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Wednesday, December 07, 2005

How NOT to Structure an Offshore Trust

U.S. persons often establish offshore trusts to hold assets to protect them from future creditors. Generally, to be effective for this purpose the settlor of the trust needs to give up power over the trust assets - otherwise a U.S. court can force the settlor to direct the payment of the trust assets to his creditors if a judgment creditor arises. Instead, most of the power over the trust is vested in a foreign trustee.

To maintain some control over the trust, the settlor often retains the power to remove and replace the trustee. That way, if the trustee starts investing in assets the settlor does not like, or is not applying the trust assets in a favorable manner, the settlor can fire him and find another trustee that is more accommodating.

A recent case in South Florida illustrates that even this apparently innocuous remove and replace power can open the door enough for a creditor to exploit. In this case, the creditor happened to be the IRS. Since the taxpayer had a remove and replace power over the foreign trustee, the Court directed the taxpayer to exercise that power and appoint a U.S. trustee. Since the Court could then exercise jurisdiction over a U.S. trustee, the effect of this will be to bring the assets within the Court's jurisdiction and allow for its application to the creditor/IRS. The trust also had the problem of having the law of the trust change to the law of the jurisdiction of the trustee in the event of a change of the trustee, which further compounds the creditor protection problem.

How should the trust have been structured to avoid this exposure? At a minimum, the trust should have not allowed for the appointment of a trustee in the U.S. Prudent use of a "trust protector" to exercise powers such as these might also diminish the exposure.

As an aside, offshore asset protection trusts are NOT recommended for purposes of avoiding federal income tax obligations.

United States v. Grant,
96 AFTR 2d 2005-270 (SD Fl., Sept. 2, 2005)
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