Foreign Trusts: Risks and Abuses

Foreign grantor trust, international business corporation, credit and debit cards

by Alan R. Eber

Excerpted from Asset Protection Strategies & Forms

• Foreign Grantor Trust
• International Business Corporation
• Credit and Debit Cards

Clients often ask if International Asset Protection Trusts (“IAPT”) are totally creditor proof. Generally, they are, provided they are conservatively structured and assets are transferred to them years before difficulties arise.

However, a U.S. court may obtain jurisdiction:

• If a settlor retains control over the appointment of the trustee.

• If the settlor is a trustee.

• If domestic trust protectors have the power to remove and replace the trustee and the trust does not specifically prohibit the protector from appointing a U.S. trustee.

• If a duress clause is not utilized.

If a U.S. court obtains jurisdiction, then it may require the trustee to repatriate assets, or require the U.S. protector to fire him and appoint a U.S. trustee. If the U.S. trustee and/or protector have the power and refuse, they can be held in contempt. Once the trustees are under the court’s jurisdiction, the court can require them to repatriate assets.

Delay Allows a “Lookback”

The client must take action before it is too late to do so. The most dangerous attack that a creditor can make against the planning strategy is to claim that the client transferred assets after a claim arose, and that the transfer was made to “hinder or delay” the collection action. Such a transfer is fraudulent.

The IAPT is not designed to allow individuals to defraud others or engage in tax evasion or criminal conduct.

If an IAPT is used to defraud creditors or evade taxation, or protect the proceeds of criminal or fraudulent activities, then a judge may ignore provisions of the trust and apply the leverage of a contempt order.

The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 became effective on October 17, 2005. That Act contains a “lookback provision” for transfers made to self-settled trusts:

(e)(1) In addition to any transfer that the trustee may otherwise avoid, the trustee may avoid any transfer of an interest of the debtor in property that was made on or within 10 years before the date of the filing of the petition, if—

(A) such transfer was made to a self-settled trust or similar device;

(B) such transfer was by the debtor;

(C) the debtor is a beneficiary of such trust or similar device; and

(D) the debtor made such transfer with actual intent to hinder, delay, or defraud any entity to which the debtor was or became, on or after the date that such transfer was made, indebted.

[Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 §1402(e)(1).]

The Foreign Grantor Trust (“FGT”)

A Foreign Grantor Trust (FGT) is a trust formed by a non-U.S. citizen or resident, and there are U.S. beneficiaries.

The non-U.S. settlor (as well as earnings of the FGT) are not taxed by the IRS.

U.S. recipients need to report money received from an FGT. [Notice 97-34, IRB 1997-25 (6/2/97) Section V. U.S. Beneficiaries of Foreign Trusts.]

Generally, a U.S. person who receives a distribution from a foreign trust after August 20, 1996, must report the name of the trust, the aggregate amount of distributions received from the trust during the taxable year, and such other information as the Secretary may prescribe. [IRC §6048(c).] A U.S. beneficiary who fails to report a distribution is subject to a 35 percent penalty on the gross amount of the distribution. [IRC §6677(a).]

This type of trust is valid only if both:

• A real foreigner sets it up.

• The money that funds it is really the foreigner’s.

This type of trust is not valid when an American arriving in Belize (for example), turns to his poorly paid taxi driver and says: “Señor, how would you like to earn $500?”

“$500! My lord, what must I do?”

“You are a foreigner; set up an FGT for me!”

This is tax fraud. Be very careful when a client requests your assistance with an FGT for his “foreign friend.” Be certain who the client really is and who is providing the money.

The International Business Corporation (“IBC”)

Even if the earnings of an IBC are not repatriated, an American who owns an International Business Corporation that earns investment income must file the appropriate tax forms and declare the income.

Foreigners investing into the U.S., under the right circumstances:

• Are exempt from paying capital gains tax. [IRC §871(a)(2) (an NRA is not taxable on U.S. capital gain if he is not physically present in the U.S. for more than 183 days during the year; and is not engaged in a U.S. trade or business); IRC §864(b) (if an NRA trades in stocks for his own account through a U.S. broker, this is not a trade or business within the U.S., unless he has a fixed place of business in the U.S.).]

• Can benefit from structuring loans that comply with the Portfolio Interest Rules. [Portfolio Interest §871(h) is not subject to the normal 30% tax that applies to U.S. interest received by non-resident aliens unless it is effectively connected with U.S. trade or business.]

Many clients are told by promoters that IBCs can be structured to give them the same benefits that foreigners enjoy. They cannot. Unlike most countries, the United States taxes citizens on worldwide income. If you earn a dollar on the moon, and never repatriate it, you still best report it.

Many promoters in international jurisdictions tell clients that they, the foreign promoter, will register the IBC in their own name and give the client a “side letter.” They then explain to the client how to set up a U.S. brokerage relationship for the IBC and thereby avoid paying capital gains tax. This is a sham. If the potential client says that the IBC need not pay U.S. capital gains tax, be wary before you become involved.

Credit and Debit Cards

Many owners of IBCs have credit and debit cards issued in the name of the IBC and use them to withdraw cash from “their” IBC.

If they do so without paying tax, this activity is tax fraud.

Alan R. Eber is a pioneer in the asset protection field and a highly sought after speaker on estate and wealth planning and protection.  Since 1974, Mr. Eber has assisted clients in establishing a wide variety of wealth preservation structures. Currently, Mr. Eber is presenting seminars on Advanced Asset Protection and Techniques and Domestic and International Trusts for the National Business Institute (NBI), the Lorman Group, and numerous other groups.  He is the author of Asset Protection Strategies & Forms, from which this article is excerpted.