If you are looking to hide your assets from a creditor, then you may already be familiar with the asset protection trust.

For the uninitiated, this is a trust which is set up with the specific purpose of shielding your assets from creditors. The asset protection trust is one of the most common, and yet one of the strongest, asset protection tools.

Now, the state of California does not allow asset protection trusts. If you live in California, this doesn’t prevent you from creating one! It just means that you will have to go to another jurisdiction in order to do so.

If you’ve been reading our website, you probably already know that there are a couple of options for this:

• A domestic asset protection trust (DAPT) is set up in a state where the asset protection laws are stronger than in California. There are a few options for this, but the typical destination for Californians, and arguably the strongest overall, is the state of Nevada.
• A foreign asset protection trust (FAPT) is set up in another country entirely. There are a few options for this, as well. Several countries have deliberately made themselves havens for foreign asset protection. The oldest and strongest of these is the Cook Islands, and this is where we recommend clients looking to set up a FAPT take their money.

So, which of these options is right for you? In this article, we’ll explain the most important differences between these two types of trusts.

Now, a note: for the purposes of this article, we’ll primarily be comparing and contrasting FAPTs in the Cook Islands with DAPTs in Nevada. We believe these are the two best destinations, barring any extenuating circumstances.

If you plan to set up an asset protection trust in a jurisdiction other than the Cook Islands or Nevada, then much of what we say here can be generalized to those jurisdictions… but not everything. That’s why you should always check the specific ordinances for the jurisdiction in which you plan to operate.

So, without further ado…

The Major Differences Between a Domestic and Foreign Asset Protection Trust

Cost

As you might imagine, a major factor in determining whether to use a domestic or foreign asset protection trust is the price tag.

Neither trust comes free, and both have costs to establish and maintain. However, a foreign trust is significantly more expensive than a domestic one.

How much more expensive? The amount will vary depending on your precise circumstances, but a FAPT will usually cost well into the tens of thousands of dollars to initially establish, and then thousands more every year to maintain. A DAPT can usually be set up for an amount in the thousands, and maintained for less as well.

A large part of the cost will consist of the additional regulatory hurdles that you will have to go through if you set up a FAPT. Setting up a foreign asset protection trust is legal, but many people who move their assets offshore do so for more nefarious purposes, so if you create one, the federal government will keep a very close eye on you. In particular, the IRS will want to make sure you are not using the trust for tax evasion.

As a result, you will have to fill out a series of rather complex forms in order to keep a FAPT, most notably IRS forms 3520 and 3520-A. The IRS is very strict with these matters, so it is of paramount importance that you fill out these forms properly with no errors. This means that in order to maintain a FAPT, you must keep exceedingly careful records and hire a reputable accountant.

The Verdict: Domestic trusts are cheaper.

Legal Precedent

Perhaps surprisingly, foreign asset protection trusts are actually older than domestic ones.

The Cook Islands International Trusts Act, which is the law allowing for the creation of FAPTs in the Islands, was originally passed back in 1988, although it has been amended a few times since then.

DAPTs have a much shorter history. The first state to permit them, which was Alaska, did so in 1997. The Nevada Asset Protection Trust dates back to 1999.

Some people might assume that newer is better, but in the legal world, the opposite is typically the case. Older laws are generally more secure. This is because, in our legal system, judges take into account not just the relevant legal statutes but also the case law written by previous judges in relevant cases.

Because FAPTs have been around for longer, the case law recognizing them as legitimate is fairly strong. The legal precedent for DAPTs exists, but it is somewhat weaker, and there are some unsolved questions.

One such question is that of jurisdiction. If you live in one state, but have a trust in another state, which state’s laws will apply? Of course, you hope it will be the state in which you set up your DAPT, but there is no firm guarantee of this – it’s possible that a judge could rule that the (much less debtor-friendly) laws of California actually apply. This is a legal question that has not been definitely answered.

That does not mean that a DAPT is worthless – a good attorney will probably be able to give one a very strong defense. Perhaps you will even be a precedent-setting case! But more is left to chance with DAPTs than FAPTs, and that is a factor to take into account.

The Verdict: Foreign trusts have stronger legal precedent.

Privacy

The Cook Islands offer a significant level of privacy to individuals wishing to set up a trust.

The government of the Cook Islands only keeps records of the name of the trust and the trustee. It doesn’t keep any records of the settlors or beneficiaries of the trusts, which means that your name will not be anywhere.

Not only that, but the records the government does keep are private, and it is extremely difficult to obtain them. The Cook Islands do not recognize subpoenas issued by American courts, so a creditor will have to go to the Islands and navigate their legal system to get any records.

You will not get this level of privacy from a DAPT. All trusts created within the United States fall under the jurisdiction of the federal government, so your trust will have no more privacy than it would if it were set up in California.

The Verdict: Foreign trusts offer more privacy.

Fraudulent Transfer Protection

One of the most important issues in creating a strong asset protection trust involves guarding against claims of fraudulent transfer.

