by Stephen A. Drake, Ph.D., CPA and CFP
In a previous article I addressed asset protection (Why Asset Protection?). In this article, I intend to outline various considerations when establishing a foreign asset protection trust (FAPT). This will include discussing tax and practical issues.
For centuries individuals have sought to protect their assets in a safe and legal manner. In recent years the foreign trust has become an asset protection device that is gaining favor. The FAPT is, for purposes of this article, an income tax- neutral trust. In other words, it is not designed to save income taxes but is designed to protect assets from future creditors and judgments. This is particularly helpful to individuals, professionals and businesses in high legal exposure situations. Preserving your assets is an investment in the future to be sure that they are available for you and your family when you need them.
Despite the fact that the FAPT is income tax-neutral, there are significant estate tax planning benefits that can be worked into the planning process. Essentially, all of the advanced estate planning that is available with traditional planning in the US is available with the use of the FAPT. In other words, you can still use your living trusts and the traditional testamentary trusts while weaving the F APT into your overall plan. Thus, you can have significant estate tax planning savings and protect your assets with the FAPT.
It is well established that you cannot defraud any creditor by making a transfer to a FAPT. For purposes of this article, any transfer of your assets relates to future creditors. If this is properly structured then a transfer to a FAPT is effective. You cannot make a fraudulent transfer to evade a creditor but if that creditor is not yet a creditor then you have every right to position your assets for their protection. Further, most FAPT’s are not for all of your assets since you will need to provide for payment to current creditors. In general you will need to set up and fund a FAPT before you are involved in litigation. Even threatened litigation can be a problem so you need to act while there are no outstanding or threatened problems.
The concept of a trust has been around since medieval England. A trust is a legal arrangement is which property is held by one party for the benefit of another party. A trustee receives title from the grantor to property for the benefit of the beneficiary. In the case of most living trusts in the US, the grantor, trustee and beneficiary are all the same person. In most FAPT’s, different parties usually occupy these positions. The grantor (usually the US person) is the person giving up the assets to the trust. The trustee is typically a foreign trust department or bank (but it can be a foreign individual(s)). The beneficiary is usually the grantor with provisions for other US persons to become successor beneficiaries. The other role in the FAPT that is not commonly seen in US living trusts is the role of the “protector”. The protector is the foreign person or entity that has the power to remove a trustee if they (it) are not doing their job. Thus, it is a way where a grantor may have a voice in how the trustee is doing their job without directly controlling them.
The FAPT has a foreign jurisdiction therefore it is a very important decision as to which foreign country the trust will be formed. The laws of all countries are different so it makes sense to choose a country that has favorable, long- established trust law. My choices for jurisdiction (subject to change depending on law changes) are either Nevis (Caribbean) and/or the Cook Islands (S. Pacific). They provide the shortest stature of limitations for the future creditor to make a claim against the trust; the creditor must hire a local attorney in that foreign country to bring a claim, there are no contingent fee attorney cases allowed, and in short, these countries have laws that make it very difficult for a creditor to get a claim against the trust. In the worst case scenario, the FAPT should allow you to negotiate a favorable (discounted) settlement with the creditor once the creditor realizes the legal and practical hurdles that must be overcome.
Now, that you know a few of the basics, how does the FAPT really work? Typically, a family limited partnership (FLP) is set up in the US. This FLP has both limited partners and general partners. The general partner is usually US person/parent and the FAPT or children or a combination of both are the limited partners. There are many reasons to set up a FLP but one of the most interesting are the generous gift and estate valuation discounts (15%-50% depending on the assets and the partnership provisions) which make it a favorite of planners in the US. This same FLP can also be worked into the plan with the FAPT to maximize estate and gift benefits while also insulating assets in the properly structured FAPT. Assuming that the FAPT owns the limited partnership interests, then the minority general partner controls the management of the FLP. The general partner is always the controlling party in a FLP. The other 98%-99% is owned by the FAPT and the FAPT is entitled to its 99% share of the distributions from the FLP. In all cases, the sooner that the FAPT is set up and funded in a foreign jurisdiction is when the assets will be protected from the future creditor.
The FAPT may have assets in another jurisdiction then where the trust was formed. In other words, the trust may have been formed in Nevis but the assets may be held or managed in the Cook Islands. Or, the trust may own assets in the US but this is not recommended since a US court may have access to an asset if an unfavorable judgment occurs in the US. There is not always a choice with US real property since it is located in the US. It cannot be moved. In that case, there is more risk of a lien or seizure. Thus, there are other planning techniques that will have to be implemented where the real property is a significant asset(s).
The costs of setting up the FAPT is higher then a domestic trust because of one or more foreign jurisdictions involved. But, if the FAPT is a help in protecting your assets then it is worth it. In addition to set up costs for the FAPT there are yearly maintenance fees for trustees and advisors. As a result, the assets being transferred must be substantial (the amount can vary depending on circumstances) to make the transaction costs effective. But if you have substantial assets there is perhaps no better way to protect your assets then with the FAPT. There are also group FAPT’s, that can reduce your set-up and maintenance costs, but a group structure cannot always meet your individual, particular needs.