Foreign trusts offer advantages over domestic options

November 1, 2005

Foreign trusts are neutral for estate, gift, and income tax purposes for individuals residing in the United States.

Q. In order to lessen the likelihood of losing personal assets in the event of a successful malpractice suit, I am considering using an offshore trust. Is this still the preferred option?

Foreign trusts are irrevocable, but usually provide a third party with a power to amend and provide the settlor (the creator of the trust) with controls over the trust. Such trusts almost always have one non-U.S. trustee acting at all times (regardless of whether the trust assets are situated in the United States), and the foreign trustee holds the trust powers and, in particular, the power to distribute income and principal of the trust. Foreign trusts typically contain provisions that allow the foreign trustee the power to change the situs (location) of the trust assets to another jurisdiction if the trust assets are under attack. Clauses known as "duress provisions" direct a foreign trustee to ignore an order of a U.S. trustee if given under duress, such as a court order directing the trustee to turn over trust assets.

In addition, unlike domestic trusts, certain foreign laws allow a settlor to effectively create an asset protection trust for his or her own benefit, thereby giving the impression that a settlor can "have his cake and eat it, too." Other favorable aspects of offshore jurisdictions are their tendency toward "pro-debtor" fraudulent transfer laws that generally require a creditor to prove a fraudulent transfer beyond a reasonable doubt.

The perception surrounding foreign trusts often results in a misconception that they offer "tax avoidance" benefits. In reality, foreign trusts are neutral for estate, gift, and income tax purposes for individuals residing in the United States.

A negative impact of a foreign trust may come into play in bankruptcy court. In particular, if a foreign trust is dated within 1 year of a bankruptcy filing, the bankruptcy court may deny a discharge of debts, thereby allowing creditors to pursue collection indefinitely. Other obvious disadvantages to offshore trusts include the cost, maintenance fees, political uncertainties of a particular foreign country, language and currency barriers, and conflict of law issues.

In spite of these disadvantages, creation of an offshore trust is perhaps the most advanced level of asset-protection planning. Often, its mere existence deters a creditor from pursuing collection of a claim. Overall, foreign trusts provide much greater asset protection than many domestic planning options, mainly due to the expense, delay, and additional hurdles encountered when proceeding against assets held in such an entity.

It is important to keep in mind that an asset-protection plan can be as simple or as complex as required. While offshore trusts are appropriate for a select segment of the population, establishing conventional trusts for family members or transfers to a spouse faced with less professional exposure may be all that is needed for others.

Q. My attorney told me that regardless of whom I leave my assets to in my will, all joint property will automatically pass to my spouse. Is this correct?

A. It is absolutely correct that the titling of an asset can and will dictate the distribution of the property at the time of your death.