What Is The Best Way To Structure Assets?
So often people write us to discuss trusts, corporations, family limited partnerships, and/or other structures designed to protect his or her wealth.
Structures are very important, but structures alone cannot do the job in a one-size-fits-all approach to asset protection. While an international trust may be just what the doctor ordered for protecting a surgeon’s life savings, the same structure will do very little to help a commercial real estate developer operating in litigious North America.
The structure is only part of the equation. The investment class is also very important. You need to put both parts of the puzzle together in a coherent fashion to truly protect and grow your wealth. If you select the wrong vehicle for your assets or choose the wrong asset classes for your structure, you can end up simply wasting your time and money.
So which structure or combination of structures might be right for you? Let’s walk through the options.
This is the Cadillac of asset protection vehicles, allowing you to select the jurisdiction in which any possible future fight over your assets would occur. Going global allows you to pick jurisdictions that favor grantors, beneficiaries, debtors, defendants, etc., at the expense of all types of future plaintiffs.
The international asset protection trust can help your future estate avoid both estate taxes and probate and allow your financial and moral influence to be felt from beyond the grave. An asset protection trust can work exceptionally well with assets that can be “picked up” and moved, including stocks, bonds, precious metals, and titles to foreign real estate, and anything else that can be “titled” offshore.
On the other hand, the Qualified Intermediary (QI) rules applicable in many “haven” jurisdictions make it impractical to hold and trade U.S. securities from a foreign trust. Some financial institutions simply do not allow a trust for which they serve as administrator to buy or sell U.S. securities. Others allow you to trade U.S. securities only once you have filed a W-8 BEN Form with the IRS. The new FATCA (Foreign Account Tax Compliance Act) rules implemented through the HIRE Act will make certain offshore financial transactions even more difficult for American-created structures that have U.S. beneficiaries.
Foreign trusts are not good vehicles for holding U.S. real estate, bulky silver, antique cars, expensive artwork, and things that are difficult or impossible to “move” across international borders. Also note that, if you move an asset into a foreign trust, you can put some of your remaining domestic assets at greater risk, because judges can get very upset when they find that they cannot attach certain assets that you have moved outside their jurisdiction. For this reason it is important to remember the domestic assets that will stay behind as well as the assets to be moved.
You should also understand that foreign trusts do not change the income tax ramifications for income, dividends, or capital gains, which must be picked up by the Trust Grantor on his/her individual trust return. So holding assets that generate passive income, such as hedge funds, in an asset protection trust will not mitigate the tax consequences of holding such an investment.
An International Business Company (or IBC) is a great vehicle for holding business assets that you intend to put to productive use. This can include real assets such as machinery or foreign real estate or intellectual assets such as patents, trademarks, and/ or copyrights, as well as, of course, any type of global business opportunity.
The IBC is not taxed in the jurisdiction where it is formed and may or may not be subject to current taxation in your home country depending on the type of income generated (active vs. passive), the nationality of the controlling shareholders, and a number of other factors.
The IBC is generally not a good vehicle for holding passive investments. The U.S. tax code includes a section on Passive Foreign Investment Companies (PFICs), and the relevant rules and regulations can make taxation of these entities held in an IBC worse than if they were held in a domestic vehicle or simply held in your own name. If, on the other hand, you are looking to roll up your sleeves and engage in an active business, the IBC or LLC is the ideal choice.
A Family Limited Partnership can be used both domestically and internationally. FLPs are a great way for senior generations to gift various assets over time to the next generation while still maintaining control as the general partner. This strategy works well for domestic real estate, closely held U.S. businesses, and assets that you generally want to “keep in the family.”
Drawbacks to an FLP include succession challenges to the general partner and the potential asset protection challenges of the general partner. Sometimes the general partner of an FLP can be an offshore IBC designed to protect the partnership from claims against the general partner, or the general partner interest can be placed into a trust.
Private Placement Life Insurance is really the only vehicle remaining that allows an individual to legally defer taxation on passive income, avoid capital gains, and eliminate estate and income tax. A VUL (variable universal life) policy can be great for assets that have the potential for large capital gains or income streams, as the income that flows into the foreign insurance company is normally tax-free.
Note that the instruments inside the insurance wrapper must be diversified under the insurance section of the Internal Revenue Code to constitute legitimate insurance.
Hedge funds are particularly good investment classes for life insurance wrappers, because they are by themselves private partnerships, which are very tax inefficient. Instead of liquidating a third of your gains every year just to meet your tax obligations, you can wrap the investment inside an insurance policy, allowing the money to grow tax-deferred.
Private placement investments with strong upside are also good candidates for insurance wrappers, while money-losing investments are best kept in your own name so you can take the tax deductions. This type of “insurance wrapper” works well with asset protection trusts to defer taxation and create a death benefit often needed to fund a multi-generational or dynasty trust.
An Individual Retirement Account (IRA) generally refers to all types of tax-deferred vehicles, including SEPS, Keoghs, 401(k), and 403(b) plans. These domestic retirement “trusts” can legally own the member interests of foreign LLCs, which in turn can own bank and brokerage accounts as well as virtually any type of business interest, real estate, or investment.
The LLC itself can be set up as a “disregarded entity,” which minimizes tax and reporting requirements and allows income to pass through to the IRA (which itself is tax-deferred). This can be a tremendously effective vehicle if you’re looking to defer significant income for your retirement years.
