In the 28 years I've worked in the offshore investment arena, I thought I'd heard every possible piece of bad advice clients could get.
But one came up recently that takes the cake.
Mindy and Ralph* are in their 50s. They're both U.S. citizens and have built a successful business in the USA. Like so many others, they're concerned about what's going on in this country – threats of asset confiscation by a bankrupt government, a general "eat the rich" mentality and a legal system that makes it easier than ever to sue anyone for any reason.
Indeed, Mindy and Ralph have spent more than five years doing online research and traveling around the world searching for offshore solutions. They quickly discovered that for Americans, heading offshore isn't as simple as putting on your socks in the morning – especially if you've never done it before.
What really scares them is the U.S. law called the Foreign Account Tax Compliance Act (FATCA), which, starting in 2014, will require any foreign bank or other financial institution Americans deal with to turn over their account records to the IRS.
My clients don't want any part of it. Trouble is, it's hard to avoid. But they've been looking.
You don't own it, so it's not reportable… right?
As part of their research, Mindy and Ralph eventually visited an island and met up with one of the leading law firms there. "Of course we can help you," one of the partners (whom I'll call Roy) told them. "We have a structure that will keep your money completely invisible to the IRS. It's called a 'Private Interest Foundation,' or PIF."
Roy went on to explain that since Mindy and Ralph wouldn't actually "own" the assets in the PIF, they wouldn't need to pay U.S. tax on its income. What's more, the arrangement would completely sidestep FATCA.
Not only that, but on this island, Roy explained, bank and professional secrecy was absolute. Unless a police agency in a foreign country could prove that Mindy and Ralph had committed a crime, no records could ever be released. What could be better?
Over the next few days, Roy and his staff showed Mindy and Ralph around the island. It's a beautiful place, full of five-star hotels and stunning beaches. Roy knew all the important people there. He even introduced Mindy and Ralph to the Prime Minister.
By now, they were seriously considering having Roy's law firm set up the PIF. Once the structure was in place, they would send a few million dollars to the law firm’s escrow account. The firm would then move the funds to offshore accounts in several countries for portfolio management. Everything would be 100% confidential, and of course, tax-free.
Mindy and Ralph thought they'd hit the jackpot. Thank goodness, they checked with me first.
Why offshore foundations are a tax landmine for Americans
I explained to them that since they’re both U.S. citizens, an offshore Private Interest Foundation wouldn't help them avoid FATCA, U.S. tax, or U.S. offshore reporting requirements. In fact, if they had listened to Roy, they very likely would end up tax evaders.
To begin with, there's no such thing as a PIF in U.S. law. The concept originated in Europe in the 1920s and gradually spread to other countries – but not to the USA.
So, to people like Roy, the fact that PIFs don't exist in U.S. law means they're legally invisible to the IRS. Too bad that's not true.
Almost 50 years ago, the IRS issued a ruling saying it has the authority to reclassify entities or contracts that don't exist in U.S. law as something else for tax purposes. In the case of a PIF, that "something else" could either be a foreign trust or a foreign corporation.
So as not to bore you with the technical details, what you need to know is that both structures require you to file various reporting forms and, in some cases, will actually result in a larger tax bill than if you had just held it all in your own name at home.
The truth is – when it comes to Americans – a Private Interest Foundation is best avoided like the plague, unless there's a really good reason to use one. And only a properly qualified legal advisor can determine that.
Once I explained this to Mindy and Ralph, there was a long silence. Finally Mindy spoke. "Gosh, they were so nice to us. Do you really think this is a scam?"
It's hard to say. It's possible that non-Americans who create such a structure might legally avoid tax liabilities in their home countries. It's equally possible that Roy thought he could make a killing at Mindy and Ralph's expense.
One thing is for sure. There are a lot of Roys in the offshore world. In the end, it doesn't matter whether they're acting out of ignorance or greed. The end result is the same – Roy earns a hefty commission, and the American clients who take his advice get screwed to the wall.
*Names, locations and a few facts unrelated to the important facts of the case have been changed to protect my clients' privacy.
Mark Nestmann
Nestmann.com
