By Lazaro J. Mur
If you are thinking about moving to the United States, you should be thinking about pre-immigration tax planning. Otherwise, you may face significant U.S. income and estate tax consequences as a result.
Proper and timely pre-immigration tax planning may involve establishing an offshore trust. Here are the top 10 most common mistakes to avoid when using offshore trusts from a U.S. tax planning point of view.
NOT KNOWING ALL THE FACTS
Many readers thinking about moving to the United States do not understand the nature of the U.S. tax regime because they may be coming from a jurisdiction that has a totally different tax system.
Once you move to the United States with your green card, you become a U.S. resident for income tax purposes. You will be taxed on your worldwide income and, if you are deemed domiciled in the United States as a result of moving to the United States, then your entire worldwide holdings will be subject to estate taxes.
Needless to say, this is a harsh reality for some to understand, much less accept. This is why pre-immigration tax planning is of critical importance if you are thinking of moving to the United States.
NOT UNDERSTANDING WHAT IRREVOCABLE MEANS
For the offshore trust to protect you from the exposure of U.S. estate taxes, it must be irrevocable.
Irrevocability is an issue that many have a difficult time with. After all, it implies a complete loss of control over the assets being transferred to the trust. However, if the offshore trust is revocable, then all of the trust estate will be included in your estate for U.S. tax purposes.
Even if the irrevocable trust contains provisions that are indicative of retained interests and control, you will have an estate tax issue.
NOT UNDERSTANDING THE SPECIFIC PROVISIONS OF THE TRUST
The offshore trust will probably have language you are not familiar with and simply may not understand. This type of trust will usually contain language specifically used for U.S. statutory planning and compliance purposes. If you come across language in a provision contained in the trust that you are simply not sure about, stop and ask: What does this mean? Why is it relevant? What are the real-life implications to me? How will this impact my family’s needs in the future if I am not around?
It is important that you read and understand each provision contained in the offshore pre-immigration trust because the trust will be irrevocable. Remember, you will have to respect and abide by each provision in the offshore irrevocable trust, as failure to do so may bring about significant adverse tax consequences.
NOT PROPERLY FUNDING THE TRUST
You may have a perfectly drafted offshore pre-immigration trust, one that you can live with because you understand each provision contained in it. Yet, unless you properly fund the offshore trust, it will be of no benefit to you.
Assets not properly transferred to the offshore pre-immigration trust will be included as part of your taxable estate for U.S. estate tax purposes and be subject to U.S. estate taxation at a rate of 40 percent. As such, the failure to fund the offshore trust means that your objective of minimizing exposure to U.S. estate taxation will not be achieved.
NOT DOING CORPORATE DUE DILIGENCE
You need to know exactly what you own and where. Too often clients forget about an offshore company or foundation they established years ago. Failure to take this into account will have an adverse effect in achieving your planning objectives. You may forget that you have a company with other shareholders and that your ownership interest in said company is not freely transferrable under an existing shareholder agreement. This may require you to contact the other shareholders and, many times, this may present a privacy issue, as you may not want everyone to know that you are planning to move to the United States.
In addition, you may have limitations on the transferability of your ownership interests under the laws of your particular home jurisdiction, especially transfers to an offshore trust.
In some cases, your home jurisdiction may even try to impose an exit tax on transfers to an offshore trust. That is why your corporate due diligence is of critical importance.
NOT KNOWING YOUR OFFSHORE TRUSTEE
Oftentimes, little consideration is given to the important question of who becomes the trustee of the offshore trust. In many cases, a professional corporate trustee will have to be appointed, and this often raises concerns.
You will probably be thinking, “Who are these people?” “Can I truly trust them with all of my assets?” “What if they take all that I have worked for all my life and disappear into the sunset?”
Do your own due diligence on the trust company, their reputation and operations. Do not take anyone’s recommendation at face value.
