Will an Offshore Trust Avoid Income Taxes?
I am a non-US citizen and I am thinking about creating an irrevocable foreign trust to hold money received from an inheritance. The trust will be set in an offshore zero taxation jurisdiction (e.g. Bahamas, BVI, Cayman Islands, etc.) and the money will be invested to produce interests. A bank account will be created to distribute the interests but will be officially owned by the trust but I will be the beneficiary. Will I still pay income taxes even though I am not officially the owner of this bank account?
I’m not certain of the answer, but my guess is that you would pay taxes on any income distributed to you. Typically, offshore trusts can be used to shelter assets from creditors in the event of bankruptcy or lawsuit, but not from taxation. That said, all of this is rather sophisticated and you will need to hire counsel with expertise in the field who can give you a definitive answer. It’s also expensive, so unless you plan to shelter a significant amount, it may not be worth the trouble or expense. In addition, be aware that you may not need to go offshore to get at least the credit protection benefits of offshore trusts, if not the tax benefits. Many states now permit the creation of self-settled asset protection trusts.
Finally, to the extent off-shore trusts do provide tax benefits, consider the ethics of reducing your taxes in this way. While no one likes paying taxes or agrees with everything our government does, taxes do support many governmental activities most of us do support, whether that’s the military, public education, roads and bridges, Medicare, the development and deployment of the coronavirus vaccine, or emergency assistance in the event of catastrophes. The tax system is an imperfect system of sharing those costs. It generally taxes those with more resources more than those with fewer both because they can better afford to pay taxes and those taxpayers have often benefited more from what society has to offer. To pay less than the system deems appropriate upsets this balance, and brings on one or more of the following results: higher taxes for those with less means, fewer or worse-funded government programs, or more government debt, in effect moving payment for services onto the shoulders of our children or grandchildren.
One reason that I’m raising these issues about taxation with respect to offshore trusts is that they are a means of avoiding taxes that is not in effect sanctioned by our government. Through our representatives, we have enacted many ways to reduce taxes which are sanctioned, including deductions for gifts to charity, tax credits for certain kinds of investments, no taxes on the grant for winning the Nobel Prize, and more. We have decided that the benefit of these activities merits the lower taxes collected. We have not decided that with respect to offshore trusts. To the extent they do reduce taxes (which as I said at the beginning, I’m not sure they really do), they do so by circumventing our tax system, not by taking advantage of its provisions.