Off Shore Trust: The SEC is Looking; Not Just the FTC

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By Kathleen Ford Bay, Esq.

Lippincott Phelan Veidt PLLC, Austin, TX

Background

In the last 40 years, the estate planning world has, in the parlance of some, divided into "domestic" and "off shore" practice areas. As the off shore asset protection trust (OAPT) industry has grown, with promoters holding out to U.S. citizens that they can prevent creditors from reaching the assets in the trust and perhaps also reduce US income tax and other U.S. taxes, various U.S. courts and federal agencies have wrestled with the legal implications of these off shore trust structures.

The IRS imposes certain reporting requirements on U.S. taxpayers with off shore trusts. U.S. citizens, resident aliens, and certain nonresident aliens must report worldwide income from all sources, including foreign accounts. Income from those accounts is taxable in the United States. The IRS recognizes that there are many legitimate reasons for holding off shore accounts, including convenience, investing, and facilitation of international transactions.  However, the use of an off shore trust or entity to avoid the payment of tax is not allowed. In most cases, taxpayers with off shore assets need to fill out and attach Schedule B to their income tax returns; Part III of Schedule B requires information about foreign accounts and usually requires reporting of the country in which each account is located. Certain taxpayers may also have to fill out and attach IRS Form 8938, Statement of Foreign Financial Assets. Additional filing requirements apply to those with foreign trusts.

Additionally, a taxpayer whose foreign accounts are greater than $10,000 at any time during the year must file by June 30 each year a Form 114, Report of Foreign Bank and Financial Accounts (FBAR), electronically through FinCEN's BSA E-Filing System. (For more details on reporting for foreign accounts, see Heimos, Reporting Requirements for Foreign Accounts, 39 Tax Management Estates, Gifts and Trusts J. 140 (May-June 2014).

The U.S. bankruptcy courts have considered off shore trusts, created under the laws of jurisdictions such as the Cook Islands, Jersey Channel Islands, and Bermuda, have held that the situs for determining if creditors are able to reach the assets is determined under U.S. situs law, not the situs of the OAPT.1

In 1999, the Federal Trade Commission (FTC) also became interested in the off shore trust world. Federal Trade Commission v. Affordable Media, LLC2 (often referred to as the Anderson case) dealt with a couple who had established a Cook Islands trust that had a provision directing any foreign trustee to refuse repatriation if the couple was under "duress." The FTC was interested in the Cook Islands trust because its settlors, the Andersons, were involved in a late-night television telemarketing venture that offered investors the opportunity to invest in products such as talking pet tags and water-filled barbells. The investment opportunities, however, turned out to be a Ponzi scheme, through which the Andersons took fees from investors who were never able to recover their investment, much less make money, and then moved the millions in fees into a Cook Islands trust. The trust was poorly structured, with the Andersons themselves named co-trustees and trust protectors, positions from which they had unsuccessfully tried to resign at the last possible moment. The United States District Court for the District of Nevada concluded, and the Ninth Circuit confirmed, that the Andersons remained in control of their trust and could repatriate the trust assets, and when the Andersons failed to comply with the order directing them to repatriate the trust assets, held them in contempt.

The interest of the Securities and Exchange Commission (SEC) has grown over the last 14 years when citizens' actions really cross the line, resulting in convictions for securities fraud and conspiracy to defraud the United States. In Securities and Exchange Commission v. Bilzerian,3 the taxpayer, a one-time corporate raider, transferred assets to a "complex ownership structure of off-shore trusts and family-owned companies and partnerships" after the SEC started insider trading proceedings against him. The taxpayer was held in contempt after failing to attempt to repatriate the off shore assets in accordance with a court order.

Case

More recently, in May 2014, the Southern District Court of New York held Samuel Wyly and his deceased brother, Charles Wyly, liable for civil fraud in failing to report stock sales by four off shore trusts and subsidiary entities located in the Isle of Man and profits of $553 million and, as part of the subsequent remedies phase of the case, the court ordered the disgorgement of all of the profits earned through their offshore transactions as follows: $123.8 million against Samuel, $63.9 million against Charles and his estate, with prejudgment interest that could result in $300 to $400 million in penalties.4 The Wylys sat on the boards of the publicly-traded companies in which the off shore trusts and entities traded, including holding warrants and options. The Wylys ceased to file required reports with the SEC after transfers to offshore entities because they did not want there to be "inconsistent positions in their SEC and IRS filings when millions of dollars were at stake."

Of note is that lawyers' memoranda and meeting summaries were admitted into evidence. Clearly, there were repeated discussions about the grantor trust status of the off shore trusts for income tax purposes and whether purchase of option and warrants resulted in the off shore entities having taxable, reportable income and also whether renouncing citizenship could help avoid income taxes in the United States. Also, the court learned of a non-name meeting between three of the brothers' attorneys and IRS officials in 2003 (before the IRS had initiated an investigation) to discuss voluntary disclosure; the attorneys learned that the IRS was very interested in whether or not SEC requirements had been ignored.

The judge (Judge Shira A. Scheindlin) recognized that the penalties being imposed were large, quite large: "By any reasonable measure, the disgorgement and prejudgment interest awarded in this proceeding will be staggering and among the largest awards ever imposed against individual defendants."

Conclusion:

The federal government wants more and more information about off shore trusts, investments, and companies in which U.S. citizens have interests. Clients with off shore interests should expect inquiries in one or more of the following areas: (1) Bankruptcy, especially on issues of choice of law; (2) FTC, if the activities that generated the monies that are then invested off shore violated FTC rules; (3) SEC, where individuals fail to comply with SEC reporting rules with respect to their off shore trusts and entities; and (4) IRS, where off shore trusts and entities have failed to comply with IRS reporting rules or are being used to improperly avoid paying U.S. income taxes.  Thus, off shore trusts face not only creditors bringing actions in state court, but various federal agencies attacking positions taken by the settlors and beneficiaries of such trusts.

For more information, in the Tax Management Portfolios, see Rothschild and Rubin, 810 T.M., Asset Protection Planning, Zaritsky and Rosen, 854 T.M., U.S. Taxation of Foreign Estates, Trusts and Beneficiaries.


1 See, e.g., In re Portnoy (Marine Midland Bank v. Portnoy), 201 B.R. 685 (Bankr. S.D.N.Y. 1996) ; In re Butler, 217 B.R. 98 (Bankr. D. Conn. 1998); In re Lawrence (Goldberg v. Lawrence), 227 B.R. 907 (S.D. Fla. 1998), aff'd, 251 B.R. 630 (S.D. Fla. 2000) (affirming turnover, contempt, and jail time where a self-settled off shore trust in the Mauritas was in issue), aff'd, 279 F.3d 1294 (11th Cir. 2002).

  2 179 F.3d 1228 (9th Cir. 1999).

  3 112 F. Supp. 2d 12 (D.D.C. 2000).

  4Securities and Exchange Commission v. Wyly and Miller, Executor, 10-cv-05760-SAS, 2014 BL 267268 (S.D.N.Y. Sept. 25, 2014).