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Asset protection trusts: evaluating new opportunities under 1997 legislation.


Offshore asset protection trusts (APTs) are an important planning tool in protecting and managing accumulated wealth. These trusts, if properly drafted, can effectively protect assets from being attached by a creditor or a plaintiff following a successful court judgment. The use of offshore APTs has become very popular as the result of increasing litigation and the resulting awards within the court system within the United States. As will be discussed later, an individual can obtain important leverage in resolving potential disputes by establishing an offshore trust and gain favorable terms in negotiations as a result.

It must be emphasized that offshore APTs are effective only when established in advance of an unforeseen misfortune. Just like buying homeowners insurance after the fire, an offshore APT will be of little benefit after the fact. Fraudulent conveyance laws, common in most offshore districts, will prevent transfers of assets following a lawsuit. For example, the Cook Islands, located in the South Pacific, allow a creditor to bring a claim of fraudulent conveyance during a two year period from the time of the creditor's cause for action, Other countries may have a shorter or longer time frame, or no specific requirement at all. Therefore, planning and preparation are essential to protecting assets by moving them offshore.

Reasons to Go Offshore

The number of lawsuits generated in the United States, coupled with the creditor-friendly court system of the United States, should be reason enough for an individual with considerable wealth to move his or her assets Offshore, especially if that individual is susceptible to lawsuits. Asset protection using offshore trusts is an excellent way to manage the risks inherent with accumulated liquid assets. This strategy is a form of insurance; simply diversify assets away from the legal and economic jurisdiction which entails the most risk. The risks are minimized by changing the way the assets are held. Barry Engel, past president and current executive committee member of the Offshore Institute, defines asset protection as "the process of organizing one's assets and affairs in advance to safeguard them against risks to which they otherwise would be exposed." Finally, offshore trusts provide a good way to manage assets and income for family members.

Because social and technological changes have brought the world closer together, it is not uncommon for an investor to think globally when planning investments to take full advantage of what other countries may have to offer. Uncertainties may also exist, particularly in the United States, about the ability of the government to provide for its citizens" retirement. As a result more and more individuals, faced with the prospect of funding their own retirement, are looking beyond their own country's borders when planning for retirement as well as the protection and preservation of their assets, in an investor friendly environment.


A number of considerations should be taken into account when deciding whether or not to move assets offshore and what type of legal, economic, and political factors to look for in various countries. As stated earlier, most countries have adopted fraudulent conveyance laws which prevent individuals from defrauding creditors and those that do not have such laws will usually require that the settlor provide assurance that he or she does not plan to avoid legitimate creditors. If the transfer was intended to move assets from the claims of specifically known or anticipated creditors, then the transfer will be deemed fraudulent. In choosing a site for an APT, a wise selection would be a country whose statutes do not contain fraudulent conveyance laws. Most offshore sites will have a statute of limitations concerning asset transfers which range from six months to six years. This period is the amount of time that a creditor has to present a claim of fraudulent conveyance.

Another major consideration is whether or not the selected APT jurisdiction will recognize foreign judgments. Belize, the Cook Islands, and Nevis are three popular offshore sites that have specific legislative certainty regarding the non-recognition of foreign judgments. A favorable jurisdiction will not recognize foreign judgments, and as a result, legal action must be brought forth within that jurisdiction's court system, probably at a much more substantial cost to the plaintiff. Some favorable APT sites require creditors to first deposit a bond before proceeding with legal action and will also make the loser pay the other party's court costs. In addition, one should consider districts with legislation that allows the settlor to keep certain powers and benefits, such as the ability to be a discretionary beneficiary, to revoke or amend the trust, and to appoint and remove trustees.

Finally, the economic and political environment of a potential offshore site will have some impact as to an investor's decision. If an individual is uncertain or uncomfortable with the thought of placing assets offshore, he or she may find an established business center such as Switzerland or Germany more attractive even though the trust legislation may not be as favorable as other parts of the world.

