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A Guide to Offshore Trusts

What exactly is an offshore trust? And how do they work? Trust & Will explains what you need to know about offshore asset protection trusts.

Patrick Hicks

Patrick Hicks, @PatrickHicks

Head of Legal, Trust & Will

Have you ever heard of an offshore Trust? If so, you may have been exposed to an idea that these types of trusts are distasteful, and possibly even illegal. Many television shows and movies have depicted a picture of ultra wealthy individuals who have smuggled their funds overseas to avoid taxes, or even worse, commit financial crimes. However, it may surprise you to find out that this depiction is not true. Offshore Trusts are entirely legal, and are a legitimate way to protect your assets. Keep reading to find out what an offshore trust is, how they work, and the answers to other key questions. By the end of this guide, you should have a good understanding of offshore trusts and whether or not they might be a helpful estate planning tool for you.

What is an Offshore Trust? 

An offshore trust is an estate planning tool that will grant an individual legal jurisdiction outside of the U.S. The individual achieves this by establishing a Trust in a different country. The assets are then transferred offshore, and are placed under management of Trustees and other types of estate plan managers. The trustees and managers of offshore Trusts cannot be U.S. citizens, nor can they have any business presence in the U.S.

In short, an offshore Trust is simply a Trust that was created abroad. The Deed of Trust provides instructions for how the assets placed in the offshore Trust should be used and distributed. The person setting up the offshore Trust can also name themselves as a beneficiary.

Individuals with high value assets, and thus higher exposure to risk, might use an offshore asset protection trust to better insulate themselves. This insinuates that moving your assets offshores could be beneficial for some individuals. 

What Are the Benefits of an Offshore Trust?

There are three key benefits of establishing an offshore Trust. An offshore trust is commonly referred to as an ‘offshore asset protection Trust.’ It wins this name precisely because it can provide an individual with an extra layer of protection. For high net-worth individuals, the likelihood for creditor claims and other legal suits increases. This is typically because your level of wealth outweighs the cost of litigation for certain entities. By moving your assets offshore, the cost of litigation increases substantially. This makes it significantly harder for creditors and other entities to come after you. This is the first key benefit.

The second benefit relates to planning for taxes and liabilities. Although establishing an offshore Trust won’t remove your U.S. tax liabilities or reporting requirements completely, it can certainly lessen the load. The reduction of your tax burden can create favorable gains for your overarching estate plan.

Last but not least, creating an offshore trust can afford you certain freedoms. For example, as a U.S. citizen, you may be barred from making certain investments or opening certain financial accounts. By organizing a trust offshores, it could open up new portals that were previously unavailable to you as a resident or citizen of the U.S.

In summary, here are the 3 key benefits of an offshore trust:

  • Add an extra layer of protection for your assets.

  • May reduce your overall tax burden.

  • Provides the freedom to make offshore investments and set up offshore bank accounts.

Is an Offshore Trust Taxable?

The short answer: no, an offshore trust is not taxable. However, this absolutely does not mean that you will not have any tax liabilities or reporting requirements whatsoever. Although U.S. jurisdiction cannot be applied to the trust held offshores, you could still be subject as a U.S. citizen or resident benefiting from the trust in some shape or form.

Because the treatment of offshore trusts is such a specialized area, it’s strongly recommended that you consult a professional. This could be a financial advisor or attorney who has extensive experience working with clients who own offshore trusts. Regardless, it is best to assume that you will have at least some tax liabilities and reporting requirements. This is especially true if the trust will create income or hold a business in its name.

How Are Offshore Trusts Taxed?

Many families elect to move their Trusts offshore to take advantage of no-tax jurisdictions. However, organizing a Trust abroad does not allow someone to escape U.S. tax liabilities completely. An offshore Trust can defer the requirement to pay U.S. taxes on interest income or capital gains made by investments held in the Trust. However, taxes are later owed on any distributions that are made to U.S. beneficiaries. 

A U.S. beneficiary will be taxed any time they receive distributions from an offshore non-grantor trust. This is common for multinational families who establish offshore trusts to benefit their family members who are U.S. citizens or residents. These distributions are categorized as capital gains income by the Internal Revenue Service (IRS) and are taxed accordingly. 

