Secret Foreign Trusts By Vernon K. Jacobs, CPA  & J. Richard Duke, J.D., LLM

An assortment of promoters are peddling various kinds of trusts that they claim are just like the "secret" foreign trusts used by the Mellons, The Carnegies, The Rockfellers and other rich families to avoid income taxes and estate taxes. They are promoted under an assortment of names including  the “Pure trust”, "Equity Trust", "Constitutional Trust", "Common Law Trust", "Family Estate Trust", "Unincorporated Business Organization" and numerous others.  In many cases, the trust package includes at least one foreign trust. With the advent of the internet, the promotion of these arrangements has proliferated. One of the more humorous claims about these trusts is that the promoter has somehow uncovered the "secret" trust of some wealthy family that has allegedly used this magical piece of legal alchemy to avoid taxes and to protect the family assets from all creditors. For those promoters who are telling you that they have secured a copy of the "secret" trusts of the super-rich like the Rockefeller family, the Ford family or the Carnegie family, ask them to show you a copy. And by the way. How did they get it? Did they steal it? Even if it were true that the very wealthy families have "special trusts" with unique tax and asset protection features, why would they share it with anyone? How in the world could anyone get a copy without stealing it? Let's be realistic for a moment. The vast fortunes of the families mentioned above were made long before the U.S. even had an income tax. In many cases, these families used business trusts because they had some non-tax advantages over corporations. After the income tax was enacted in 1913, many of the most wealthy families put their wealth into corporations which they then contributed to charitable foundations, while leaving large amounts in their family trusts. The tax deductions for giving stock to the foundations offset a lot of taxable income. As the laws changed, many of the devices used by the very wealthy were "grandfathered" so that their arrangements would continue to be legal but no else could do the same thing. The really wealthy families can afford to buy a few obscure tax laws that help them to shelter their taxes but those "loopholes" are seldom available to the rest of us. In addition, before 1976 it was legal to use a foreign trust to defer or even to permanently avoid U.S. income and estate taxes. The laws were changed in 1976 to require that U.S. persons who provide the funding for a foreign trust with a U.S. beneficiary will be subject to  tax on the income of the trust. But the trusts in existence before the law was changed were grandfathered so long as they were not altered.  Even if you could find someone who would sell you a "grandfathered" foreign trust, it would not do you any good because you would not be able to keep the grandfather status. But, according to a promoter you have just met,  now you too can thumb your nose at the IRS for a mere $10,000 (or whatever the traffic will bear) for the purchase of this magical and "secret" trust document of the very rich.  But there's a small catch. You can't tell anyone about this secret trust. No, you can't even show it to your lawyer or your tax preparer. Besides, they wouldn't understand it anyway because most lawyers and tax preparers aren't trained to understand trusts. Or at least, that's what you are likely to be told. A basic principle of the U.S. tax law with respect to trusts is that someone will pay taxes on the income of the trust. It might the founder/grantor/settlor who creates the trust. It might be the trust beneficiaries. If neither of them pay the taxes on the trust income, then the trust will pay the tax - and at a much higher tax rate. The only exception is a charitable trust in which a charity will get all or a substantial part of the trust income or assets. And, if it's a foreign trust , the U.S. person who puts assets in the trust is subject to taxes on the income of the trust - even if it's an irrevocable trust. If you are tempted by some slick talking promoter, remember this. The IRS is presently on a "witch hunt" for the promoters of these phony trust packages. When they find one, they subpoena his customer records and then they audit the people who bought the trust packages. William Comer , a Certified Paralegal, has spent years doing legal research for his law firm clients on this subject. A few years ago, he included his conclusions in two chapters of his book, Freedom, Asset Protection and You . Chapter 19 is a devastating critique of what Bill calls "Defective Domestic Trusts" and chapter 20 does the same thing with regard to "Defective Foreign Trusts".   There are some international "advisors" who advocate using a secret foreign trust as a way to avoid/evade U.S. taxes.  Aside from the fact that these arrangements are patently illegal for U.S. persons, they will eventually backfire. Right now, the IRS is actively investigating many thousands of foreign trusts based on information they have gleaned from various promoters. Few people who have foreign trusts can resist the temptation to brag about it to friends, relatives, neighbors and everyone at the local country club. It's not unusual for one of these people to feel they are being cheated because the braggart is evading taxes -- so they inform the IRS. Even if the person who creates the trust is able to keep his mouth shut for many years, there are numerous paper trails to alert the authorities. And assuming that someone is able to keep the trust a secret until they die, their estate will become liable for huge amounts of back taxes, penalties and interest. After the dust is settled, their heirs will curse them in perpetuity. Foreign trusts are being used by those of moderate wealth to protect some of their assets from the litigation lottery in the U.S.  A properly structured foreign trust will make it extremely difficult for a judgement creditor to gain access to the assets in the foreign trust.  However, to do this, the person who puts money into the trust must give up effective control over the assets to the foreign trustee.  Thus, it is not advisable for anyone to put more than a nest-egg into such a foreign trust as a worst case precaution against losing all of their other assets.  But --- these asset protection trusts are tax neutral, which means they don't result in any tax savings.  For tax purposes, the person who puts the assets into the trust must pay income taxes on any income earned by the trust.  This is an over-simplified description of a conplicated form of asset protection and is not intended to be complete explanation of the subject.

About the authors: Vernon Jacobs is a CPA who provides tax accounting and consulting services for clients with international interests.   J. Richard Duke , JD, LLM is an attorney who specializes in international tax law and is an Adjunct Professor of international tax law.  Sponsored by Offshore Press, Inc .., Copyright, 2006 All rights reserved. Offshore Press, Inc., Box 8194, Prairie Village, KS 66208. Phone (913) 362-9667. Email to Offshore Press  Vernon K. Jacobs, Webauthor .