Lawsuit and Asset Protection

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  Frequently Asked Questions About
Asset Protection From Lawsuits

Question About “Pure Trust Organizations”
How Can The IRS Enforce Tax Rules On Non - Residents?
How Do Annuity Contracts Protect Your Assets?
Domestic Asset Protection For Real Estate ?
Do You Really Need An Offshore Bank Account?
Who Is Best Qualified For Asset Protection Advisor?


Question About “Pure Trust Organizations”

The online Asset Protection Forum that I’m hosting generated a lot of interesting replies to a question about the validity of a tax avoidance arrangement called a “Pure Trust”. The general consensus is that the arrangements are a sham for tax purposes and might not be valid for trust law purposes. Free copies of the online comments are available to APS subscribers on request via email or regular mail. An extensive expose about these questionable trusts is available in Bill Comer’s book, Freedom, Asset Protection & You.  Copies of his book are available from Research Press, Inc. and a discount is available to our subscribers.

How Can The IRS Enforce Tax Rules On Non - Residents?

Question: Your comments about the new tax rules on expatriates (9/96, Page 3) doesn’t make sense to me. If someone decides to leave the U.S., how can the IRS enforce these rules? Why can’t someone just take their money and leave if they want to do that? (P.G., New Jersey)

Reply: The expatriate tax rules basically apply to “U. S. Source Income”. That means income earned in the U.S, or income and gains from assets that are located in the U.S. To ensure that the taxes are paid, the tax code includes an assortment of provisions that require the U.S. payor to withhold taxes on amounts that are payable to non-residents. If a U.S. payor fails to do that, the U.S. person or business can be subject to some draconian penalties. No U.S. person or company would intentionally fail to withhold except when they are not aware of these rules. In most cases, the withholding will exceed the amount of taxes due so the non-resident must file a return to get a refund of any over withholding.

In extreme cases, the IRS can make a “jeopardy assessment”. In plain language, the IRS can assess a tax based on their own “estimates” of the taxes due, plus estimated interest and penalties. In some cases, IRS agents have been known to have made outrageous “estimates” that exceed the gross income from some activity or the gross value of some property. Then they can proceed to place liens on property in the U.S., to garnish wages and to attach bank accounts. That then forces the taxpayer to file a return and to negotiate with them. As for estate and gift taxes, the IRS can collect the taxes from any U.S. beneficiaries if the donor or the estate hasn’t paid the taxes.

For clarification, it’s my understanding that if a U.S. citizen expatriates with nothing but cash on which all taxes have been paid, the former citizen will not be subject to further U.S. taxes except on any U.S. source income. If a U.S. citizen were to sell off a substantial amount of assets and not pay the taxes before leaving the country, the IRS would patiently wait until they had an opportunity to seize any property in the possession of that former citizen if he or she ever went to any country where the IRS could enforce their summons powers and get permission for extradition.

Despite these extensive powers, the IRS convinced the Congress that expatriation and foreign trusts were a significant source of non-compliance with the U.S. tax laws. The result was the new rules that just passed in August, 1996. I invite comments from any readers who may have any other specific information or experience with how the IRS enforces their claims against non-residents and former citizens.


How Do Annuity Contracts Protect Your Assets?

QUESTION: Can you please describe how certain types of annuity contracts aid in minimizing the risk of losing assets? (John Z.)

ANSWER: There are two aspects to that question. One is how different annuity contracts protect the policyholder from the risk that the insurance company might become insolvent. The other involves the protection of the annuity contract from being taken by (assigned to) a creditor.

In the first case, a fixed annuity contract is one that provides a guaranteed rate of return to the policyholder. That guarantee is made by the insurance company and is backed by the financial strength of the insurance company. As an annuity policy holder, you are an unsecured general creditor of the insurance company. If the company becomes insolvent, you may lose part or all of your investment. However, all of the states participate in a “Guarantee Association” to protect policyholders from loss due to the insolvency of a single insurance company. Because of this, policyholder losses are usually not severe when an insurance company becomes insolvent. However, this arrangement has never been tested with severe losses by one of the top five insurance companies. If one of those companies went broke, it could ruin the Guaranty Association quickly.

