Offshore Trusts
An offshore trust is a trust that is established in another country that does not recognize U.S. judgments. It also uses a trustee based in that country.
The main reason to set up an offshore trust is to protect assets from lawsuits. The person who creates the trust (the settlor) transfers legal title to the foreign trustee and is also the beneficiary. U.S. courts have no power to make that trustee pay a judgment against the settlor.
To reach the assets, a creditor must start over with a lawsuit in the trust’s country. In the Cook Islands, which has the longest litigation record, the creditor has two years after the transfer to file suit there. It also has to establish fraudulent intent beyond a reasonable doubt.
How Does an Offshore Trust Work?
Every offshore trust has a settlor, a trustee, and a beneficiary. The settlor creates the trust and funds it. The trustee, typically a licensed trust company in the foreign country, holds and manages the assets. The beneficiaries, usually the settlor and family, can receive distributions. The trustee decides whether to make distributions and when. The settlor can ask for money but cannot demand it. Because the trust is irrevocable, the settlor cannot take the assets back.
Many offshore trusts hold their investments through a Cook Islands or Nevis LLC that the trust owns. The settlor manages the LLC in ordinary times. When a lawsuit arrives, the trustee can remove the settlor as manager.
How Does an Offshore Trust Protect Assets?
The main reason an offshore trust protects assets from creditors is that the trustee is located outside the United States. Unlike with a domestic asset protection trust, a creditor cannot enforce a judgment against the trustee. Protection also comes from Cook Islands law and the trust’s duress clause.
The trustee. A U.S. judge can direct the settlor to repatriate the assets but cannot compel a Cook Islands or Nevis trust company with no U.S. presence to hand them over.
The statute. Courts in the Cook Islands and Nevis refuse to enforce U.S. judgments against the trust when those judgments rest on law inconsistent with the local trust statute or concern a matter local law governs. The creditor has to bring a fresh case in that country’s court.
The duress clause. Under the trust deed, the trustee must refuse any instruction the settlor gives while acting under a court order. So a settlor who obeys the court cannot undo the protection.
Cook Islands trust deeds are not public records, but a creditor with a judgment can question the settlor about the trust under oath.
Which Country Is Best for an Offshore Trust?
The Cook Islands is the best country to set up an offshore asset protection trust. Creditors have contested Cook Islands trusts in court since the late 1990s, and none is known to have recovered assets held by one that was properly structured.
Nevis is the main alternative and costs about the same. Its law matches the Cook Islands on the creditor’s burden of proof and the two-year deadline to sue. Nevis also requires something the Cook Islands does not, a bond of EC$270,000 that a creditor must deposit before bringing any action against trust property. But Nevis licenses its trust companies under a looser regime. Fewer court decisions have tested its trust law. The Cook Islands remains the stronger choice of the two.
Belize costs less and can make sense at $250,000 to $500,000 of liquid assets, but its trustee market is smaller and its statute far less tested.
What Are the Disadvantages of Offshore Trusts?
An offshore trust’s main disadvantages are the settlor’s loss of control, continued exposure to U.S. courts, weaker protection for some assets and transfers, and cost. Protection is weaker in three situations:
- Transfers after a lawsuit. A transfer made after the creditor has sued loses the timing rules in the Cook Islands statute that would otherwise protect it. The same statute says the timing alone does not prove intent to defraud. Cook Islands trusts are still often set up after a lawsuit has begun, though post-lawsuit funding carries more contempt risk and a weaker bargaining position.
- U.S. real estate. A U.S. court controls real estate in the United States no matter who holds title, so liquid assets get the strongest protection.
- Bankruptcy. A bankruptcy trustee can set aside a debtor’s transfer, made within ten years before filing, into a trust the debtor created and can benefit from. The trustee has to show the debtor acted with “actual intent to hinder, delay, or defraud” a creditor (Bankruptcy Code ยง 548(e)(1)). Even then, the assets return only if the foreign trustee sends them.
Repatriation Orders and Contempt
A U.S. judge can require the settlor of an offshore trust to bring the assets home. If the judge finds that the settlor is able to comply, the settlor can be jailed for civil contempt.
