Note: The information in this newsletter is presented for educational purposes only and may be considered controversial by some legal or financial professionals. Readers are encouraged to discuss these concepts with qualified legal or financial advisors who are familiar with the reader's specific financial situation.

Dear Friends and Subscribers:

When the new foreign trust reporting rules first came out this year, it appeared the new rules only required US grantors of offshore trusts to ensure that the IRS would have access to the information they wanted about the income of the foreign trust. The new law even emphasized that the US agent for service of process was only subject to service by the IRS. Now, it appears that the new definition of a foreign trust will also force the US grantors of foreign trusts to carefully avoid putting any appreciated assets into the offshore trust unless they are willing to pay capital gains taxes on such assets. The alternative seems to be to have the trust subject to the jurisdiction of US courts and to have all “substantial decisions of the trust” subject to control by US trustees. That alternative would seem to kill the asset protection benefits of the offshore trust.

If you have an offshore asset protection trust, you need to have a meeting with your lawyers as soon as possible to be sure you aren’t going to be subject to some unpleasant tax surprises. Even if you have a domestic trust, if you have any foreign trustees, some advisors believe this may be enough to require some changes in your trust agreement. The details start on page 6.

Do You Really Need An Offshore Bank Account?

I was one of the speakers at the Sound Money Investor’s offshore conference in Nassau from Dec. 4 through Dec. 7. It seemed that the main message from most of the other speakers is that the door may be closing for those who want international financial diversification. A number of the other speakers encouraged the audience to have a foreign bank account. The reasons given were usually (1) access to foreign investments not otherwise available to U.S. citizens, (2) protection from a declining dollar and (3) having some cash offshore before the U.S. government closes the door. One speaker even claimed that an offshore bank account offered asset protection.

As for the asset protection argument, you will be required to disclose your foreign accounts if you are subject to a judgment and you can be required by a US court to repatriate the money if you have the legal power to do that. I would encourage you to forget about the asset protection argument for having a foreign bank account.

As for protection from a declining dollar, you can hedge against that by buying foreign currencies through a U.S. bank. If you are concerned about currency controls, that would seem to be a valid reason to gradually move some money into an offshore bank account.

The claim that you need an offshore account to have access to foreign investments that are not registered with the U.S. SEC is true, but it’s not enough. Foreign investment firms or issuers won’t sell to a U.S. citizen unless it’s done through an offshore trust, an offshore corporation or even an offshore partnership. To have access to the direct purchase of foreign investments, you will need more than a foreign bank account. There is an excellent article about foreign bank accounts in the November issue of the Oxford Club newsletter. (Quotation isn’t permitted, so if you want the information you’ll have to join. The membership fee is $169 a year. For membership details, call Jennifer Lawrence at 410-223-2623.)

Tax News Digest

Interest Rates on Trust Accumulations and Tax Underpayments:

The interest rate charged by the IRS for tax underpayments is now the rate that is used to compute the interest on deferred taxes for trust accumulations in a foreign trust. It changes quarterly but the rate for the last six months of 1996 was 9%. That rate is unchanged for the first quarter of 1997. However, starting in 1997, the interest is compounded. Previously, the interest was computed as simple interest.

Getting Ready For April 15th:

Due to the August, 1996 tax laws there are a few changes that will affect your tax obligations for 1996. Some that are applicable to subjects that have been discussed in this newsletter include the following.

(1) Dependents social security numbers will be required for any child born before December, 1996.

(2) A non resident or resident alien who has any US tax obligations will be required to have an individual taxpayer identification number (ITIN) if they do not have a social security number.

(3) If you elect to use per diem rates for travel expenses, make sure your tax preparer doesn’t forget that there were two sets of per diem rates for 1996. The rates changed after March 31, 1996.

(4) The IRS has recently issued final regulations implementing some changes made by the 1993 tax law with respect to investment interest deductions. Previously, you could not offset investment interest against capital gains, but the ‘93 law gives you an option to elect to use capital gains to offset investment interest if you will treat the gains as ordinary income when the property is sold.

New Estate Tax Court Decision Offers Hope For Substantial Estate Tax Savings:

What if you could retain the income from the stock in a family corporation and sell the future remainder interest in exchange for a private annuity? What affect would that have on the estate taxes your family would have to pay when you die? A new case (D’Ambrosio Estate v. Com’r., No. 95-7643, 3rd Circuit, Nov. 26, 1996) offers some opportunity to do this.