Fraudulent transfer involves making yourself insolvent, or appearing to do so, with the intention of avoiding a specific debt. Needless to say, there are a lot of ways in which asset protection trusts can run afoul of this.

So, what differentiates legitimate asset protection from fraudulent transfer? There are several factors, but one of the most important is timing: if you move your assets close to when you incurred a specific debt, your transfer is more likely to be considered fraudulent. Other factors include how much you transferred and received in return for your transfer, to whom you transferred the assets, and how transparent you were in your dealings with the court.

Now, here’s where a FAPT can really come in handy: The Cook Islands do not recognize judgments rendered by foreign courts, including those of the United States. To obtain a judgment against a Cook Islands trust, a creditor must actually file a claim in the Islands.

There are a few obvious costs of doing this, including having to travel all the way to the South Pacific and hire a lawyer there. On top of this, there are some additional procedural hurdles in place:

• The Cook Islands do not allow for an attorney to be hired on a contingency fee agreement, meaning that a plaintiff will have to pay all of their legal costs out-of-pocket and up-front.
• There is an extremely short statute of limitations in the Cook Islands for fraudulent transfer claims: they must be filed within one year of the transfer, and within two years of the cause of action arising.
• The claimant must prove intent to defraud.
• The claimant must prove their claim beyond a reasonable doubt. This is an extremely high legal standard, much higher than in most civil matters.

Nevada trusts do not proffer this level of protection. When you create a trust in the United States, then it will be subject to judgments rendered by American courts, no matter the state. Here, everything falls under the umbrella of the federal government, and the plaintiff will not have to fly far away and hire a new lawyer in order to obtain a judgment against you.

That said, Nevada trusts do offer a couple of significant protections against fraudulent transfer:

• There is a very short statute of limitations in Nevada as well. Claimants must file a petition within two years, with a tolling period of six months from when they find out about the transfer.
• The standard of proof for fraudulent transfer is clear and convincing evidence. This is lower than beyond a reasonable doubt, but still a good deal higher than in most other jurisdictions.

So, both trusts have protection against fraudulent transfer… but the stronger one is clear.

The Verdict: Foreign trusts offer stronger protection against fraudulent transfer claims.

Dissuasion

A large part of asset protection involves the art of dissuasion.

By creating a trust, you are sending a message to creditors that they’d better be pretty darned confident in the strength of their case before filing a lawsuit against you, because they will face an uphill battle in gaining control of your assets.

If done properly, asset protection should make creditors less likely to sue you. And if they do sue you, it should make them more likely to settle for a smaller amount and earlier on.
Since FAPTs have so many more procedural hurdles than DAPTs, it should come as no surprise that they offer more dissuasive power. But again, DAPTs are not completely toothless, either.

The Verdict: Foreign trusts provide stronger dissuasion.

Appearance

Regardless of the strength of the trust, many people are concerned about foreign trusts looking shady.

Creating a trust in another state has less of a stigma attached to it than “offshoring” does, even if you are not offshoring for an illegal or unethical purpose. The term evokes all sorts of negative connotations, and many clients are concerned that this will give their actions an aura of wrongness in court.

It’s true that this stigma does exist, to some degree. But it is not a great risk, and it can be alleviated simply by having a strong attorney who is able to demonstrate honesty and transparency on your part.

Part of this involves simply holding your back upright and recognizing that there is nothing wrong with what you are doing. You have as much right to try to protect your assets as a creditor has to try to obtain them; you shouldn’t feel guilty about not pulling any punches when they almost certainly will not. And offshoring your assets is a perfectly legitimate means of protecting them, as long as you follow all the necessary laws.

The Verdict: Domestic trusts have better optics (but not to the degree many clients think).

To Sum It All Up…

Deciding whether to use a DAPT or FAPT is a complex decision involving many factors.

Broadly speaking, however, most of these factors can be condensed into a very simple tradeoff: ease versus efficacy.

Offshore trusts will offer the strongest protection possible, but this protection will be significantly more expensive than a domestic trust.

Domestic trusts, for their part, are cheaper and easier to set up, but do not offer quite the same level of protection as a foreign trust.

In choosing which trust is right for you, there are a couple of major factors to consider.

First, how much risk do you face? Certain groups, including individuals in certain professions, face a very high probability of a lawsuit. The higher this probability, the more likely it will be that offshoring will be the right option for you.

This determination involves a careful analysis of exactly what your risks are. For instance, doctors are at a high risk of a lawsuit generally – but some fields of medicine are more dangerous than others. No two situations are alike and there are a lot of factors that affect your risk level.

Second, how much are you planning to put in the trust? The more assets you own, the more reason you have to offshore them, both because you can afford to do so and because you have more to lose.

Where should you draw the line? As a general rule, offshoring is the preferable option once you reach the $1 million mark. If you have less than seven figures, then you can probably make do with a DAPT, unless your risk level is truly dire.

Are you confused about what type of trust you should create to protect your assets? If so, contact the offices of Bohm, Wildish, & Matsen, LLP. We have helped thousands of clients set up asset protection plans that were tailored to their specific circumstances, and we would be happy to help do the same for you.