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Control, use, and enjoy your assets without legal ownership

A fundamental rule for high-level asset protection planning is separating legal ownership from control. What does this mean? Imagine someone sues you. You get dragged into court, and a judgment is entered against you. To satisfy the judgment, a creditor can take assets that you own personally, such as stocks, bonds, real estate, and business investments. If you own these assets in your name, a creditor with a judgment against you can take them away.

You can hold these assets without direct personal ownership to avoid this situation. An asset protection trust lets you control, use, and enjoy the assets without the added risk of personal ownership.

Establish a trust (vs. LLC)

Asset protection trusts have been used for decades to protect valuable assets from lawsuits and creditors. A trust is simply an agreement between parties to manage and hold assets in a certain way.

These parties include the trust creator, the Trustee, and the Beneficiaries. A trust creator is also called a Settlor, Trustor, or Grantor. The Trustee is the manager and decision-maker for the assets in the trust. The Beneficiaries are the people or organizations that use and enjoy the trust assets.

An asset protection trust works by separating legal ownership from the beneficial enjoyment of the assets in the trust.

The Settlor who creates the trust transfers assets to the Trustee of the trust. The Settlor then no longer legally owns those assets. They have given up legal ownership and beneficial enjoyment of the assets.

Those trust assets are now legally owned and managed by the Trustee of the trust. The beneficial enjoyment (i.e., the power of use or benefit) of those assets lies with the trust’s Beneficiaries. The best asset protection trust laws allow the Settlor to be a Beneficiary.

Take, for example, a $500,000 investment account. The account is in Mike’s name. He owns it outright. He’s the legal owner who calls the shots on what happens with the $500,000, and he also has beneficial enjoyment of the money—i.e., he gets to use it if he wants. Mike sets up a trust and retitles the account into the trust. Legal ownership of that $500k now lies with the Trustee of Mike’s trust. Beneficial enjoyment of those bucks now goes to the Beneficiaries of the trust.

Here is the best part. With proper drafting and the right choice of trust laws, Mike can be a Trustee and a Beneficiary if he wants.

Irrevocability

An asset protection trust must be irrevocable by the trust creator. Imagine you create a trust and transfer your assets to the trust. Down the road, you end up with a creditor who brings you into court. If you have the power to revoke a trust and take back the assets, a judge will order you to do so. The assets you put into the trust will be returned to your name. Those assets can then be seized and taken by your creditor.

There is a common misconception that an irrevocable trust is rigid and permanent. An irrevocable asset protection trust can be modified if needed. It just can’t be changed for the benefit of a creditor.

Flexibility

A great asset protection plan should be flexible. As mentioned before, a Trustee can have the power to alter an irrevocable trust. For example, a trust can change jurisdictions, or the beneficiaries can change. These powers are desirable if a creditor attacks the trust or the assets in the trust.

Imagine you are subject to one of the millions of lawsuits in the United States annually. The suing attorney wants you to disclose your assets (so they know whether it’s worth pursuing you).

You have an asset protection trust in place. With advice from your attorney, you decide to be temporarily removed as a beneficiary. You can tell the suing attorney that you are not the beneficiary of a trust. Those trust assets remain protected, and often the lawsuit will not move forward. Attorneys don’t sue without assets to pay for potential judgments.

What if the lawsuit does move forward and has a very motivated creditor? What if the creditor is willing to fly overseas to get your trust assets? The trust’s flexibility allows it to move from one country to another. Your creditor goes to the offshore court and discovers the trust has moved to another unspecified country.

A flexible asset protection plan has a lot of strength and possibilities.

Jurisdiction

Jurisdiction is the location of the asset protection trust. It is the location of the laws that form the rules of your trust. For example, the state of Wyoming is a jurisdiction. It has trust laws specific to Wyoming. Offshore examples include Nevis, the Cook Islands, and many others.

Each jurisdiction has pros and cons in utilizing its laws.

Domestic vs. Offshore

There are both domestic and offshore jurisdiction options for asset protection trusts. Domestic refers to laws within the US. Offshore refers to the non-US jurisdiction options.

Domestic Option

Some US states offer asset protection trust laws. The earliest laws have been around since the late 1990s. Nevada, Wyoming, Alaska, and South Dakota are some of the most well-known asset protection trust laws.

One of the pros of the domestic option is familiarity with the country— i.e., it’s still in the United States. People often feel more comfortable relying on laws from a country they are familiar with.