First, let’s be sure we’re “on the same page” with respect to a “remainder interest”. If someone offered you a choice between $1,000 today and $2,000 in ten years, which will you choose? If you took the $1,000 today, you would have to invest it at about 7.2% a year (compounded) after taxes in order to have $2,000 in ten years. And, $1,000 today would be worth $4,000 in 20 years at that same after tax rate of interest. The present value of $4,000 in 20 years (at 7.2% a year) is therefore $1,000 today. So if you were to buy a remainder interest in some property that was worth $4,000 but had to wait 20 years to own the property, that future benefit might only be worth $1,000 today.

So, if you owned preferred stock in a family corporation and that stock would give you a steady income for the rest of your life, it would be nice if you could sell a remainder interest in your stock now, at a discounted value, to get it out of your estate and save some estate taxes for your children. And if your children don’t have the cash to pay for the discounted value of that remainder interest, what if they could buy it with a private annuity - paying for it over time until you die? There would be no estate tax on transferring your family business to your children and you would have an income for your retirement years.

However, the IRS has been taking the absurd position that your children would have to pay you $4,000 today in order to get $4,000 worth of preferred stock when you die - based on the current value of the stock rather than the discounted value. (If you are now age 65, your life expectancy is about 20 years.) Unfortunately for you, the Tax Court and a number of Appeal courts have agreed with the IRS in the past.

The good news is that the Third Circuit Court of Appeals has opened the door for a possible Supreme Court review of this issue and has given taxpayers a wedge to argue this issue. If you have a substantial estate with some income producing property, this is a decision that may open some doors for you. If you decide to pursue this strategy now, you will probably be looking at a court case until this issue is settled by the Supreme Court. To decide whether to wait or to take advantage of this recent decision, get in touch with your estate tax lawyer as soon as you can.

Seven Rules For Giving A Deposition

The December, 1996 issue of the Journal of Accountancy included an article by Patricia J. McEvoy and Melville W. Washburn called “Be Ready For Your Deposition”. The recommendations in the article would apply to anyone who is being deposed by the plaintiff’s counsel. The authors offer seven rules for handling the questions posed by the plaintiff’s counsel.

1. Tell the truth. (It’s hard to remember things that didn’t happen.)

2. Don’t volunteer any information. (Only answer the questions that are asked.)

3. Don't try to persuade the opposition counsel. (Just give the facts as you know them.)

4. Don’t offer an education to the opposition counsel in your area of expertise.

5. You can admit that you don’t know the answer or that you can’t remember.

6. Make it clear when your answers are based on memory and on your records.

7. Be wary of questions about “standard” or “customary” work procedures.

For a copy of this article, your CPA should be able to find it for you.

Glenn Sowders, JD, CPA, our IRS tax defense advisor, had this to say about responding to questions by an IRS representative.

“One of the primary instructions I give to clients in a tax case is that they should answer questions as concisely and as shortly as possible without being misleading. Any added explanation or voluntary information merely gives the questioner additional time to formulate his next question, and quite often will suggest an additional line of questioning. A client should never guess or speculate, and should never be afraid of saying that he or she doesn't recall, if that is the case.”

Domestic Spendthrift Trust Doesn’t Stop The IRS

Bill Comer recently sent me a copy of a 1996 case in which the Sixth Circuit Court of Appeals overruled a district court in a case involving the state law relating to a spendthrift trust and the federal law relating to a tax lien. [Bank One Ohio Trust Company vs. U.S., CA-6, 94-3974, 4/4/96] For me this case is a reminder that when the “Feds” want your money, there’s hardly any protection available in any form of U.S. entity. Frank Reitelbach’s father established a trust for Frank with a spendthrift trust provision that prohibits any trust income from being used to satisfy any debts of the beneficiary and from being assigned by the beneficiary to any other party. The IRS levied Bank One (as trustee) for the income that was otherwise payable to Frank. Bank One appealed and the Circuit Court held in their favor. The IRS appealed that decision and the Sixth Circuit Court of Appeals held for the IRS. Basically, the Appeals court found that state law was not binding on federal tax liens. So, in the US, a spendthrift irrevocable trust might protect the income and assets in the trust from any legal predators other than the Federal folks. So, if you are more concerned about losing your money to your government than to some future judgment creditor, your best bet is to get the money offshore in a jurisdiction that won’t cave in when the feds come calling.

Clinton Defies A California District Court On Cryptographic Issue

According to the Electronic Frontier Foundation (EFF), Federal District Court “Judge Marilyn Hall Patel struck down Cold War export restrictions on the privacy technology called cryptography. Her decision knocks out a major part of the Clinton Administration's effort to force companies to build "wiretap-ready" computers, set-top boxes, telephones, and consumer electronics.

