Many people come to me saying that they want to go offshore to protect their assets and reduce their taxes, but are often not ideal candidates. I try to explain that I do not help people go “offshore”. What I do is help people protect their assets, reduce their taxes, and obtain greater financial privacy, all in a legal and ethical manner. Offshore structures are just some of the tools that sometimes come in handy to reach these goals.
For many people, “Going Offshore” is not just the wrong tool to use to accomplish these goals, but for many it is a very dangerous and unwise tool. As I described in my prior article, “What is Jurisdiction?”, the point of going “offshore” is to take advantage of another jurisdiction that may provide more friendly laws and regulations in regards to taxes, asset protection and privacy.
However, just setting up a foreign company and then doing business inside the old jurisdiction will not work. You need to be in a situation where some or all of your business can be successfully transplanted to that new more friendly jurisdiction. Examples of “offshore” friendly businesses are: importing/exporting, software design (particularly if you are already using offshore technicians or have significant offshore clients), Internet services, financial services, entertainment industry, and other types of intellectual property. If you do not have a business that lends itself to “going offshore” then it would be wise to focus on more cost-effective domestic alternatives.
If what you are doing is entirely defined as “US Source Income” (that is you are making, providing, storing, and/or delivering a product or service inside the USA from resources located inside the USA) then there is very little reason to “go offshore”. Setting up a foreign company that is going to do business inside the USA will require the foreign company to submit itself to the laws and tax regulations of the jurisdiction. Far from reducing taxes and protecting assets, this often results in some very negative tax consequences and subjects otherwise safe assets to US liabilities. It is for this reason that most non-US companies and investors usually establish US companies to act as affiliates and/or subsidiaries of the non-US structure.
So the bad news is that “going offshore” may be unsuitable for many if not most US taxpayers.
The good news is that there are a lot of reasonably priced alternatives that can still help to protect your assets, reduce your taxes, and obtain greater financial privacy.
The easiest and simplest of these is the good old tried and true “S Corporation” which combines limited liability protection with a convenient “pass through” tax treatment. A favorite of small businesses and investors for decades, the S Corporation provides adequate asset protection by segregating the liabilities of the business from the assets of the owners. Establishing an S Corporation is simple and even a Limited Liability Company (hereinafter an LLC) can be used for those like me who think the LLC is simply the greatest thing since sliced bread. In addition the S Corporation can provide significant savings in “self-employment” taxes (the 15.3% you have to pay for Social Security and Medicare). Instead of having to pay the self-employment tax of 15.3% up to the $113,700 cap (for 2013), you can give yourself a modest salary, and take the rest of the profits as profit distributions. Although you will have to pay taxes on the profit distributions, the savings of 15% can add up very quickly and is a safe and secure way of saving taxes as long as you pay yourself a “reasonable” salary with withholding. For additional privacy you can use a Revocable Trust to own the shares and appoint a nominee officer to be named in any official papers, thus obtaining near anonymous treatment.
For most small businesses an S Corporation is all they need to protect their assets and significantly reduce their taxes. However, if the operations of the business require significant investment of capital and involve significant exposure to liabilities, additional efforts may need to be taken to insure necessary protection is in place. For such situations we have developed the “Advanced Corporate Fortress”. This combines three (3) US entities that are used together to limit the exposure of the business assets to liabilities, and to maximize the tax savings of the owners. First a C Corporation is established that will stand alone as a taxable entity. All assets of the business will be placed into this C Corporation for protection. An LLC treated as a “disregarded entity” will be established to do anything that involves any exposure to liability. Although the LLC will be owned 100% by the C Corporation, it will have little or no assets that could be seized by a potential litigant. Finally an S Corporation is established to provide management and possibly employee payroll services for the LLC. In summary the C Corporation holds the assets of the business behind its protective wall, the LLC acts as a shield to protect the C Corporation since the LLC will be exposed to any and all liabilities but has no assets, and the S Corporation helps further protect the owner’s interests and reduce the owners taxes as described above. There are also several other advanced strategies that can be used to take advantage of the fact that the C Corporation has a very low initial tax bracket, thus allowing you to place some income into the C Corporation at a reduced tax rate and then lending it out to the S Corporation which can then deduct the interest payments on the loan as deductible expenses thereby further reducing the taxes of the owners.
