An "offshore" trust is a trust that is set up under the trust rules or is governed by the rules in an offshore jurisdiction, which does not actually need to be overseas or in another country – though it can be. The assets of the offshore trust could be invested in the NY Stock Exchange or exchanges and investment instruments in other states and countries.

Basically, the trustmaker is importing the laws of whatever the other jurisdiction is, and is using a trustee with authority to operate in that jurisdiction for distribution purposes. Such a trustee may be a trust company, a law firm, or a financial firm based in an offshore jurisdiction.

While offshore trusts were a popular option in the past, since the passage of the Patriot Act, and the addition of many restrictive and onerous penalties for administrative noncompliance incidents, it is done less often. But when large enough monetary amounts and potential for litigation among entrepreneurs exists, and one wants to shelter the assets from creditors, or when income is being earned offshore, it is still utilized.

Offshore Trust vs Offshore Companies

An alternative to an offshore trust would be investments in companies (either corporations or limited liability companies or partnerships) offshore. Nearly every major corporation has many offshore entities and holdings to help limit their federal tax liability. For example, UPS won a big case against the IRS several years ago where every package worth less than $200 is self-insured in a Bermuda corporation, which has very low tax rates. So, UPS paid large amounts of money from its profits to the Bermuda corporation, which doesn’t pay taxes, and accumulates dollars there.

Many warranty companies, as well as many car dealerships that sell large volumes of warranties, have offshore entities that may or may not be owned by offshore trusts, to gather assets that might be earned here, basically as insurance pools. A majority of these types of companies use this strategy, except for, mostly, "Main Street" companies, which do not use offshore trusts and offshore corporations. In those cases, the companies are still subject to all the same liabilities, and would have to pay for those liabilities with more limited after-tax dollars, because they are not using that offshore strategy to set up loss reserves.

Automobile dealerships often use offshore trusts, because they provide financing, in addition to selling high volumes of warranties — both of which are very profitable. As they can set these entities up anywhere to conduct those financial transactions, as well as set up self insurance for them, they often go offshore for the tax advantages.

Captive Insurance

This brings up the topic of "Captive Insurance." Captive insurance companies can be onshore or offshore, with the difference typically being the administrative taxes applied in the formation and funding of those trusts.

States in the US are in competition with each other for this captive insurance business. Vermont, Kentucky and Arizona, among others, are good states for captive insurance companies, with more states getting into the action.

When there is an actuarial analysis of these self insuring companies for the true needs for self insurance, that basically sets up large amounts of money that companies with significant cash flows can buy the insurance and get a deduction from their regular business and now have income in their captive insure; but most of money isn’t really income because it is held in reserves.

Typically, for a business that makes $250,000 – $500,000 a year, and confidence is high that it will continue to do that, the tax benefit of this strategy may outweigh the administrative costs of using the strategy. There is initially a cost incurred each year whether profits are earned or not, so it is important to know the likelihood that these profits are going to continue.

Types of businesses that could profit from using this strategy, and should consider building loss reserves with a captive insurance company, include:

  • Manufacturing companies
  • Transportation companies with high risk of injury to personnel
  • Medical companies where there is significant exposure to claims, especially when considering the huge claims from litigators and large penalties these companies can suffer under the Patient Self-Determination Act and other kinds of federal legislation.

    Captive insurance is also available from large insurance companies like Lloyd’s or other specialty private placement insurance, so the question becomes, do you want to buy it from them, or do you want to self insure?

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