The primary advantage of a domestic trust is no IRS reporting requirements. You don’t have to tell the IRS what’s in your trust if it’s managed in the United States. There are no complicated forms to file every year with your tax return.

The major con of the domestic option comes from Article 4, Section 1 of the US Constitution, the “Full Faith and Credit Clause.”

Imagine a Washington state resident who sets up a Nevada asset protection trust. This person gets sued and ultimately must defend against an attack from a creditor. The creditor will argue to the judge that Washington laws should apply. The person with the trust will say that Nevada laws should apply. This is a choice of law analysis; unfortunately, the judge will likely agree with the creditor.

After winning the case under Washington laws, the creditor goes to Nevada to enforce the judgment. The Nevada court must follow Washington’s ruling and allow it to be enforced against the trust assets. This is the Full Faith and Credit Clause in action. The court of one state must follow and abide by the judgment of a court in another state.

Offshore Option

Two top offshore jurisdictions for lawsuit asset protection are the Cook Islands and Nevis. The Cook Islands created its asset protection trust laws in 1984. It was the first jurisdiction to offer this type of asset protection legislation.

There are many benefits of using the Cook Islands or Nevis trust legislation. For starters, the countries are far away—especially the Cook Islands. If you must litigate the case in the Cook Islands, you will be traveling far to get there.

There are many hurdles for a US attorney or creditor trying to seize assets from an offshore trust.

A US attorney must hire local counsel to present their case. Local counsel is not allowed to work on contingency fees. The US attorney would pay an hourly rate for the work. This is a significant deterrent for creditors who want to keep costs low.

Another expense is the court bond required to file a claim. A bond is necessary because the loser must pay the other side’s fees if they don’t prevail. A US creditor must post this bond to start the court process. If the creditor loses the case, the defendant gets to pay their attorneys for their defense out of that bond.

Another offshore advantage is the short statute of limitations for fraudulent transfer claims. A fraudulent transfer claim is when a creditor tries to void, or undo, an asset transfer to your trust. Even with a recent cause for litigation, the statute of limitations for a fraudulent transfer claim is as short as one year. You won’t find such a short time frame anywhere in the US.

Let’s talk about some of the cons of the offshore asset protection trust. Foremost are the IRS reporting requirements. If you have a fully foreign offshore trust, you are required to tell the IRS all about it. You must file a separate trust tax return. Your foreign Trustee also has IRS paperwork to file. You must report the assets that are within the trust. This includes the locations and the amounts that are held in the trust. You must file these reports annually.

And if you forget to file or make a mistake, there are significant financial penalties to pay. It’s either a set fine or an amount based on the asset’s value.

Along with the reporting requirements, offshore trusts are more expensive to maintain than domestic trusts. CPA fees, trustee fees, and registration fees bring the annual costs of an offshore trust up to $5,000–$10,000.

Hybrid Approach – Best of Both Worlds

Another approach to an asset protection trust is a hybrid of both domestic and offshore planning. You can take the pros of each and leave behind the cons. Choose the protection of a registered offshore trust combined with the easy IRS compliance of a domestic trust.

We accomplish this with our PREP Trust®. The PREP Trust® (Personal Residence and Estate Preservation Trust) is an asset protection trust that is both offshore and domestic.

The trust has the same level of protection as a registered offshore trust, but the domestic aspect of the trust makes it easy to manage. The PREP Trust® is a tax-neutral, domestic grantor trust for IRS purposes. That means there is no tax return to file and none of the offshore trusts’ IRS reporting requirements. If a legal threat emerges after the PREP Trust® is established, the trust can become a fully offshore trust and remove itself entirely from the US court jurisdiction.

Assets within the PREP Trust ® can also remain within the United States. Many think setting up an offshore asset protection trust requires you to ship all of your assets out of the country. That is not the case. They can stay in the US with your current bank or brokerage. These accounts can be retitled in the name of the trust.

There is no initial acting foreign trustee. One is set up to step in if needed in case of a lawsuit, but the client can start as the initial Trustee. From the client’s perspective, the trust is managed similarly to a revocable living trust. Clients can begin as the Trustee in control. They feel good about that. It helps them get into the asset protection world, which checks the boxes of being effective and lets the clients stay in control while also distancing themselves from the assets so they no longer own them and control them personally. They control the assets through the trust.

Starting Early

The final key concept for asset protection planning is to start early. You will be better off if you start asset protection planning before a hint of litigation. Your plan will be stronger and more effective if it is implemented when times are good. If you wait until after a lawsuit or when a potential case emerges, your options may be more limited.