In the case of a variable annuity contract, you have no guarantee as to the rate of return you will make on the money on deposit, but your funds will be segregated in such a way as to make you a secured creditor if the insurance company were to become insolvent. In effect, the insurance company is a trustee for those funds, which are kept in “separate accounts” and are not available to satisfy the claims of other creditors of the company - such as the other policyholders.

As for whether the funds in your annuity contract are protected from your creditors, that varies from state to state, but only a few states provide any significant protection. Where the protection is available, it’s usually because a spouse or children are the beneficiaries of the contract. In most cases, life insurance enjoys much better protection from your creditors than an annuity contract. However, if your annuity contract is part of a pension or qualified retirement plan, then many of the states provide substantial or even total protection of those assets from your creditors.

Some annuities issued by foreign insurers (like the Swiss Annuity) provide nearly absolute protection of the cash value of the contract from the claims of your creditors so long as the beneficiary of the contract is a spouse or a dependent.

However, according to the November, 1996 issue of Adrian Day’s Investment Analyst, (410\234-0691) “Proposed IRS Regulations would eliminate the tax benefits of annuity policies issued by non-U.S. insurance companies.... The (proposed) regulations would require all earnings on an annuity contract to be included in the owner’s taxable income, even though those earnings had not been paid out (and )... would apply to any foreign annuity purchased on or after April 7th, 1995.”

Note: Final regulations issued on January 7, 1998 (TD 8754) resolved this issue on a favorable basis for foreign insurance companies.


Domestic Asset Protection For Real Estate ?

A long time subscriber has asked if there are some ways to protect U.S. real estate from the litigation epidemic besides converting the equity into cash and going offshore. According to Bob L.

“I have always been leery of those islands. The tale is a little too sunny and breezy. Nifty way for the rip-off artists and lawyers to get rich. The islands are fine for folks in the narcotics business. What the hell, in that world, tax dodging is not something you are going to lose a lot of sleep over. Aren’t there other subjects that you could cover in detail? I think of real estate ... (and) I am not alone. There are plenty of people who own real estate (of various kinds). As I understand it, real estate is one the most vulnerable assets you can have.”

Residential real estate can be best protected in states with generous homestead laws, such as Florida, Texas and Kansas. A secondary option for a residence is available for those who live in the states that provide for tenancy by the entireties for the ownership or real estate by a husband and wife. A third option would be the use of a qualified personal residence trust. Mark Warda, our Associate Editor, suggested the use of dual living trusts for a husband and wife in those states that do not recognize tenancy by the entireties as a form of ownership. Another form of protection

is to borrow out the equity as much as possible and then put that money into some protected form - such as a family limited partnership or a life insurance contract. A more extensive explanation of these tactics are available in the November, 1994 issue of APS. More information on tenancy by the entireties is available on the internet at http://www.protectyou.com. This is a web site sponsored by Howard D. Rosen, Esq. For more information on qualified personal residence trusts, ask for a free article on that subject by Gideon Rothschild, Esq. (212\421-2233)

It seems that the preferred method of protecting the equity in non residential real estate is to put the real estate title into a family limited partnership, limited liability company or sub chapter S corporation.. Borrowing out the equity and putting the cash into a more protected form (like a homestead or life insurance contract) is another device that is often suggested. Another option is to transfer ownership of the real estate to a trust in which children are irrevocable beneficiaries.

Of course, some of these methods can be enhanced with the use of a foreign asset protection trust but you’ve indicated that you aren’t comfortable with offshore devices.


What Is A Foreign Trust ?

Question: Does everything about a foreign trust have to be located offshore? Can the trustees by in the U.S.? Can the assets be in the U.S.? What are the minimum requirements to have a foreign trust? (R.G., Michigan)

Reply:  Until recently, there was a set of different tests that were used to determine if a trust was foreign or domestic. The decision usually depended on the facts of each case - and on a preponderance of the characteristics of one or the other. (Foreign or domestic.)

The 1996 tax law imposes a relatively straightforward definition of a domestic trust and then states that if it’s not a domestic trust, it’s a foreign trust. However, it would be possible to have an offshore trust that is treated as a domestic trust by the tax law.

