By David Richardson, Mid-Ocean Consulting Ltd.
Foreign nationals planning on a move to the U.S. need consider pre-immigration planning to protect their assets from risk of attachment and the rising level of taxation on the wealthy. The following is a brief on planning that could exempt assets from such seizure and taxation.
Absent major tort reform, wealthy Americans (and increasingly, HMW individuals internationally), are seeing a rise in litigation to historically elevated levels; on a per capita basis, far greater than any other country in the world. And the increase shows no sign of abating.
Added to which, increased taxation to pay for and support Congressional stimulus packages and US healthcare reform is now in excess of 50% in certain States. By example, for investors in California the top rate on net investment income is 50.92% (Federal tax rate: 43.4%, California tax rate: 13.3%).
These top tax rates apply to international investors who either become U.S. citizens or are classified as U.S. tax residents in possession of a "Green Card” or subject the "Substantial Presence Test". The result, even absent litigation, clients are facing very significant erosion from increased investment and income taxes.
One of the most effective ways to preserve assets is by international structuring that is at once transparent and compliant (from a reporting and tax perspective) yet at the same time, distancing asset ownership from the client and thus would-be creditors; executed in a non-adversarial way with solid economic rationale.
A key element in this structure is international variable life insurance that is offered in a variety of credible financial jurisdictions like The Bahamas, Bermuda, The Cayman Islands, The Isle of Man and others.
Such policies are akin to their U.S. domestic counterparts by adhering to the same US tax code (7702 et al) but offer distinct advantages. First the similarities:
• Policies may be funded with single or multiple premiums
• Policy assets are invested in client chosen investments- mainly a set menu of mutual funds
• Growth of such assets are income tax exempted during lifetime
• Policy death benefits are income tax exempt at death
• The policy’s cash surrender value (CSV) may be accessed via policy loans during lifetime either partially or wholly income tax exempted
Now the dissimilarities and thus advantages that apply to some, if not all, international carriers:
• Policies may be bought with “in-kind” premium i.e. assets vs. cash
• Clients may chose their own investment manager to manage policy held investments
• The manager may choose virtually any investment class including stocks, bonds, mutual funds, hedge funds, private equity etc.
• Generally, fees are fractional compared to domestic offerings
In addition to these competitive advantages, there can be significant additional protection in the domicile of international insurance carrier. The Cayman Islands updated their insurance legislation such that it fully protects the premium(s), the growth on the premium and the death benefit from the claim of creditors putting the greatest clarity in this section of the applicable law of any jurisdiction. Critically, the Cayman Segregated Account Statute 7 (8) c legally segregates the assets of one policy from another, while also keeping them legally distinct from the insurance company’s general assets and liabilities.
Interestingly, Puerto Rico, as a quasi-US/offshore jurisdiction has recently enacted law (2011) that would immediately exempt assets placed into a policy issued by an international P.R. carrier, provided that those assets or monies were not subject to any prior or current claim. This offers very substantial, statutorily provided protection that must be respected by every other U.S. State Court. Also of note, in owning a PR issued contract, as a U.S Commonwealth jurisdiction, a U.S. taxpayer would be free from any FBAR/FACTA reporting obligations.
Such policies are typically held by a trust or foundation for estate planning and dispositive reasons. When settled prior to becoming tax resident in the U.S., the trust is forever US Estate Tax exempted, currently at a 40% rate in excess of the current individual exemption of $5.34 million. This means a trust owning a tax exempt life insurance funded with a $10mm single premium on a 50 year old male could be worth $40mm (assuming 7% growth and net of all insurance fees) at age 70. In the event of death of the insured in that year, the death benefit could be freely distributed to US and/or non-US beneficiaries free of any US Estate Tax.
The same amount, growing at the same rate would be worth $30mm (assuming blended tax rate of 35%) before Estate Tax and a $18mm. Using reasonable, “real world” assumptions, $40mm vs. $18mm is compelling math.
The domicile of such a trust/ foundation can also be an additional layer of protection in that most jurisdictions have a “fraudulent disposition” period to help establish objectively if the assets settled in trust were done so purposely to defraud creditors of the settlor. The Bahamas by example has a 2-year conveyancing Statute. Meaning that if the assets have been in the trust for +2 years, it’s presumed that they were not placed there purposely to defraud a creditor.
If the trust is challenged before the 2-year period, the burden of proof, though somewhat lower, is still on the creditor to establish that those assets (in particular) were placed in trust as a fraudulent conveyance and are rightly his or hers.
In any event, under certain tracing claim actions the trust may be permeated. It can happen. In this situation, the courts could award the trust assets to the creditor. That is, specifically it could order non-exempted assets to the creditor. However, in the Bahamas, as we have noted earlier, insurance is such an exempted asset.
The other relevant point is that in court, the debtor now has a cogent, commercial argument for having established the structure in the first place; that is to make and hold international investments in the most tax efficient manor, in a fashion which is at once both transparent and compliant. This, as opposed to other structures where the intent is clearly to avoid or even evade liabilities- contingent or otherwise.
Asset protection, as most things in life, can be done by degrees. Some structures offering better protection than others. That said it is our opinion that a trust, established in a good Common Law jurisdiction, offering a balanced conveyancing period (neither too long, not too short) and owning an international variable life insurance policy, acquired from a quality carrier (in the better infrastructured jurisdictions) offers perhaps the best asset protection. The combination also provides significant income and estate tax mitigation.