How to Set Up an APT

With the increasing popularity of APTs, many financial planners and trust companies have emerged to assist with the setup of an APT. Some of these planners and companies have turned the setup of an APT into a commodity, with blank forms available to process client requests without tax planning and other estate considerations. A reputable law firm and trust company, both with offshore trust experience should be retained, as planning is essential.

A properly drafted APT will most likely be considered a grantor trust for U.S. taxation purposes. The income from the trust flows through to the settlor of the trust. Usually, a limited partnership (LP) or a limited liability company (LLC) is formed in the United States with the trust's settlor acting as the general partner or managing member. The individual's assets are then transferred to the LP or LLC and an interest is then used to fund the APT. The underlying entity will also provide its own degree of asset protection.

Although the individual is still allowed control over the assets in the capacity of a general partner or LLC manager, the ownership is turned over to the trustees who hold an equity interest. Turning ownership over to another party may seem difficult, but it is necessary to obtain the protection that an individual is seeking. Of course, the selection of a reputable trust company and trustees is essential. One bright spot, in light of giving up ownership, is the fact that most APT jurisdictions allow the settlor to also act as a protector of the trust. The protector can usually veto any decision made by the trustees as well as appointing and firing trustees.


The primary advantage of moving assets offshore is that generally, the enforcement of foreign judgments is restricted. For example, if a claimant is successful against you in the United States, in order for that claimant to reach your assets located offshore, he or she would need to bring charges against you in that particular country in which the trust is located. This prospect alone is a severe roadblock in the path of the creditor/claimant considering what is necessary in order to receive a judgment. First, in most countries, attorneys are not allowed to accept cases on a contingent fee basis. In addition, the claimant will most likely incur substantial costs associated with the lawsuit in the form of increased legal costs, long-distance telephone costs, and travel costs. Also the claimant will need to become familiar with the foreign country legal system, and may also have to bear the court costs of an unsuccessful suit.

Effects of Recent Tax Law

An asset protection trust does not offer any form of income tax advantage, provided that the trust qualifies as a grantor trust for U.S. income tax purposes. The settlor of the trust will fall under grantor trust rules, generally by the fact that certain controls and interests are retained. Income of the trust simply flows through to the grantor and is reported on his or her U.S. tax return. However, the Small Business Job Protection Act of 1996 and the Taxpayer Relief Act of 1997 included major changes in the taxation and reporting requirements of foreign trusts, generally to ensure that U.S. citizens report any income received from foreign trusts and not to discourage the use of these trusts for asset protection purposes. The 1996 Act amended IRC Section 7701 (a) (30) (E) to provide that a trust will qualify as domestic if a United States court is able to exercise primary supervision over the administration of the trust and one or more U.S. fiduciaries have the authority to control all major decisions of the trust. Attorneys specializing in asset protection like the change because it provides more certainty to whether a trust is domestic or foreign. The distinction is important because under the 1996 Act, foreign trusts are subject to new reporting requirements with major penalties levied when failing to comply with the reporting requirements. Domestic trusts with significant foreign activities or foreign assets will also be subject to the reporting requirements. One of the requirements is reporting an event that is deemed to be reportable, such as the creation of a foreign trust by a U.S. citizen, transfers to a foreign trust, or the death of the grantor (if a U.S. citizen), by a responsible party, such as the grantor or the executor of a decedent's estate.

Before 1997, property transfers to foreign non-grantor trusts were subject to a 35% excise tax on the gain portion of the appreciated property transferred. However, in 1987, the IRS ruled that the excise tax does not apply to foreign trusts that are taxed as grantor trusts. Again, because most asset protection trusts are structured as grantor trusts, the excise tax does not apply. In 1997, Congress repealed the 35% excise tax, as well as the penalty provisions of Section 1494(c), and replaced the excise tax with a gain recognition provision for transfers to non-grantor foreign trusts. Gain is now recognized upon the transfer of appreciated property by a U.S. citizen or trust to a foreign trust. The transfer is treated as a sale to the foreign trust at fair market value, with gain recognized equal to the excess of fair market value over the adjusted basis of the property to the transferor.

