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Crypto Law/Level VII · Loopholes worth understanding/7.3 Loopholes they sell you/Lesson 2

Offshore trusts and crypto

What an offshore trust can and cannot do for a US crypto holder: who is taxed, what must be reported, and why courts still reach the person who controls the keys.

Education, not legal, tax or investment advice. Crypto law differs between countries and states and changes often. Check the current rules where you live with a qualified lawyer or tax adviser before you act.

The lean path

The cheapest, lowest-tax, simplest and most private route the law allows, best first. Each step names the rule it rests on and the condition that keeps it lawful.

  1. The lawful version of trust privacy is a domestic revocable living trust: no extra tax, kept out of public probate, and §1014(b)(2) preserves the step-up at death; its income remains taxed to you as before.
  2. A US person funding a foreign trust with a US beneficiary stays taxed as owner under §679, or recognizes gain at transfer under §684; no zero-tax version exists, so legal fees buy no tax saving.
  3. If a foreign trust serves a lawful purpose, file Form 3520 and see that Form 3520-A is filed; under §6677 failures cost the greater of $10,000 or 35%, and of $10,000 or 5%, respectively.
  4. Creditor protection works only for assets placed before any claim: transfers to self-settled trusts within ten years of bankruptcy with intent to defraud are avoidable under 11 U.S.C. §548(e), and FTC v. Affordable Media jailed controlling settlors.
  5. Whoever holds the keys controls the coins: a settlor keeping the seed phrase invites sham treatment under Notice 97-24, while a foreign trustee holding them adds custody and insolvency risk.

Materials26 U.S.C. §679 and §684 on law.cornell.eduThe IRS page ‘Foreign trust reporting requirements and tax consequences’ and the Form 3520 instructionsIRS Notice 97-24, on abusive trust arrangementsThe Trust Law track’s lessons on offshore and asset-protection trusts

Wonder

  1. If a trust in another country owns my coins, are they still mine for US tax?
  2. Can a US court make me bring back coins held by a foreign trustee?
  3. What does it take each year to keep an offshore trust within the law?

Explore

  1. Offshore trust pitches aimed at crypto holders usually promise three things: no tax on gains, invisibility and protection from creditors. A trust is an arrangement in which a trustee holds property for beneficiaries on terms set by the person who created it, the settlor; the Trust Law track on this site explains the mechanics. This lesson tests the three promises against US federal law, the system most pitches target. Other countries have their own rules and can reach different answers, but the same three questions apply everywhere: who is taxed, who must report, and whom can a court reach?
  2. For a US person, moving coins into a foreign trust rarely ends US tax. Under section 679 of the Internal Revenue Code, a US person who directly or indirectly transfers property to a foreign trust is treated as the owner of that portion of the trust for any year in which the trust has a US beneficiary. Owner treatment means the trust’s gains and income are taxed to the settlor as if the trust were not there. IRS Notice 97-24 adds that substance, not form, controls: a trust whose settlor keeps effective control may be ignored as a sham, with its assets treated as the owner’s.
  3. If no one is treated as the trust’s owner, section 684 generally treats a US person’s transfer of property to a foreign trust as a sale or exchange at fair market value. The transferor then recognises the built-in gain on the coins at the moment they go in. For a holder whose coins have risen sharply, that is the very tax the pitch promised to avoid, charged on the way in. Notice 97-24 also warns that transfers to a trust may be completed gifts for federal gift tax. The realistic outcomes are continued taxation of the settlor or a taxable transfer up front.
  4. Invisibility fails on paperwork. Under section 6048, US persons report transfers to and distributions from foreign trusts on Form 3520, and a foreign trust with a US owner files Form 3520-A. Section 6677 sets the penalties for failing to report: the greater of $10,000 or 35% of the gross reportable amount for Form 3520 items, and the greater of $10,000 or 5% for Form 3520-A. Foreign-account reports may apply too (lesson 2.3.6), although FinCEN said in Notice 2020-2 that an account holding only virtual currency was not then reportable on the FBAR and that it intended to propose a change. CARF adds platform reporting abroad (lesson 7.2.7).
  5. The creditor-protection promise meets the courts. In FTC v. Affordable Media (9th Cir. 1999), Denyse and Michael Anderson had placed commissions from a telemarketing Ponzi scheme in a Cook Islands trust. When the trustee refused to send the money back, the district court found that the Andersons remained in control of the trust, rejected their claim that compliance was impossible, held them in civil contempt and had them taken into custody; the appeals court upheld the contempt finding. US bankruptcy law adds 11 U.S.C. §548(e), which lets a trustee undo transfers to a self-settled trust made within 10 years before the filing with actual intent to hinder, delay or defraud creditors.
  6. Crypto adds a twist. A trust only really holds coins if someone other than the settlor controls the private keys. If the settlor keeps the seed phrase, the trust deed and the facts diverge, and retained control is exactly what Notice 97-24 and the Affordable Media court treated as decisive. If a foreign trustee holds the keys, the beneficiaries carry that trustee’s custody and insolvency risk (lesson 4.1.5). Offshore trusts have lawful uses when fully reported; the trap is the promise of tax-free, invisible or untouchable coins. A practical check: ask which Code sections, forms and annual filings the plan assumes, and who holds the keys.

Key facts

  • Under IRC §679, a US person who transfers property to a foreign trust is treated as owner of that portion for any year the trust has a US beneficiary.
  • IRC §684 generally treats a US person’s transfer of property to a foreign trust as a sale or exchange at fair market value unless a person is treated as the trust’s owner.
  • IRS Notice 97-24 (1997) states that substance rather than form controls taxation and that abusive trust arrangements may be disregarded as shams.
  • Under IRC §6677, Form 3520 failures can cost the greater of $10,000 or 35% of the gross reportable amount, and Form 3520-A failures the greater of $10,000 or 5%.
  • In FTC v. Affordable Media (9th Cir. 1999), the settlors of a Cook Islands trust were held in civil contempt for failing to repatriate its assets.
  • Under 11 U.S.C. §548(e), a bankruptcy trustee may avoid a debtor’s transfer to a self-settled trust made within 10 years before the petition with actual intent to hinder, delay or defraud creditors.

Exercise nine, six, three, one

9CollectList up to 9 promises made in an offshore trust pitch you have seen or can find, or in this lesson’s examples, about tax, privacy or protection of crypto (some lists are shorter).
6ClusterSort them into 6 categories: income tax promises, transfer and gift tax promises, reporting or privacy promises, creditor-protection promises, custody and key-control arrangements, and promises you cannot yet classify.
3DistillReduce the 6 to 3 groups: promises US law directly contradicts, promises that depend on full reporting to be lawful, and promises that depend on who really controls the keys.
1CrystallizeWrite 1 sentence explaining why, for a US person, putting crypto in a foreign trust does not by itself remove tax or reporting duties.

Fact check

Dates, figures and claims checked against the published sources listed below.

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