Foreign real estate, foreign art acquired and held abroad, precious metals, and precious gem stones all have one very important thing in common: They are not reportable to the U.S. IRS, as a foreign trust, IBC, bank, or brokerage account would be. It is therefore possible to maintain a low profile with these items no matter how the ownership is structured, despite the new reporting requirements of IRA Form 8938.
The lack of “present” income is ideal if you’re looking to grow your assets offshore in a private and discreet way. Real estate that produces agricultural products, such as coconuts, wood (teak, mahogany), alternative fuels (sugar, coconuts, corn), etc., can also be an excellent way to diversify out of traditional investment classes as well as the dollar and into hard assets that produce non-dollar-denominated income. While the income must be reported (unless in an IRA or insurance wrapper), this kind of an investment nevertheless can be a great way to protect and grow wealth that can increase in value as the dollar declines vis-a-vis other world currencies, such as the Brazilian real.
Debt can be used as an effective asset protection structure and strategy, especially in the context of U.S. real estate. Many advisors strongly recommend against debt, but that is because they do not understand the role of debt as an asset protection vehicle. Instead of putting real property in a trust, which may not protect it at all, why not leverage the property instead and then put the equity that you pull out of the property into an asset protection structure? The property involved becomes very unattractive to potential plaintiffs as soon as they realize that they will have to get in line behind a bank holding a first mortgage position against it.
To the extent that your international investment returns from the cash you pull out of the real estate exceed your domestic interest expense, you are ahead both with your returns as well as your asset protection. A number of my clients borrow in dollars and then invest in a basket of foreign currencies they believe will strengthen vis-à-vis the dollar, thereby positioning themselves to pay back the debt in dollars that will be worth less than they are today. The very low U.S. interest rate has also created an arbitrage situation, in which dollar CDs abroad can pay higher rates of interest than the cost of the loans in the United States.
The bottom line point is that certain assets are predisposed to be fitted together with certain structures rather than others for maximum asset protection and tax benefits. Knowing what you need or want from an asset protection strategy influences your investment mix, and, conversely, a strong desire for a particular asset mix dictates the type of asset protection structure that will work best for you. Keeping the relationship between the two in mind will help you to maximize the effectiveness of both your structure and your overall investment return.
At What Cost An Offshore Structure?
Companies in the business of setting up offshore structures generally know one thing—how to set up structures in the jurisdiction where they focus. What they likely know nothing about are the tax implications for you back home (wherever home is) once you’ve set up that structure. They also likely have little idea whether the structure you’re paying them to set up for you will actually achieve your intended goals. That’s usually not the point with these guys. The point is processing the structure. Period.
Last year an attendee at one of our offshore events asked what she should do with the Panama corporation she’d had for years.
“Why did you set up the corporation in the first place?” we countered.
“Because a friend told me I needed one,” she said.
No more thinking than that had gone into it. By the time we spoke with her, she’d been spending US$550 per year for several years to maintain the shell company, even though she had no idea what to do with it.
Get Rid Of It!
We spent a little more time trying to understand this attendee’s situation, and, when we did, we were able to answer her opening question. What should she do with her Panama corporation? Get rid of it. As she explained her plans to us, a Panama corporation didn’t figure into them, and the cost of maintaining it was wasted money.
We had another similar conversation, in this case, the person we were speaking with had been using his corporation to hold real estate. He’d recently sold the property out of the corporation and wanted to know what to do with the structure now. We suggested he let it go dormant (that is, stop paying the renewal fees), as he didn’t have another immediate use for the entity. With the cost of a new entity being more or less the same as two years of fees to maintain the corporation in question, the guy would save money in the long run.
Having structures you don’t use is a waste of money (of course). However, it’s also a waste of money having structures you don’t need.
Another reader recently told us that an advisor had recommended he set up a slightly complicated set of structures to save taxes on his options trading income. The structures company he was speaking with told him he should set up a BVI corporation and a Panama corporation. Have the BVI entity own the Panama entity… do his trading through the Panama corporation… then have the BVI entity pay him a salary. According to this structures company, that set-up would eliminate taxes on trading profits and allow the guy to avail of the Foreign Earned Income Exclusion (FEIE)… even though he was still living in the United States.
That is not the case. In fact, that advice is so off that it could get the reader into serious hot water.
First, the double structure plan doesn’t change anything for U.S. tax purposes. Passive income is passive income. Taxes on it can’t be deferred using a corporate structure. In fact, such a structure likely creates a higher tax burden for the income in question.
Additionally, as the income is passive in nature, it can’t qualify the individual for the FEIE. Furthermore, in this case, the individual is living in the United States. He couldn’t qualify for the FEIE anyway.
Why would a structures company give such advice? Without knowing who they are or anything more about them, we can only speculate. Their objective is to sell structures. They probably don’t care and more probably don’t know anything about U.S. taxes.
The unfortunate reality in this case is that the trading profits are taxable in the United States. There’s no two ways about this. Our advice to the reader, given that, was to set up an offshore LLC. That entity could then open a bank account and an offshore trading account. Again, the trading profits still would be taxable in the United States (because they are passive income); however, using a pass-through entity such as an LLC helps minimizes the IRS paperwork. The LLC structure also provides some asset protection.
Setting up a structure comes at a cost and so does maintaining it. You want to weigh the benefits against the costs before proceeding. If you’re starting an active business offshore, then you definitely want a corporate entity. If you’re doing long-term estate planning, then you likely want an offshore trust and/or LLC to hold your investments. If you’re planning on diversifying into many different investments offshore, then forming a single entity to own those investments could make sense.