Recent U.S. Trust Legislation

For those who wish to protect their assets but are wary of placing their trust in foreign jurisdictions, Alaska and Delaware enacted trust legislation in 1997 allowing asset protection trusts in their states without the cost and complexity usually associated with the offshore structure. Alaska and Delaware trust law is distinguishable from other U.S. trust law in that Alaska and Delaware will enforce spendthrift provisions in respect of a settlor who is a discretionary beneficiary of a self-settled trust. This means that settlors may maintain some access to their assets while still insulating the assets from creditors and having the assets deemed removed from their estates for estate tax purposes.

The Alaska Trust Act became effective April 2, 1997, and provides protection from creditors as well as unlimited trust duration. In order to receive the benefits provided for by the Alaska Trust Act, the trust must be established with certain requirements. First, some of the trust assets must be held in Alaska and be administered by an Alaskan resident, trust company or bank. Second, the Alaskan trustee must be required, on an exclusive or non-exclusive basis with other trustees, to maintain records for the trust and to prepare or arrange for the preparation of income tax records that must be filed by the trust. Third, part of the administration of the trust must occur within Alaska.

An individual can transfer assets to an irrevocable Alaska trust and be a beneficiary to whom the trustee can distribute trust property. The trust assets will no longer be subject to the claims of the settlor/grantor's creditors under Alaska law, even if the settlor/grantor is the only person to whom the trustee may distribute trust assets and income. (If the trust must distribute assets to the settlor/grantor, then the protection from creditors does not apply.) If there are beneficiaries in addition to the settlor/grantor, this protection from claims of creditors applies even if the settlor/grantor retains the right to veto distributions to other beneficiaries of the trust. The protection also applies if the settlor/grantor retains the right to direct where the trust property is to pass upon his or her death. By retaining these veto and control powers, transfers to the trust will not be subject to girl tax when the trust is created. However, retaining either of these powers will cause the trust assets to be included in the settlor/grantor taxable estate at death.

Under the Alaska statute, there are four instances in which spendthrift provisions of a trust will not be enforced:(15)

* if the settlor retains the power to revoke or terminate all or part of the trust without the consent of a person who has an adverse interest, then the settlor's creditors may attach the trust assets to the extent of the power of revocation or termination;

* to the extent that the trust income and principal must be distributed to the settlor/grantor (i.e., the settlor/grantor is entitled rather than merely eligible to receive distributions from the trust);

* if at the time of the transfer to the trust the settlor was in default by 30 or more days of making a child support payment; or

* if the transfer was intended, in whole or in part, to hinder, delay, or defraud creditors under Alaskan fraudulent transfer law.

Delaware trust law became effective July 1, 1997, and the provisions closely parallel those of Alaska. Delaware law is slightly different from the Alaskan rules in certain instances in which spendthrift provisions of a trust will not be enforced. Delaware spendthrift protection will not be enforced in respect of:(16)

* any person to whom the transferor is indebted on account of an agreement or order of court for the payment of support or alimony in favor of such transferrer's spouse, former spouse, or children, or for a division of distribution of property in favor of such transferrer spouse or former spouse, to the extent of such debt;

* any creditor who became a creditor of the transferor in reliance upon an express written statement of the transferor that any property that was the subject of the qualified disposition thereafter remained the property of the transferor and was available to satisfy any debt to such creditor incurred by the transferor;

* any person who suffers death, personal injury or property damage on or before the date of a qualified disposition by a transferor, which death, personal injury or property damage is at any time determined to have been caused in whole or in part by the act or omission of either such transferor or by another person for whom such transferor is or was vicariously liable; or

* transfers intended, in whole or in part, to hinder, delay, or defraud creditors under Delaware fraudulent transfer law.