Now for some people, none of this is necessary. They have no business and are only concerned with protecting their assets. For these people the “Personal Preservation Fortress” is ideal. It is simple yet provides extremely powerful protection. The Personal Preservation Fortress uses two entities to provide the ultimate in asset protection. An LLC is established to hold all the assets of the individual(s). The individual(s) will receive 99% of the shares of the LLC. An Irrevocable Trust is established naming someone other than the owner(s) of the LLC as beneficiaries (this is usually children, grandchildren, pets, etc.). The Trust will receive a 1% interest in the LLC and nothing else. Here is why this system works: creditors can only take what you have. If all you have is a partial interest in an LLC, then the creditors can only take that. Now in most states creditors who seize an LLC interest of less than 100% receive only an “assignment” of that interest, not the interest itself. As such they cannot vote the shares, and they cannot demand distributions from the LLC. This is because the LLC is treated as a partnership and most states provide protection to the other partners from being forced to accept as full members involuntary additions to the partnership. Although the creditor cannot vote the shares and cannot demand a distribution of income or assets, the creditor may be liable for demands of additional capital. That is the creditor may be required to pay additional funds into the LLC in order to maintain its economic position. Finally, if the LLC produces taxable income this income does not need to be distributed to the members, but the members still must pay taxes on the income. So the creditor would have to pay taxes on income earned by the LLC which the creditor did not actually receive. Finally, the only remaining voting member of the LLC is the Trust, which is “influenced” by the owners who act as members of the Trust Committee. The Trust Committee can remove the Trustee if the Trustee fails to satisfy the Trust Committee. As you can see, this is a very unpleasant situation for a creditor to be in, and you can expect them to start negotiating on reasonable terms. The best part about this system is that it applies to all creditors including the dreaded Internal Revenue System.
Finally, there is a unique structure that combines the benefits of an Individual Retirement Account with a tax-free entity:”The IRA Rescue Plan”. This program was initially established to assist people with large amounts of IRA money earning low rates of return who wanted to invest in unconventional investments that would otherwise be prohibited or difficult with a traditional IRA. First, the funds in your current IRA must be transferred to a more cooperative Custodian (conventional Custodians like banks, brokers, etc. only make money when you trade or keep your funds in their institution). We then establish a LLC following the dictates of an important US Tax Court ruling and have the IRA Custodian buy 100% of the shares of the new LLC. The client is then appointed President of the LLC, and does whatever he or she wants to do with the money (subject to basic good faith business limitations). The IRS requires that certain rules be maintained regarding distribution of funds from the LLC to the client, but these rules essentially involve reasonable compensation to insure that the client is not “defrauding” the LLC and thus unreasonably avoiding taxes and penalties on the IRA withdrawal. The long and short of it is that the IRS does not want you to transfer the funds from your IRA to an LLC, and then raid the piggy bank and avoid paying the withdrawal fees and penalties. If care is taken, funds can be paid to the client. Now, not only do we have the IRA funds in an entity managed by the client totally free and clear of the IRA limitations as to investments, the LLC is also a tax exempt entity since all profits of the LLC “pass through” to the IRA which pays no taxes on interest, dividends and/or capital gains. Furthermore, the IRA is one of the few entities to withstand the recent changes to the Bankruptcy Code. Funds in an IRA are still safe from creditors, and the LLC, being owned by the IRA, is thus protected.
As you can see, there is an amazing number of options available for people who may find “offshore” planning too risky, or who simply do not fall into a category whereby they could benefit from “going offshore”. If anything, the choice may be too much to deal with. But that is a good thing. Having plenty of options on how to protect your assets, reduce your taxes, and obtain greater financial privacy is a consumers dream come true. If you have any questions please do not hesitate to contact us.