The tax liability is further increased through the IRS ‘throwback’ rule. The ‘throwback’ rule states that when a beneficiary receives income from an offshore trust, the applied income tax rate will be from the year that the income had been earned, not the year it was distributed. This magnifies the beneficiary’s tax liability because the highest marginal tax rate is applied.

This also leads to an interest charge because there has technically been a delay in the reporting of the income. This is the U.S. tax systems’ way of eliminating the benefit of delaying your tax payments. The interest charge is compounded and is not deductible.

How Safe is Offshore Trust?

The safety of an offshore trust is directly related to how it is organized and the number of precautions that are taken. This is true even for the case of a Trust established here in the U.S.

First and foremost, it’s recommended that you organize your offshore Trust in a country where the government is stable. Political instability can lead to regime changes, and thus swift changes to tax policies, currency exchanges, and the nation’s economy. Unstable regimes are also often associated with corruption. According to AlperLaw, common offshore trust jurisdictions include the Cook Islands, Nevis, the West Indies, and Hungary.

Next, careful selection of roles involved in the Trust can help increase the safety of the Trust. For instance, the Trustee is often a foreign Trust company or institution. A non-U.S. citizen can also serve as the Trust protector, such as a close friend or advisor. One must be wary to appoint individuals and entities that are trustworthy to help minimize the risk of Trust fraud or embezzlement.

Last but not least, it helps when the only asset held in the offshore Trust is the ownership of a foreign Limited Liability Company (LLC). This type of entity can be controlled by a debtor and can better insulate their personal assets from creditors.

Should I Set Up an Offshore Trust?

Whether or not you should set up an offshore Trust is a decision that should be made upon your personal circumstances. 

Setting up an Offshore Trust can be costly, and may not necessarily be worth the hassle. In addition, deferring your tax payments is not necessarily favorable based on current U.S. tax laws. However, some individuals might have specific reasons for which setting up a Trust in a non-U.S. jurisdiction is advantageous. 

For starters, removing your assets out of U.S. soil can add an extra layer of protection from creditors and any other entities trying to come after your wealth. This process can also give you more investment freedom. Because an offshore Trust is not treated as a non-U.S. entity, this could then open up new types of financial opportunities. This could include opening up foreign bank and savings accounts, as well as exploring foreign investments. 

How Do I Set Up an Offshore Trust?

The process of setting up an offshore Trust is not drastically different from setting up a Trust domestically. However, you are navigating a sometimes challenging process of selecting the right non-U.S. jurisdiction and finding a trustworthy offshore Trustee. 

Below are the steps to setting up an offshore Trust. You may find it beneficial to work with an experienced U.S.-based Trust attorney who can help you with each of the following steps:

  1. Research and select a non-U.S. country in which to establish your offshore Trust.

  2. Hire a foreign entity to serve as your Trustee. A practical choice would be an offshore Trust company based in the country in which the Trust will be established. You can also work with a U.S. Trust company or asset protection attorney to help you find a trustworthy offshore Trust company and location.

  3. Determine your offshore Trust structure, non-U.S. jurisdiction, and Trustee. Working with your domestic estate planning attorney can be helpful during these planning stages.

  4. Cooperate with your selected offshore Trust company’s procedures, such as conducting a financial background check.

  5. Draft and finalize your offshore Trust agreement. 

Create Your Trust Today

Creating an offshore Trust is not necessarily the right choice for everyone. Offshore trusts have often been cast under a bad light by fictional television shows or movies. However, in reality, they can be a helpful, legitimate tool for some individuals. 

In this global economy, we have an increasing number of multinational families who hold assets and businesses across multiple borders. For some of these families, creating a Trust in one of their home countries while having U.S. beneficiaries might be the clear choice from a logistical perspective. We also have individuals who would greatly benefit from the tax policies of a different country. 

Regardless of your choice, know that you’re empowered to set up your Trust in a way that is safe and protected. It’s always helpful to consult an expert to figure out how to best structure your Trust, whether it be here in the U.S. or somewhere else. 

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