“The decision is a victory for free speech, academic freedom, and the prevention of crime. American scientists and engineers will now be free to collaborate with their peers in the United States and in other countries. This will enable them to build a new generation of tools for protecting the privacy and security of communications.

However, in apparent anticipation of an adverse ruling by Judge Patel, the Clinton Administration engaged in a regulatory “shell game” by moving the regulations from the State Department to the Commerce Department, without eliminating any of the provisions the Judge found to be unconstitutional.

A few days after announcing the favorable decision, EFF reported that, “President Clinton ordered on November 15 that the regulations be moved from the State Department to the Commerce Department. Judge Patel's decision of December 6 (released December 16th) struck down the State Department regulations as a ‘paradigm of standardless discretion’ that required Americans to get licenses from the government to publish information and software about encryption. Over Christmas, the Clinton Administration published its new Commerce Department regulations, containing all the same problems, and put them into immediate effect today.

“The Clinton Administration has been using the export restrictions to goad companies into building wiretap-ready ‘key recovery’ technology. In a November Executive Order, President Clinton offered limited administrative exemptions from these restrictions to companies which agree to undermine the privacy of their customers. Federal District Judge Patel's ruling knocks both the carrot and the stick out of Clinton's hand, because the restrictions were unconstitutional in the first place. The Cold War law and regulations at issue in the case prevented American researchers and companies from exporting cryptographic software and hardware. Export is normally thought of as the physical carrying of an object across a national border. However, the regulations define "export" to include simple publication in the U.S., as well as discussions with foreigners inside the U.S. They also define "software" to include printed English-language descriptions and diagrams, as well as the traditional machine-readable (program) code and human-readable source code.

“The secretive National Security Agency has built up an arcane web of complex and confusing laws, regulations, standards, and secret interpretations for years. These are used to force, persuade, or confuse individuals, companies, and government departments into making it easy for NSA to wiretap and decode all kinds of communications. Their tendrils reach deep into the White House, into numerous Federal agencies, and into the Congressional Intelligence Committees. In recent years this web is unraveling in the face of increasing visibility, vocal public disagreement with the spy agency's goals, commercial and political pressure, and judicial scrutiny.

“Civil libertarians have long argued that encryption should be widely deployed on the Internet and throughout society to protect privacy, prove the authenticity of transactions, and improve computer security. (The computer) industry has argued that the restrictions hobble them in building secure products, both for U.S. and worldwide use, risking America's current dominant position in computer technology. Government officials in the FBI and NSA argue that the technology is too dangerous to permit citizens to use it, because it provides privacy to criminals as well as ordinary citizens.”

[Reprinted with Permission of The Electronic Frontier Foundation. Complete details of the case, are at their web site: ttp://www.eff.org/pub/Legal/Cases/Bernstein_v_DoS/Legal/961206.decision The Electronic Frontier Foundation (EFF) is a nonprofit civil liberties organization working in the public interest to protect privacy, free expression, and access to online resources and information. EFF is a primary sponsor of the Bernstein case. For more information about EFF, visit their web site at http://www.eff.org ]

“Good News & Bad News” For Domestic Trusts Located Offshore

There are at least a few thousand US citizens or residents who have assets in trusts that are located offshore. Until the 1996 tax law, it was a common practice to structure such trusts as grantor trusts that were treated as domestic trusts for tax purposes. A primary motive for this structure was to avoid the imposition of the 35% excise tax on untaxed gains on assets that were transferred to a foreign trust. By structuring the trust as a domestic trust for tax purposes and as a foreign trust for asset protection purposes, the structure provided asset protection without the imposition of the 35% excise tax. With some generous help from Richard Duke and Jeffrey Verdon, two of our editorial advisors, here’s a summary of the problem and a solution.

Some Background

Before the 1996 tax law, the situs of a trust as domestic or foreign was determined by the underlying facts and circumstances [Treas. Regs. Section 1.441-3(f).], including:

(1) The residence of the trustee;

(2) The location of the assets;

(3) The country under whose law the trust was created;

(4) The nationality of the grantor; and

(5) The nationality of the beneficiaries

With these criteria, it was possible to structure a trust as a foreign trust for asset protection purposes and as a domestic trust for US tax purposes. Under the new tax law, objective standards are established for determining whether a trust is domestic. If it is not a domestic trust, then it is a foreign trust. [IRC Sections 7701(a)(30)(E) and (a)(31)(B).]

Basically, the new law (after 12/31/96) provides that if the trust is not subject to the jurisdiction of a U.S. court or if there are no US trustees who have “authority to control all substantial trust decisions”, it will be treated as a foreign trust. According to Juliann Martin, A Tax Editor for Tax Analysts, it’s even possible that “the mere existence of a foreign trustee who might have some power to prevent or restrict the actions of the US trustees could result in treating a domestic trust as a foreign trust.”

