longer legally your assets, and therefore, the assets are not vulnerable to standard levy or garnishment.  

The foreign courts are not bound by the decisions of U.S. courts, and this makes it difficult for creditors to use U.S. courts to take the assets to satisfy a U.S. judgment.  Offshore trust jurisdictions do not recognize U.S. judgments and will not enforce collection remedies issued by U.S. courts.

Enforcement of Alimony and Support Orders Against Offshore Trusts

A trust can protect assets from divorce orders by placing assets outside of U.S. jurisdiction and outside your control.

U.S. judges can enforce alimony and child support judgments using contempt power. If you do not pay alimony or child support a judge can hold you in contempt of court. If you still do not pay after being held in contempt the judge can order your arrest and incarceration. You can be held in jail until you pay.

Offshore trusts help you protect against enforcement of support judgments because you have previously given up ownership and control of your assets. A defense to contempt is your inability to pay a support judgment. If your assets are under control of an offshore trustee, who is required not to comply with U.S. court orders, you no longer have the requisite control and discretion to pay support awards from an offshore trust.

Your lack of assets and ability to pay could be a defense to support order enforcement and contempt.

However, evading child support and spousal support by using an offshore trust can lead to significant negative reprucusions in other aspects of your divorce case.

Offshore Trust Tax Issues

A  foreign irrevocable trust will be treated as a “grantor trust” for taxation purposes. A grantor trust is a trust whose taxable income is reported by the person who established the trust, and the trust is disregarded for U.S. tax purposes. The trust does not file a tax return. You, the grantor, reports all trust income on your personal tax return as ordinary income.

In addition, IRS has strict reporting requirements for trustees and beneficiaries of offshore trusts. There are substantial penalties if you fail to report offshore trust financial information.

Alternative Divorce Protection

We advise our clients of the relative complexity and high cost of offshore trusts, and we encourage them to consider possible alternatives to protect their assets from the financial consequences of divorce.

The first line of protection is a competent prenuptial agreement that clearly separates your individual assets from marital property and which sets limits on alimony and support awards. Properly drafted agreements, with full and truthful disclosure, are enforceable in Florida.

An irrevocable trust established by a third party is a second tool that can protect some assets from divorce awards. If you are the beneficiary of a spendthrift trust your beneficial interest is protected from divorce orders if the trust is properly drafted and if you do not serve as the trustee.

An irrevocable trust with discretionary distributions is effective because of the inability of a court to force a third-party trustee to exercise his discretion to distribute money to you that could be applied to support obligations.

Summary

Asset protection is relatively difficult in divorce situations owing to the U.S. court’s enhanced powers to enforce collection from assets otherwise exempt from normal civil judgments. Offshore trusts provide the best tool to protect against court orders compelling equitable distribution of assets or payment of alimony and support.