Generally, a transfer will be found to have been made with an actual intent to hinder, delay or defraud creditors only if it was intended to remove assets from claims of specifically known or anticipated creditors. In Alaska, a creditor who suspects that he or she has been defrauded has the longer of four years from the date of the transfer to the trust or one year after the transfer is or reasonably could have been discovered within which a fraudulent transfer claim can be brought. The fraudulent conveyance stipulation is shown by a preponderance of evidence standard, rather than by the beyond a reasonable doubt standard that is generally required offshore. This, to some, may not provide adequate reassurance that the trust assets will remain safe from creditors.

A major difference between offshore and inshore trusts is that Alaska and Delaware trusts are subject to the jurisdiction of the United States Bankruptcy Court. Further, under the full faith and credit clause of the U.S. Constitution, Alaska and Delaware courts are required to enforce judgments of other U.S. states. It remains to be seen if these trusts will be able to provide asset protection similar to those available offshore once the courts become involved.

Because Alaska imposes no state income tax on Alaskan trusts, by creating a non-grantor trust and allowing for accumulation of income, an Alaskan trust income should avoid state income tax in both Alaska and the settlor domicile state. However, if the trust is a grantor trust and the settlor lives in a state which imposes an income tax, an Alaskan trust cannot be used to avoid state income tax. Rev. Rul. 76-103 holds that transferring a trust to a state where the grantor creditors cannot attach the assets makes that transfer complete for estate and gift tax purposes.(18)


When deciding between an offshore or inshore asset protection trust, a person must thoroughly consider their motivation and financial goals in order to determine which location is best. People in professions that inherently carry a higher risk for future litigation, such as doctors, attorneys, and accountants, may be better served offshore whereas professionals with less exposure to litigation may choose to remain inshore. Whichever location is chosen, the APT provides a viable estate planning tool which is beneficial to many.


Rothschild, G. (1996). Establishing and drafting offshore asset protection trusts. Estate Planning. Pg. 65-71.

Lattman, J. (1997) Protect yourself offshore. The Offshore Library [Online], HYPERLINK [1998, February 12].

CCH. (1997). APTs relatively unscathed under new rules. Financial and Estate Planning, Issue 422.

Rothschild, G. (1996).

Colombik, R.M. (1996). Asset protection trusts that really work. The Attorney-CPA, Fourth Qtr. Pgs. 6-7. Rothschild, G. (1996).

Arad, G. and Beck, E (1997). "Offshore" at home and abroad: asset protection and estate planning aspects of Alaska, Delaware and foreign trusts. International Counselor. [Online], HYPERLINK [1998, January 28].

Colombik, R.M. (1996).

Lockwood, D.L. (1997). Expert's critical analysis of the foreign trust tax law changes and their effect on foreign asset protection trusts Insights and Strategies. 10:3. CCH (1997).

IRC Section 1491.

Rev. Rul. 87-61, 1987-2 CB 219.

14. Chapter No. 6, SLA 1997.

15. Alaska Statute (AS) 34.40.110(b).

16. Arad, G. and Beck, P. (1997).

17. AS 34.40.110(d).

18. Rev. Rul. 76-103, 1976-1 CB 293.

Dr. Ralph V. Switzer, Jr., JD, CPA, is a Professor of Finance and Accounting and Taxation in the College of Business at Colorado State University. He is a licensed member of the Colorado and American Bar Associations and a member of the Colorado Society of CPAs and the American Institute of CPAs. He is also a member of the National Society of Accountants. He has published several books and has served as counsel to the U.S. Department of Justice.

Sharla Vega holds a Masters in Taxation at Colorado State University. Her main interest is in estate planning.

Sean Von Loh holds a Masters in Taxation at Colorado State University and his prime interest is in banking.
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Author:Switzer, Ralph; Vega, Sharla; Loh, Sean Von
Publication:The National Public Accountant
Date:Nov 1, 1998
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