Many foreign trusts in the past were funded with appreciated assets (or the assets have appreciated since funding the trust). Many of these foreign trusts included a foreign trustee, along with the situs of the assets being located outside the United States. In addition, many of the trust settlements (documents) stated that it was governed by a foreign law. Such trusts, generally, had a foreign situs. Most of these trusts were grantor trusts--either under IRC Section 679 (due to having a U. S. beneficiary) and/or due to retained controls (such as reserving a testamentary special power of appointment) under IRC Sections 671-678. These sections of the tax code required the U. S. grantor of a foreign trust to pay taxes on any income of the trust - whether or not the income was distributed. However, this section of the tax code [Subpart E] does not make such a trust a domestic trust. Subpart E only finds a grantor to tax; it has nothing to do with whether the trust is a domestic trust or a foreign trust. --under the old law or under the new law.

Meanwhile, a separate part of the tax code [IRC Sections 1491- 1494] requires US persons (including US partnerships, corporations, estates or trusts) to pay an excise tax on the transfer of appreciated assets to a foreign entity. The excise tax is 35% of the unrealized gain on any assets subject to this code section. Taxpayers can elect to pay a maximum 28% capital gains rate on such gains instead of the 35% rate, but the appreciated assets are still subject to immediate taxation when they are transferred to a foreign corporation, partnership, estate or trust.

The Bad News

Because of the change in how the law defines whether a trust formed by a US person is a foreign trust or a domestic trust, many existing trusts will be deemed to have been converted into foreign trusts and that alone will trigger the 35% tax on any unrealized gains.

Without any alteration of the terms of an existing trust, many offshore asset protection trusts formed by US persons will be treated as foreign trusts under the new tax law. That means the trust will be “converted” from a domestic trust into a foreign trust and any appreciated assets in the trust at the end of 1996 will be “deemed” to have been transferred to a foreign trust. That will then trigger the 35% excise tax or the 28% capital gains tax under IRC Sections 1491 - 1494.

Meanwhile, It’s now much more difficult to structure a trust as a foreign trust for asset protection purposes and to have it treated as a domestic trust for tax purposes - particularly for the purpose of avoiding gain under IRC Sections 1491 - 1494. There is some dispute among different asset protection lawyers (including some of our editorial advisors) as to whether it’s possible at all. Even if it is technically possible, it’s not technically easy to change the terms of thousands of existing trusts so that the trusts might also be classified as domestic trusts to avoid the 35% excise tax.

Either the foreign trust is subject to the jurisdiction of a US court and all substantial decisions of the trust must be made by US trustees, or the trust will be a foreign trust and any untaxed assets owned by the trust will be subject to the 35% excise tax under IRC Section 1491. And, all of this was effective as of the first day of 1997.

To “add gasoline to a fire”, this new legislation is far reaching and extremely confusing to many (or most) tax practitioners who are seriously studying the new tax laws. The law uses the words, many times, "except as are provided by Treasury Regulations." But there are no regulations yet and no one knows when we will get any regulations. Certainly if the tax bar and tax accountants are confused, the IRS people who must administer these laws are also confused.

(Addendum: Since this was published, Gideon Rothschild has indicated to me that he sees no justification for the claim that grantors of foreign trusts will be subject to the IRC 1491excise tax just because there has been a change in the definition of what is a foreign trust. It seems to be his position that the grantor trust rules supercede the IRC 1491 rules. I'll attempt to resolve this in the February, 1997 issue of APS.)

Some “Good News” - So To Speak

A few weeks ago (right after I sent out the December, 1996 issue of APS) Jeffrey Verdon sent me a copy of an IRS Notice (96-65, Dec. 6, 1996) in which the IRS offered some relief for domestic trusts that want to retain their status as domestic trusts by modifying the trust agreement.

Basically, the IRS has extended the time in which trust agreements can be modified, for trusts that were already in existence on August 20, 1996. If these trusts attach a statement to their tax return with the IRS that modifications are in progress, the trust will have up to two years to implement the modifications. Here’s the bottom line. Even if you don’t think that you have a foreign trust, if there is any trustee who is not a US person, you should ask your lawyers if they have looked at your trust agreement in light of the new tax rules.

Are There Any Solutions?

