Asset Protection Trusts and Tax Planning

The typical offshore trusts that we create for our clients are tax neutral.  That simply means our asset protection structures do one thing very, very well . . . they protect your assets . . . but they are not intended to be used as tax shelters or as a mechanism for avoiding taxes.  Trying to dodge taxes is, in fact, one way to reduce the effectiveness of an asset protection plan.

Tax Filing and Asset Protection

Generally speaking, the creation of an offshore trust does typically result in the creation of a “foreign trust,” as defined by the Internal Revenue Service.  Tax filings, in the case of foreign or offshore asset protection trusts, can become somewhat complex.  The same is not true of domestic asset protection trusts.  In fact, domestic asset protection trusts usually require the filing of only one additional tax form.  In most cases, a good asset protection attorney can draft an offshore trust so that it is treated as a domestic trust for tax purposes and filing requirements.  That makes life easy.

Styling Offshore Asset Protection Trusts as Domestic

The location of a trust–the jurisdiction under which a trust is created–does not necessarily dictate whether the trust is foreign or domestic for tax purposes.  The I.R.S. has specific rules for determining whether an asset protection trust is foreign or domestic.  Those rules look at the following factors:

• Court Test
  • A United States court must have the ability to exercise primary supervision over the operations of the trust.
• Control Test
  • One or more United States citizens must have the ability to control all substantial decisions regarding trust assets, including
    • Distributions–when, how much, and whether of income or principal
    • Designation of beneficiaries
    • Termination
    • Decisions regarding lawsuits
    • Decisions regarding removal, replacement, or addition of trustees

The way a foreign asset protection trust can meet the above-criteria is through what asset protection attorneys call a “migration provision.”  In the case of the Court Test, offshore trusts can be drafted so that the U.S. and a foreign jurisdiction supervise the trust.  In the event of a legal crises, the trustees have the option to allow the trust to migrate to the foreign jurisdiction.  Only at the time of migration does the trust become a foreign trust for asset protection purposes.

The same type of migration provision applies for the Control Test as well.  During times of normal operation, a U.S. trustee can act with respect to trust assets without any consent from a foreign trustee.  In the event of a crisis, i.e. a lawsuit that threatens trust assets, a resolution by the trustees can effect a migration of the trust to the control of foreign trustees.

Asset protection attorneys drafting offshore trusts should always seek to develop a plans that are tax neutral to the extent possible, and by taking advantage of migration provisions, offshore trusts can be drafted so that they are taxed as domestic trusts until such time as there is a threat to trust assets.