Wealth Management - Hoop Jumping For Protection And Profit

Holding on to your personal wealth calls for high-level wealth management. J. Richard Duke, of Duke Law Firm,P.C., provides some important pointers on the critical issues of offshore estate planning for US citizens, which should incentivise you to jump through the necessary bureaucratic hoops.

Many wealthy Americans view the US tax laws and the US courts as mechanisms for redistributing wealth. Wealth preservation and wealth protection are high priorities for US citizens. High rates of estate, gift and generation-skipping transfer ("GST") taxes destroy family wealth. In addition, the US taxes US citizens and resident aliens on their world-wide income and subjects US domiciliaries to gift, estate and GST taxation on world-wide assets.

Applicable Us Taxation
Marginal rates of taxation are 39.6 percent for income, 55 percent unified rate for gift and estate transfers, and 55 percent for GST taxes. Sales of capital assets are taxed at 20 percent for assets held more than 18 months, and 28 percent for assets held more than 12 months, and up to 18 months. Each person receives a unified (gift and estate) "applicable exclusion" amount equal to $625,000 in 1998 and $650,000 in 1999, reducing estate and gift transfers subject to unified gift and estate taxation. The applicable exclusion increases to $1 million in 2006. Estate taxes are further reduced by debts, liabilities and dministration expenses of the estate. Each person may elect to receive a qualifying $1 million exemption against GST taxes (for transfers before or after death to a generation two or more below), with no further reductions. Assets left outright to a surviving spouse or to a qualifying marital trust are not subject to estate taxation; however, at the surviving spouse's death, such assets are subject to estate taxation, minus the applicable exclusion.

Offshore Advantages
Some of the reasons for using offshore ("foreign") trusts and other structures are as follows:

  • Trust assets escape the US court system. Future claims of creditors against the settlor or his family, such as divorce actions against the settlor's lineal descendants, are avoided;
  • The trustee of the offshore trust may purchase foreign securities as a non-US person and avoid costly reporting with the US Securities & Exchange Commission;
  • The trustee of the offshore trust, as a non-US person, may acquire life insurance from a foreign carrier and not be subject to state insurance laws;
  • Investments are made under the modern portfolio theory. Most states in the US require trustees to invest under the prudent person rule, which requires the trustee to evaluate each individual trust asset to determine whether each investment will produce reasonable income and is safe in preserving principal. The prudent investor rule requires the evaluation of all trust assets and the allocation of the assets according to an overall strategy for aligning risk-and-return objectives with trust objectives. The prudent person rule focuses on preserving principal; the prudent investor rule focuses on increasing principal under the modern portfolio theory of investing;
  • The rule against perpetuities is avoided. This rule, in most US states, permits trusts to continue during the lifetime of beneficiaries living at the decedent's death, plus 21 years for beneficiaries born later. Offshore trust laws either abolish this rule or permit trusts to continue for many years;
  • Assets located in the US are reduced by paying US estate and other taxes attributable to trust assets;
  • Miscellaneous reasons include establishing trusts for non-US relatives, holding interests in foreign enterprises, and preparation for expatriation.

Types Of Offshore Trusts
For tax purposes, offshore trusts are generally classified as foreign grantor trusts (GTs) and foreign non-grantor trusts (NGTs).

The GT, referred to as an asset protection trust, is funded by a US person and includes a US beneficiary. The settlor is taxed each year on income earned by this tax-neutral trust. This trust is irrevocable for legal purposes; however, for income tax purposes the settlor is taxed as the owner. Transfers of appreciated property to this trust are not taxable until the property is sold by the trustee. This trust is implemented for reasons other than income tax planning.

During the lifetime of the settlor, the GT grants the trustee discretion to distribute income and principal among the settlor and his family members. Upon the death of a married settlor, the GT establishes a bypass trust, consisting of the applicable exclusion, as well as a marital trust. At the subsequent death of the surviving spouse, or at the death of an unmarried settlor, a GST trust, consisting of either $1 million or $2 million, is established for the benefit of children, or children and other lineal descendants such as grandchildren. The GST trust is exempt from US estate and GST taxation and is commonly referred to as a dynasty trust or an exempt trust. The GST trust continues for as many years as the settlor desires so long as the time does not exceed any rule against perpetuities under the governing offshore trust law.

Trust assets exceeding the amount funding the GST trust pass into a non-exempt trust, which generally includes provisions avoiding the GST tax but causes the non-exempt trust to be subject to estate taxation at the deaths of settlor's children.

Foreign Non-grantor Trust
The NGT is funded by a US person; however, the trust provides that it cannot have a US beneficiary during the lives of the settlor and his spouse. Distributions, if any, during this period are generally made to a foreign charity. This trust is irrevocable for legal and income, estate and gift tax purposes, and the settlor is not taxed on trust income. Transfers to this trust are treated as taxable gifts, minus the applicable exclusion. Transfers of appreciated property to this trust are taxed. The trustee of the NGT generally accumulates income and begins making distributions to US beneficiaries one taxable year after the deaths of the settlor and his spouse. The NGT permits trust assets to appreciate without income or capital gains taxation. Also, after assets are transferred to the NGT, appreciation is excluded from estate taxation.

For some US persons the NGT may avoid or defer income taxes and achieve other objectives. The primary benefit of the NGT is the avoidance of estate taxation. The trustee can acquire life insurance from foreign carriers on the life of the settlor (or settlors, if a survivorship policy is acquired). The trustee may form other entities for legal and tax planning purposes.

The trustee of the NGT may acquire life insurance, typically a variable life policy permitting the trustee to select and diversify the investments (called portfolio bonds in Europe). The settlor funds the NGT in order to provide the trustee with the necessary cash to make the premium payments. For each year in which transfers are made to the NGT, the settlor can file an election using a part of his $1 million GST exemption against such transfers. Upon the death of the settlor, the insurance proceeds, not the premium payments, are exempt from the GST tax, even if the proceeds exceed $1 million. The insurance proceeds are excluded from the settlor's estate for estate tax purposes, except for an amount approximating the premium payments.

As a non-US tax person, the NGT can own interests in foreign corporations and avoid the controlled foreign corporation rules and other international tax laws that otherwise cause US persons to be immediately taxed on foreign income. The controlled foreign corporation rules may be avoided during the settlor's lifetime by having the trustee of an NGT and a US person, including the settlor, each owning 50% of a foreign corporation, which engages in an active trade or business outside the United States.

Numerous tax returns are required to be filed by US persons relating to the formation, funding, operations, earnings and distributions by offshore trusts and other foreign entities. Due to substantial penalties for failure to file these tax returns, as well as potential criminal liability, US persons must file all required tax returns relating to offshore matters. For wealthy Americans, however, the benefits of offshore planning far outweigh the costs.

Quotes

"Trust assets escape the US court system. Future claims of creditors against the settlor
or his family, such as divorce actions against the settlor's lineal descendants, are avoided."

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