Preservation | Family Wealth Protection & Planning

If you have questions about asset protection planning or any of the topics discussed in Keith’s presentation or this series, please contact Keith or another attorney in our Trusts & Estates group.

Generally, if a taxpayer fails to pay any tax after demand by the IRS, the U.S. will have a lien on all of the taxpayer’s property.^[1] It is commonly understood that traditional creditor protection does not work against tax liens — the IRS can go after all of your property even if the property would generally be protected from creditors under state law. However, in the 2019 U.S. Tax Court case of Campbell v. Commr. Of Internal Revenue,^[2] the Tax Court determined that assets placed in an off-shore trust could not be considered in an Offer in Compromise, which in effect, allowed the trust assets to remain shielded from a tax lien and therefore out of reach of the IRS.

In April 2004, the taxpayer, Campbell, created an off-shore asset protection trust on the Caribbean island of Nevis with a Nevis corporate trustee. Campbell and his family were the beneficiaries of the trust. Campbell funded the trust with $5 million (20 percent of his net worth at the time). No contributions were made to the trust after April 2004.

Shortly after creating the trust, in May 2004, the IRS notified Campbell that his 2001 personal income tax return was being audited based on his failure to report a tax shelter strategy called a “custom adjustable rate debt structure” (CARDS) transaction. The IRS had issued a notice in March 2002 requiring taxpayers to report any involvement in a CARDS transaction, such as the transaction used by Campbell. However, Campbell had failed to properly report his involvement in the 2001 CARDS transaction.

In 2006 Campbell moved back to the U.S. and invested $27 million in real estate opportunities involving the Gulf Coast region after a series of hurricanes. Campbell lost all of his investment due to economic circumstances and Chinese drywall problems that were beyond his control.

In 2007, the IRS issued a deficiency notice to Campbell for $1.1 million. Campbell filed for an Offer in Compromise (OIC), which allows a taxpayer to reduce the tax due if there is “doubt as to collectability.” Campbell claimed he could only pay $12,603 due to his change in economic circumstances. The IRS determined that Campbell could pay much more due to the asset protection trust in Nevis, which then had $1.5 million. Campbell appealed to the Tax Court.

The Tax Court found that the asset protection trust could not be considered for purposes of the OIC as Campbell (i) funded the trust prior to his tax liability, (ii) did not retain the right to replace the trust company as trustee, and (iii) could not force the trustee to make distributions or investments.  The Tax Court further determined that a taxpayer’s “ability to pay” for purposes of the OIC is to be determined as of the date the tax liability is assessed.

Prior cases have held that off-shore asset protection trusts were not protected in bankruptcy based on the state law of the forum court (as opposed to the law designated in the trust document).^[3] However, the Tax Court did not address federal fraudulent transfer laws or whether a judgment against Campbell could have been satisfied with the assets in the off-shore trust.

Lesson: This case highlights the importance of engaging in asset protection before you have foreseeable creditors. It is never wise to engage in asset protection to specifically protect your assets from tax liens, as this will often be criminal. However, engaging in asset protection for general creditors is wise for people in high-risk industries, and in this case, that type of planning had the secondary effect of also protecting assets from paying federal taxes.

[1] See 26 U.S.C. Section 6321.

[2] Campbell v. Commr. Of Internal Revenue, T.C. Memo. 2019-4.

[3] In re Rensin, No. 17-11834-EPK, 2019 WL 2004000 (Bankr. S.D. Fla. May 6, 2019); In re Portnoy, 201 B.R. 685 (Bankr. S.D.N.Y. 1996); In re Brooks, 217 B.R. 98 (D. Conn. Bkrpt. 1998); In re Huber, 2012 Bankr. LEXIS 2038 (May 17, 2013); Gideon Rothschild, Daniel S. Rubin and Jonathan G. Blattmachr, “Self-Settled Spendthrift Trusts: Should a Few Bad Apples Spoil the Bunch?”, Journal of Bankruptcy Law & Practice (Vol. 9, No. 1); Rush University Medical Center v. Roger Sessions, 980 N.E.2d 45 (IL 2012)  (The Supreme Court of Illinois found self-settled trust was void against creditors under Illinois law, even though the trust provided it was to be governed by the law of the Cook Islands).