The decision of who to appoint as your offshore trustee is as important as choosing which bank to use. The critical difference is that if you don’t like your bank or banker, for any reason, you can simply close the account and take your hard-earned money elsewhere. It’s not so easy with the trustee of your irrevocable offshore trust. For this reason, you need to be very clear on what power(s) you have under the terms of offshore trust to terminate the existing trustee and appoint another trustee.
Equally important is the need to understand which fees will be charged, not only for accepting the trust (the acceptance fee) and the annual ongoing fees (annual fees), but also the fees involved in case you decide to terminate the trustee relationship (the termination fee).
There are many qualified trust companies out there. Make sure you find the one that best fits your needs and it is actually experienced and familiar with the appropriate type of pre-immigration offshore trust structures and related U.S. compliance requirements.
NOT CHOOSING THE PROPER JURISDICTION
Not all offshore jurisdictions are the same. Some offshore jurisdictions are not suitable for this special type of pre-immigration offshore trusts. Some may not have the infrastructure you have come to expect in these days of complete comfort and connectivity.
If you plan on visiting potential trustees, make sure their jurisdictions have a suitable airport and adequate hotel accommodations. Determine the logistics ahead of time of how you can get to their locations if you choose to visit them in person.
You will, of course, want to know if a selected jurisdiction’s laws favor using this type of offshore trust and if the offshore trust is in full compliance with all applicable laws. Therefore, you are going to want to speak with independent counsel in that jurisdiction and even request a legal opinion on the matter at hand.
Remember, this pre-immigration trust is not an aggressive offshore asset protection trust which requires a very special type of jurisdiction with favorable fraudulent transfer statutes. However, if properly drafted and funded, the offshore pre-immigration trust may also protect your assets from future creditors.
NOT UNDERSTANDING THE U.S. REPORTING REQUIREMENTS
Once you become a U.S. resident, you now have a number of somewhat complex reporting obligations. Anonymity is a myth. There is no such thing as secret bank accounts or invisible bearer shares these days.
For this reason, you must be thorough with your comprehensive corporate due diligence and make a complete list of all your worldwide bank accounts and global holdings. Otherwise, if you don’t make full and complete disclosure to your trusted certified public accountant, he or she will not be able to properly inform you of all your new U.S. reporting obligations.
Do note that failure to properly comply with applicable reporting obligations can result in substantial tax penalties, regardless of how well the offshore trust is drafted.
NOT TAKING INTO ACCOUNT FAMILY NEEDS
Oftentimes, your desire to avoid U.S. estate taxation by fully funding an offshore pre-immigration trust may run afoul of your family’s current financial needs.
How are you going to pay for your lifestyle? How are you going to get your hands on money if you have already transferred all of your assets to the offshore trust?
More importantly, will dipping into the offshore trust result in unanticipated income taxation or even U.S. estate taxation because you are deemed to have a retained interest (control) over the assets transferred to the offshore trust? That is why it is so important to have your certified public accountant and financial advisors as part of your pre-immigration tax planning team.
NOT CONSIDERING A CHANGE OF MIND
It may well be that after you move to the United States, you may have a change of heart. You may want to pack up and leave. What then? What will you do now that all of the assets are held inside the offshore pre-immigration trust?
First, depending on how long you have resided in the United States, you may find yourself facing an exit tax. Moreover, because the offshore trust is irrevocable, how can you transfer the offshore trust once you leave? These are critical questions that should be considered because nothing is certain, except death and taxes.
If you are thinking of moving to the United States, plan ahead. Otherwise, you may have unexpected adverse U.S. income and estate tax consequences because of the move.
Remember, you don’t necessarily need to have a crystal ball and have everything planned out and finalized five years before the day you actually move to the U.S., although doing so would be helpful in avoiding the dreaded five-year income tax look-back rule that may be applicable if you do move to the U.S. within five years from the date you establish and fund the offshore pre-immigration trust. However, contrary to popular misconception, that five-year income tax look-back rule has no application with respect to U.S. estate taxation and your efforts to minimize your U.S. estate tax exposure with proper pre-immigration tax planning that utilizes an offshore pre-immigration trust.