Assuming that you have already established an offshore trust for asset protection purposes, it’s most likely that it will be treated as a foreign trust under the new laws because the trust will not be subject to control by U.S. trustees and to jurisdiction by a U.S. court. The definition of a domestic (U.S.) trust will be based on a two part test. First, a court within the U.S. “must be able to exercise primary supervision over the administration of the trust”. The second test is that one or more U.S. fiduciaries (trustees) must have the authority to control all substantial trust decisions. Here’s a somewhat more technical explanation by Richard Duke.

Unless a trust meets both of these tests, it will be treated as a foreign trust and will be subject to the new reporting requirements for a foreign trust. If there is a U.S. trustee subject to the supervision of a U.S. court, you will have a domestic trust for tax purposes.


Do You Really Need An Offshore Bank Account?

I was one of the speakers at the Sound Money Investor’s offshore conference in Nassau from Dec. 4 through Dec. 7. It seemed that the main message from most of the other speakers is that the door may be closing for those who want international financial diversification. A number of the other speakers encouraged the audience to have a foreign bank account. The reasons given were usually (1) access to foreign investments not otherwise available to U.S. citizens, (2) protection from a declining dollar and (3) having some cash offshore before the U.S. government closes the door. One speaker even claimed that an offshore bank account offered asset protection.

As for the asset protection argument, you will be required to disclose your foreign accounts if you are subject to a judgment and you can be required by a US court to repatriate the money if you have the legal power to do that. I would encourage you to forget about the asset protection argument for having a foreign bank account.

As for protection from a declining dollar, you can hedge against that by buying foreign currencies through a U.S. bank. If you are concerned about currency controls, that would seem to be a valid reason to gradually move some money into an offshore bank account.

The claim that you need an offshore account to have access to foreign investments that are not registered with the U.S. SEC is true, but it’s not enough. Foreign investment firms or issuers won’t sell to a U.S. citizen unless it’s done through an offshore trust, an offshore corporation or even an offshore partnership. To have access to the direct purchase of foreign investments, you will need more than a foreign bank account.


Who Is Best Qualified For Asset Protection Advisor?

One of the most frequent requests I get from subscribers is to recommend an asset protection advisor.

I've commented in the past that a lot of lawyers and other financial advisors are jumping on the asset protection "bandwagon" as an opportunity to generate high hourly billing rates by working for people who have accumulated a substantial net worth.

Bill Comer told me he has noticed that a lot of lawyers are looking for work - any kind of work. A few of them have approached him to ask to buy or license the use of the estate planning and asset protection trust and partnership documents that he has prepared for other attorneys. What they seem to want (according to Bill) is a pre-packaged set of legal forms with which they can become "instant experts" at asset protection. Bill tells me he is seeing a lot of lawyers who used to specialize in other areas of the law who are now offering to prepare documents for trusts, limited liability companies, family limited partnerships, tax exempt foundations and whatever else they can sell.

To be able to provide basic (i.e., domestic) asset protection services, the attorney should have some substantial experience with various kinds of trusts, partnerships, corporations, bankruptcy laws and the related income and estate tax laws. From what I've seen, only a small percentage of lawyers can honestly say they have more than five years of experience where they devote at least half their time to that sort of legal work.

To provide advanced (i.e., international) asset protection services, the attorney should also have extensive personal experience in working with foreign trusts and foreign trustees, plus an extensive knowledge of how the U.S. tax laws apply to foreign trusts and other foreign sources of income. It's my opinion that real experience is the most critical qualification in using offshore trusts for asset protection. Your lawyer needs to have developed an extensive network of reliable contacts in this field.

Let me share a "secret" about using lawyers or other advisors. The best way to get the best help at the least cost is to find the person who spends most of his or her time doing what you need. When you hire someone without that experience, the biggest cost to you will be the mistakes they will make at your expense.

Most of the various advisors to my newsletter have been heavily involved in the asset protection field for at least six years. To the best of my knowledge, they are among the best in the field. So if you are looking for an asset protection advisor, I suggest that you begin by reviewing the credentials of our advisors, which are available at their individual advisor pages. You can get a summary of each at our advisor page.