Asset Protection and Tax Deferral for U.S. Nationals

U.S. nationals are different from the nationals of nearly all other countries in that they are taxed in the United States on their worldwide assets and income. They are required to report their earnings and assets to the IRS annually, wherever they may reside. This contrasts with the situation for the nationals of most other countries, who are not taxed by their home country when non-resident except for income and gains, if any, which arise in that home country. For most nationalities, being non-resident for any length of time provides opportunities to build up wealth for the long term that should be made use of. For U.S. nationals the opportunities are also there, but they have to be carefully considered to avoid future misunderstandings with the friendly people at the IRS. The problem is that the IRS in their generosity will tax gains on declared offshore investments on an annual basis and count them as income even though what is generally considered a 'taxable event' - withdrawal of income or sale incurring a capital gain - has not occurred. This removes some of the attraction that offshore investing has for other nationalities.

Offshore investment is not illegal for non-resident U.S. nationals, although some investment houses that do not wish to be SEC registered will not accept investors whose identity credentials are from the United States. It is a pity that U.S. nationals are not able to enter such investments, as many of them are market neutral funds that made double-digit returns while stock markets were doing so, and have continued to make positive double-digit returns while stock markets are making double-digit losses. The onshore U.S. investment environment does not seem to supply many alternatives to stocks (and their mutual funds), bonds (and their mutual funds), and cash - except for 'accredited investors' (i.e. rich investors), who can invest in what they like, onshore or offshore. The average U.S. investor starts on an uneven playing field and it has become debatable over the last few years whose side the brokerage houses, through which the average U.S. investor invests, are on.

The other consideration for U.S. nationals is the security of assets. The United States is a society populated by lawyers who are fond of litigation, a considerable amount of which is frivolous. However, just because a suit against someone is frivolous does not mean that they will emerge victorious in defence. A misplaced cup of coffee can do serious damage to an individual's wealth.

For most non-U.S. nationals, the preferred vehicle for asset protection and tax avoidance is a trust. U.S. tax law regards trusts as look-through, and trust structures will only be of help in mitigating taxation if there is some kind of divestiture of assets. If the trust 'settler' (the individual who puts the assets into trust) is still seen to control or benefit from those assets, the trust structure in the view of the U.S. authorities essentially does not exist.

What U.S. nationals and long-term residents can benefit from, however, in place of a trust, is a Deferred Variable Annuity (DVA). A DVA is a legal structure that defers taxes due on gains on assets held inside it. Much like an IRA, it allows the value of the assets to compound free of taxation. Taxes are only due when income is taken from the structure, which should be after the age of 59.5. A DVA differs from an IRA in that it is opened with a single-premium lump sum, and the annuity thus purchased can be automatically swapped for an offshore annuity. The offshore annuity allows a wide range of asset classes to be held within, including offshore market-neutral funds, but can also hold onshore US assets, including property. If the selected domicile of the DVA is in the right jurisdiction, it makes for a difficult legal target for suitors. The result is that both onshore and offshore assets can be held in a tax-friendly and protective structure. After the initial payment of 1% Federal Excise Tax, there is no annual tax reporting requirement until income is taken from the DVA.

There are a small number of commercially available DVAs. These are suitable for sums of US$60,000+. The points on which they differ depend on where they are domiciled. There may be, for example, a limited fund range, or the obligation to include life insurance with the package. While these are worth considering on their merits, more scope for asset selection - and, in our view, greater asset protection - are afforded by opting for a bespoke structure from a qualified law firm. This way you can include just about anything you like. Furthermore, it is normal practice to place such a structure in trust in a different offshore jurisdiction to that of the DVA, rendering it all the more legally inaccessible to anyone but yourself and your named beneficiaries.

DVAs set up through an offshore domicile can only be initiated when you are a U.S. non-resident. You can maintain one when you are back in the States, but you cannot start one after you have returned. A DVA for your longer-term money will promote its growth by legally avoiding taxation on gains and allowing access to the benefits of a wide variety of investment opportunities, including successful market-neutral funds. In addition, it will render your nest egg as close to legally bulletproof as you are going to get.

Banner Japan K.K. provides information on DVA structures. Details are free on request.