In the last 40 years, the estate planning world has, in the
parlance of some, divided into “domestic” and “off shore” practice areas. As part of the response to U.S. citizens
using off shore trusts, the Treasury Department instituted income tax reporting
requirements and the bankruptcy courts
addressed whether language in off shore trusts prevents creditors in the United
States from reaching the assets and compelled compliance by holding the trust
beneficiaries in contempt. The Federal
Trade Commission has weighed in. Recently in a Securities and Exchange matter, civil
disgorgement and prejudgment interest imposed by the Southern District Court of
New York against two brothers, Texans (one deceased), will probably result in
an ever greater chill factor on taxpayers and their counsel practitioners when
considering the use of off shore trust planning. Securities and Exchange Commission v. Wyly
and Miller, Executor, 10-cv-5860-SAS (S.D. N.Y. 2014).
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 U.S. The Internal Revenue
Service recognizes that there are many legitimate reasons for holding off shore
accounts, including convenience, investing, and facilitation of international
transactions. (Often, off shore trusts
are referred to as “offshore asset protection trusts” or “OAPTs”.) To use 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.
Another requirement is that a taxpayer whose foreign
accounts are greater than $10,000 at any
time during the year must file by June 30 each year 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, “Reporting Requirements for Foreign Accounts”, 39 Tax
Management Estates, Gifts and Trusts J. 140 (Bloomberg USA No. 3, May-June
2014)).
Bankruptcy courts that have considered off shore trusts
(created under the laws of the Cook Islands, Jersey Channel Islands, Bermuda,
for example) 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. In re Portnoy (Marine Midland Bank v.
Portnoy), 201 B.R. 685 (Bankruptcy, S.D. N.Y. 1996 ; In re Butler, 217 B.R.
98 (Bankruptcy, 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).
Cases outside of the bankruptcy court have also held that
repatriation of off shore trusts’ assets can be ordered where the settlor may
have directed that a “protector” can change the trustee. See the Federal Trade Commission case known
colloquially as the “Anderson case” (discussed more below) where a court held
both Mr. and Mrs. Anderson in contempt when they refused to repatriate assets
in a trust in the Cook Islands and let them do some jail time.
Federal bankruptcy courts are not the only place where U.S.
Federal law and the interests underlying the law are used to prevent assets in an
off shore trust from being reached by the U.S. citizen’s creditors. In 1999, the Federal Trade Commission became
interested in the off shore trust world.
Federal Trade Commission v. Affordable Media, LLC, 179 F.3d 1228 (9th
Cir. 1999) deals with a couple with a Cook Islands trust that had a provision
directing any foreign trustee to refuse repatriation if the couple was under
“duress”. Why was the FTC interested?
Did you ever see those late-night television infomercials about
investing and selling bar bells that could be filled with water and also
investing and selling talking pet tags?
The Andersons made millions in what has been described as a Ponzi scheme
where they took fees from investors who were never able to recover their
investment, much less make money, and then moved the monies off shore.
The interest of the Securities and Exchange Commission 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, 112 F. Supp. 2d 12 (2000), the taxpayer,
after the SEC started proceedings against him, transferred assets to a “complex
ownership structure of off-shore trusts and family-owned companies and
partnerships.”
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 4 off shore trusts and subsidiary entities (in the Isle of Man) and profits
of $553 million: $123.8 million again
Samuel, $63.9 million against Charles and his estate, with prejudgment interest
that could result in $300 to $400 million in penalties. 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 judge’s decision included a finding that the Wylys did not continue
to file required reports with the SEC after transfers to the off shore trusts
because they did not want there to be “inconsistent positions in their SEC and
IRS filings when millions of dollars were at stake.” (The SEC also sued the family’s lawyer – a
former Jackson Walker partner and Jones Day consultant, who entered into a
settlement agreement before the Wylys’ trial admitting wrongdoing and agreeing
to pay $795,000; he also testified at trial.
The Texas State Bar Association website indicates that this attorney is
now “retired”. (The attorney whose
seminars led to his consultation on off shore trusts for the Wylys later went
to Federal prison for felony money laundering and gambling.)
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 options 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.
(There is no discussion of the attorney-client privilege and one cannot
but wonder if attorney advice will be used routinely in future cases by federal
entities to help convict clients of federal crimes and hold them liable for
civil penalties. If so, will the
attorney advice also be used to prevent the attorney from practicing before the
Federal entity or affect the attorney’s license in the state(s) of practice?).
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.”
The SEC and defendants had six attorneys on each side. The defendants’ attorneys were all with the
same law firm in three different offices, Dallas, Houston, and New York.
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 choice of law being
that of the settlor/beneficiary and not (necessarily) that of the state or off
shore jurisdiction where the trust was purportedly established; also Congress
has changed the Bankruptcy Code to say that any transfer to a self-settled
trust within 10 years of bankruptcy can result in trust being included in the
bankruptcy estate (11 U.S.C. § 548(e(1)); (2) Federal Trade Commission – if the
activities that generated the monies (that are then invested off shore)
violated FTC rules (which has clearly happened, but is not necessarily going to
be a frequent occurrence), the weight of the Federal government is likely to be
exercised through the Federal Trade Commission; (3) Securities and Exchange
Commission – the SEC is pursuing citizens and their off shore trusts and
entities when one does not comply with SEC reporting rules; and (4) IRS – the Wyly
opinion indicates that the IRS has an investigation open into the income taxes
that would have been paid had there been no off shore trusts and subsidiary
entities (companies). Between 1992 and
2002, income related to exercise of options and warrants transferred (some by
sale) to the offshore trusts and then sold was not reported by 4 public U.S.
companies on whose boards the Wylys sat as the Wylys’ position was that the
offshore trusts were not taxable in the U.S.
The Federal Judge disagreed, holding that the offshore trusts were
grantor trusts as described in Section 674 of the Internal Revenue Code and
must disgorge an amount equal to the taxes avoided on profits relating to the
exercise of options and sale of stock in the 4 companies where the Wylys were
influential insiders (about $112 million for Sam Wyly and $59 million for
Charles Wyly). Section 674 of the
Internal Revenue Code treats a grantor as an owner of a trust when the
beneficiary enjoyment of that trust “is subject to a power of disposition,
exercisable by the grantor or a nonadverse party, or both, without the approval
or consent of any adverse party” and that the trustee physically located in the
Isle of Man was not an independent trustee and followed dictates delivered by
the Wylys.
For a discussion of the possible rather serious fallout in
the income tax arena of the Wyly court’s discussion of the offshore trusts as
grantor trusts for income tax purposes based on the manner in which the
offtrusts operated on a day-to-day basis (and not on the actual provisions in
the documentation), see Akers, Resurrection of “De Facto Trustee” Concept –
Securities Exchange Commission v. Wyly, 2014 WL 4792229 (S.D.N.Y. Sept. 25,
2014), at www.bessemertrust.com/portal/site/Advisor.
Thus, offshore 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.
Kathleen Ford Bay
Posts
