Offshore Asset Protection & the New IRS Traps02/25/2013
During the past 30 years the United States has witnessed an ever-growing exodus of individual assets to exotic "tax haven" countries.
This burgeoning overseas flight of personal capital has been motivated by the need for "asset protection" — guarding personal wealth from attack by hungry creditors, aggressive litigants, or ex-spouses; and "tax minimization" — reducing or eliminating taxes, especially on income earned outside this country.
These expatriate assets have found welcome homes in a proliferation of newly independent small island-states that have compensated for their lack of raw materials, industry and technology by creating a new "tax-haven" industry, supported by local legislation guarantying tax exemption, secrecy and asset protection to foreign investors.
Unfortunately, many of these infant tax-haven jurisdictions lack the social and political infrastructure necessary to guarantee a stable investment environment.
Thus, the unwary investor who chooses the wrong location, may replace his concerns for domestic asset preservation with worries about the safety and stability of his offshore investments.
To further complicate the situation, the proliferation of new "tax-haven" jurisdictions has been mirrored by an equally troublesome proliferation of offshore "trust mills" — foreign enterprises whose sole business is the sale of pre-printed "boilerplate" offshore trusts and corporations.
These documents purport to establish investment entities in compliance with local "tax-haven" laws, but do not address U.S. tax laws and regulations governing foreign investments or asset transfers by U.S. citizens or residents.
Nevertheless, the need to protect assets from our increasingly litigious legal system and the desire to avoid our over-burdensome system of taxation continue to fuel the increasing migration of personal capital out of the United States.
Our government has mounted a campaign to stem the flow of wealth into these offshore havens through legislation designed to discourage U.S. investors from sending their money to foreign countries.
Congress has chosen the tax code as its primary weapon. In both the Small Business Job Protection Act of 1996 and the Taxpayer Relief Act of 1997, Congress included provisions imposing oppressive reporting requirements and heavy penalties on overseas investments.
The Internal Revenue Code now targets various types of offshore entities, including: foreign trusts, controlled foreign corporations, foreign personal holding companies, personal foreign investment companies, and passive foreign investment companies.
The U.S. tax laws place these entities at an economic disadvantage by taxing them either earlier than similar domestic investment vehicles or at a higher tax rate.
Thus, if you are planning on sending your money offshore, you must be aware of these new "tax traps," which often catch U.S. investors unaware, imposing upon them severe penalties ($10,000 per month plus interest) and, in some cases, even criminal prosecution.
The "boiler-plate" trusts and corporations sold by offshore "trust mills" invariably qualify as one of these targeted entities, subjecting the unwary U.S. investor to these I.R.S. "tax trap" penalties.
Thus, foreign trusts are now subject to the following "tax traps":
- Any transfer of assets to a foreign trust must be reported to the IRS; and
- Distributions from a foreign trust to a U.S. person may be taxed as income to that person; and
- Undistributed earnings may be taxed as income to the U.S. creator of the trust; and
- If the foreign trust has accumulated earnings from earlier years and makes a distribution, a U.S. recipient may be required to pay income tax on the distribution as if the income were generated in the previous year(s) and you had failed to report it, i.e., you will pay income tax plus penalties and interest; and
- You will be required to provide the IRS with extensive filings with respect to all trust transactions and who the trust beneficiaries are; and
- If you fail to file you may be fined up to 35% of the trust's assets and an additional $10,000.00 per month for each month the report is late; and
- If you fail to file you may be subject to criminal charges.
- A grantor, transferor, or executor of an estate transferring assets to a foreign trust; or
- A U.S. beneficiary of a foreign trust.
- Report to the IRS annually concerning all business activities of the foreign corporation; and
- Pay an income tax on corporate earnings, regardless of whether or not the corporation distributes the earnings to you; and
- Treat some of the income derived from the foreign company as "ordinary" income rather than "capital gains"; and
- Face severe financial penalties if you fail to comply.
- A shareholder who owns 10% or more of a foreign corporation in which more than half of the corporation's stock is owned by five or fewer U.S. persons; or
- A shareholder of a foreign corporation in which more than half of the corporation's stock is owned by five or fewer U.S. persons and 60% or more of the corporation's gross income is investment income; or
- A shareholder of a foreign corporation which earns 75% or more of its gross income as investment income, or which holds 50% or more of its assets as investment assets
To be sure, confidential "tax haven" countries do still exist; a few of them are even socially, politically and financially stable; and the goals of secrecy, total asset protection and tax-free income are still attainable.
But they are gems in a minefield. The unwary investor buying a "one size fits all" trust or a "canned" corporation from an offshore mill risks stepping on a mine.
Only a qualified professional, well versed in current U.S. tax law, as well as domestic and international asset protection law, can structure a plan to fit an individual investor's specific needs and at the same time avoid the I.R.S. "tax traps".
Such specially designed plans do not come cheap. The old adage holds true: "You get what you pay for."
But through the use of specially developed tax compliant offshore strategies, established in one of the few remaining truly confidential and safe tax-free jurisdictions, a discerning investor, guided by a properly qualified U.S. tax attorney, may tip-toe around the mines, avoid the "tax traps" and achieve complete secrecy, asset protection and tax-free growth and income.
"You get what you pay for."