Using Trusts For Asset Protection

Introduction to Trusts for Asset Protection

Trusts can be one of the best methods of asset protection – and also one of the worst. Whether a trust ends up being the good, bad or ugly depends on a variety of factors, including whether the trust is self-settled or not, how the trust is funded, where the trust is formed, and what language is created in the trust document.

What Trusts Are

Let’s say you and I are sitting on a beach. I have a $5 bill, but I want to go swim in the water, and I don’t want to get the bill to get wet. So I say to you, “Here, hold my $5 bill for me until I get back.” If you agree, then you and I have just created a trust — the $5 bill is the property (a/k/a “res”) of the trust, and the terms are simply that you will hold it for me until I return. So, a trust is really just an agreement between two people, where one of them holds property for the other.

Simple enough? Well, we could start throwing a bunch of terms into it, such as “When we’re done, I’ll buy you a drink for holding it for me”, or “If my sister comes by, give the $5 to her.” Eventually, we could agree on so many terms that it would be necessary to reduce our agreement to writing, usually called the “trust document” (a/k/a “Deed of Trust”).

So why do trusts seem complicated? Two reasons:

First, trust law has evolved much more slowly than other areas of the law, and the use of arcane phraseology is often still required in the trust document. In other words, the trust law often heeds “substance over form” or “what I say is more important than what I mean” and NOT “form over substance” (what I meant is more important than what I say). This means that if you miss including certain old English phrases, you might mess up the trust document.

Second, tax law as it relates to trust is very, very complicated, and allows for the creation of many types of what I will call “tax trusts” that did not exist at common law, such as Grantor Retained Annuity Trusts (GRATs), and similar entities.

Trusts are not created by the government and you usually don’t have to “file” a trust document for the trust to be effective. Because you don’t have to file anything, it is easier to keep the existence of trusts a secret.

Trusts and Taxes

The U.S. Internal Revenue Code is often an indecipherable, overly complex mess, and this hold true in regard to trust taxation. However, a general rule is that if you give property in trust, that property is now the property of the trust, and you don’t have to pay income or capital gains taxes for it in the future, although you may have to pay some gift taxes now. The exception is the so-called “Living Trust” or “Grantor Trust” where you still pay taxes for the trust, even though you’ve given it all away to the trustee.

Contrary to popular belief, foreign trusts created by U.S. persons, and/or having U.S. persons as beneficiaries, are subject to U.S. tax, including U.S. income tax. This was not necessarily the case before 1996, but that year Congress changed the laws and virtually eliminated all tax benefits for using foreign trusts (not that there are not a bunch of shysters out there today still selling trusts to U.S. citizens and insisting that they are somehow “tax free”). The failure to disclose to the IRS the creation, funding or a beneficial interest in a foreign trust can amount to criminal tax evasion.

Why Trusts Are Marketed For Asset Protection

There are a number of reasons why trusts are so heavily marketed for asset protection, none of them are reasons to use a trust for asset protection planning.

Tax Evasion Background. Until the mid-1990s, offshore trusts were used to shelter income and avoid estate taxes, and certain loopholes in the Internal Revenue Code allowed this. Many planners attempted to hide their aggressive tax planning by disguising their trusts as asset protection trusts. Congress eventually, however, passed the Small Business Protection Act, which effectively nixed all tax benefits for offshore trusts, and now foreign asset protection trusts give almost no tax benefits (and, to the contrary, if not formed and managed correctly, create some really horrible tax consequences). Still, this was another factor that caused a surge in offshore trust formations.

Mass Marketing of Shysters. Beginning in the mid-1990s, various shysters comprised of disbarred attorneys, multi-level marketers, and outright thieves looking to embezzle from the trusts once they were set up, started mass-marketing offshore trusts like crazy. The worst of these groups were the Global Prosperity Group (“GPG”), whose founders have since been indicted and fled the U.S. to avoid prosecution, and Prosper International League, Ltd. (“PILL”) which set up useless Belize trusts by the thousands. Also, a bunch of really bad attorneys got into the “asset protection game” giving seminars on an almost daily basis and selling totally useless “Do It Yourself” kits for thousands of dollars – and people bought them like crazy.

Trusts Are Cheap to Produce. Once you have a trust form you are satisfied with, you can duplicate it, fill in the blanks and squirt out a functional trust document in minutes with your only costs being paper and toner. And if you have set up your own trust company offshore, nearly all that money is gravy. No hard planning, no slaving over particular language in the trust deed, just squirt that form out and get ready for the next client.

One Shot Solution. Trusts are something that a client comes to you, you squirt out the trust, the client funds the trust and pays fees to an offshore trustee, and you may never see the client again. With offshore trusts, once you have done your job, you are done. You get all of your fee up front, and no ongoing risk management necessary. If something blows up later, you’ve already got all of your fee, and the client probably wasn’t going to pay you to do another trust anyhow, so no big loss to you.