One option that occurs to me is to first have your trust reformed to comply with the new laws so that you can bring back any appreciated assets without exposing them to the 35% excise tax or the 28% capital gains tax. Then, you can take steps to make sure your offshore trust isn’t holding any appreciated assets. The next step would be to recreate your foreign trust without any appreciated assets. Without that problem, you could still have a foreign trust on which you pay taxes as a grantor but the trust would not be subject to the jurisdiction of US courts or control by US trustees who are subject to control by US courts. Another option is to either pay the 35% excise tax on any unrealized gains on assets held by your offshore trust or to make the election to pay the 28% (maximum) capital gains tax on such unrealized gains. For some of you, that might be the least costly alternative for now. If or when I find a better solution, I’ll let you know in a future issue.

Seminars and Conferences

An Introduction to Asset Protection:

The Asset Protection Institute is sponsoring a seminar on Saturday, February 1st, 1997, from 9:00 a.m. to 1:00 p.m. at the Hyatt Rickeys Hotel, 4219 El Camino Real, Palo Alto, California. The topics to be presented include domestic and offshore methods of asset protection and estate planning. The speakers include Robert Matthews and our offshore editorial advisor, Arnold L. Cornez, JD. The fee for the four hour program is just $50. To register or to request additional information, call (800) 710-0002 or (805) 498-7908.

A Professional Conference on Offshore Trusts:

A two day conference for attorneys, accountants and other financial advisors who are interested in the latest information about offshore asset protection trusts will be held in Lake Tahoe, NV on March 6-7 and in Orlando, FL on March 20-21. The programs are sponsored by Professional Education Systems, Inc. The speakers include Barry S. Engel, Ronald L. Rudman, Ferdinand Marcus Weber and Neal L. Wolf. The registration fees are $999 for one person or $799 if two or more are registered at the same time. There is a $100 discount for registrations before February 6, 1997. For further details call 800-843-7763.

1997 Swiss Wealth Protection Seminars:

For those of you who have an interest in learning more about the benefits of Swiss banking, Swiss annuities or Swiss insurance, JML Swiss Investment Counsellors, Ltd. is offering a series of two day seminars during 1997. Two will be held in Hamilton, Bermuda on March 15-16, 1997 and June 28-29, 1997. The registration fee is $295 for one person or $395 for a couple. For further details call 800-256-7296, Ext. 600.

Yours truly,

Vernon K. Jacobs

Note: I welcome feedback and information for publication in future issues and I will try to reply but I might not be able to answer every comment, question or suggestion individually. My email address is vkj@rpifs.com.

The Jacobs Report on Asset Protection Strategies is published by Research Press, Inc. 4500 W. 72nd Terrace, PO Box 8194, Prairie Village, KS 66208. Full service subscriptions are available for $145 a year (12 issues) in the U.S. and $175 a year outside of the U.S. An email only edition is available for $30 a year, without access to other subscriber services. For subscription information call (913) 362-9667 or visit our web site at http://www.rpifs.com/ap101.htm

Editors & Advisors To The Jacobs Report On Asset Protection Strategies

Vernon K. Jacobs, CPA, CLU, Editor & Publisher, 4500 W. 72nd Terrace, Prairie Village, KS 66208 (913) 362-9667 <email vkj@rpifs.com>

Gideon Rothschild, J.D., CPA, CFP, Siller Wilk, LLP, 747 Third Avenue, New York, NY, 10017 (212) 421-2233 <email grothschild@sillerwilk.com>

Jeffrey Verdon, JD, LLM, 2801 West Coast Highway, Suite 380, Newport Beach, CA 92663 (800) 521-0464

William L. Comer, Author, Freedom, Asset Protection & You, POB 268, Clare, MI 48617 (517) 386-7729

Glenn Sowders, J.D., CPA, 800 West 47th St., Ste 701, Kansas City, MO 64112 (816) 531-6163 <asowders@aol.com>

Mark Warda, JD, 1725 Clearwater-Largo Rd., Clearwater, FL 34616 (813) 587-0999

Scott E. Blakesley, J.D., Husch & Eppenberger, 1200 Main St., Ste. 1700, Kansas City, MO 64105 (816) 421-4800

J. Richard Duke, J.D., LLM, 550 Montgomery Highway, # 300, Birmingham, AL 35216-1808 (205) 823-3900 <assetlaw@bham.mindspring.com>

Arnold L. Cornez, J.D. Author, Offshore Money Book, 430 Cowper Street, Palo Alto, CA 94301 (408) 738-3700 <offshore@offshore-net.com>

Terry Coxon, Passport Financial, Inc., 207 Jefferson Square, 1601 W. 38th St., Austin, TX 78731 (800) 531-5142

Mark Skousen, Ph.D., Editor, Forecasts & Strategies, 7811 Montrose Rd., Potomac, MD 20854 (301) 424-3700

(C) 1997, Vernon K. Jacobs, All rights reserved.