In FTC v. Affordable Media, LLC, a 1999 Ninth Circuit decision (179 F.3d 1228), the Cook Islands trustee called a U.S. restraining order an event of duress under the deed and declined to bring the assets back. The settlors spent about six months of 1998 in custody. The court accepted that inability to comply is a defense but set a “particularly high” burden for asset protection trust settlors. Because the settlors, as protectors, could appoint new trustees and decide whether duress existed, it upheld the finding that they could comply and affirmed the contempt.
The Ninth Circuit left open whether an inability the settlor created on purpose counts. The Eleventh Circuit, covering Alabama, Florida and Georgia, has ruled against the settlor on that issue. Its 2002 In re Lawrence ruling (279 F.3d 1294) affirmed a bankruptcy debtor’s contempt for not turning over his offshore trust’s assets, upholding the finding that he had kept control of it. It also held, in the alternative, that self-created impossibility is no defense.
Retained control, including informal direction of the trustee, is the main reason settlors have lost offshore trust cases.
How Are Offshore Trusts Taxed?
A U.S. person who sets up an offshore trust and is also one of its beneficiaries owes the same U.S. income tax as before. Section 679 of the tax code treats that person as the trust’s owner in any year the trust can benefit a U.S. person, whether or not the settlor kept control. The trust’s income then goes on the owner’s return.
Americans can lawfully own an offshore trust, but the law requires these filings:
- Form 3520, the settlor’s own return, covering transfers to the trust and the settlor’s ownership.
- Form 3520-A, the trust’s annual return, which the foreign trustee signs and files. The U.S. owner must make sure it gets filed.
- FinCEN Form 114 (the FBAR), due when the settlor’s foreign accounts, including the trust’s, together exceed $10,000 at any time in the year.
- Form 8938, attached to the settlor’s income tax return once foreign financial assets pass its thresholds.
On the Cook Islands trusts I set up, the settlor’s CPA prepares these filings. For Form 3520-A, the CPA works from figures the trustee supplies. Each late or missing Form 3520 or 3520-A carries a penalty of $10,000 or a percentage of the amount involved, whichever is greater, unless the failure had reasonable cause and no willful neglect.
How Do You Set Up an Offshore Trust?
Setting up an offshore trust takes four steps. For my clients, a Cook Islands trust is usually signed and registered within three to four weeks of hiring me.
- Planning. The attorney reviews the assets, any pending or expected claims, and the settlor’s solvency after the transfer.
- Trustee review. The trust company checks the settlor’s identity and the source of the funds.
- Drafting and signing. The attorney drafts the trust deed and any LLC documents, and the trust is signed and registered.
- Funding. The trustee or the LLC opens an account at a foreign bank or brokerage, and the settlor moves assets into it.
Opening the account takes three or four more weeks with a Cook Islands bank, or six to eight with a Swiss bank. Funding goes wrong when a wire is scheduled before the receiving account opens, or when an LLC interest or account is never formally assigned to the trust and stays the settlor’s property.
An offshore trust account is a bank or brokerage account held in the trustee’s name or the LLC’s at a foreign institution with no U.S. offices. A bank with a U.S. presence can be served with a garnishment writ like a domestic bank, though whether the writ reaches deposits at its foreign branches varies by state. A U.S. court has no such reach over a foreign bank without any presence in the United States.
How Much Does an Offshore Trust Cost?
Setting up an offshore trust in the Cook Islands or Nevis costs between $15,000 and $30,000. That range covers the attorney’s legal fee and the trust company’s first-year charge. From the second year, the trust company charges roughly $5,000 a year. The settlor also pays a CPA for the U.S. tax filings.
Who Needs an Offshore Trust?
An offshore trust fits a person with real, recurring lawsuit exposure and assets of $1 million or more in total, or $500,000 or more in liquid assets no exemption covers. Someone with no professional liability, no pending claim, and exemptions that already cover most of their wealth usually does not need one.
A domestic asset protection trust costs less, but in my view it is only good if the settlor lives in a state that authorizes one. For a resident of that state, it is a bonus layer of protection. Elsewhere, the home-state court hearing the creditor’s suit is likely to apply local law instead. Even for a resident, a bankruptcy court can reach the transfer under the same ten-year rule and order a trustee inside the United States to pay.