Havens Can Wait
By Brian O'Keefe

(FORTUNE Magazine) – Exotic offshore trusts may seem like an alluring way to shelter your money from income taxes. But watch out: The island on Survivor was less treacherous.

Just picture it. After a quick meeting with your new tax consultant, you set up a complex offshore trust, then thumb your nose at the IRS and forget about filing 1040s forever. Pretty soon you're strolling Caribbean beaches and sipping daiquiris while your money gets whisked from the Caymans to Belize and beyond. Of course it all flows back to you, with a 20% return. Per month. Best of all, it's completely tax-free.

The pitch sounds appealing, and it is becoming more and more common. In bookstores and on the Internet, through seminars in local Holiday Inns and ads in newspapers, the number of hucksters selling offshore wisdom has exploded in the past few years. Once the province of discreet, high-net-worth individuals who sought referrals through letters of introduction, the offshore tax haven is now being marketed to the masses in America. But can you really avoid taxes by going offshore?

"That's a big no," says Gideon Rothschild, a New York tax attorney and chair of the American Bar Association's committee on asset protection. "There is absolutely no tax savings whatsoever using an offshore trust." Assuming you're a law-abiding person, that is. All U.S. citizens are taxed on worldwide income, no matter where it gets stashed. It's legal to open offshore trust or bank accounts, and there are some advantages to putting money overseas for asset protection. But you must notify the government of any accounts greater than $10,000 and file any income with the IRS.

Offshore tax haven schemes typically revolve around trust arrangements established in countries that charge little or no tax (most commonly in the Caribbean, where island nations use low taxes to lure commerce). Funds flow through multiple trusts or other entities designed to shelter the money from taxes. A trustee is appointed to oversee it all, transparently removing control--and tax liability--from the original owner. But as long as you retain authority over your funds from afar, you're legally bound to report your income and open to prosecution if you don't.

Increasingly the government is paying attention. Flooded with evidence of fraudulent trusts, the IRS started cracking down in 1996. Since then it has won nearly 50 convictions in foreign trust cases, and another 80 investigations are currently open. Take Lyle Hotchkiss, a Michigan dentist who was sentenced in late September to 27 months in prison for, among other things, stashing $100,000 in the Bahamas. Disgusted by Hotchkiss' brazen disregard for U.S. tax law, the judge ordered him to buy a full-page ad in the local paper with his picture attached to a "candid admission of wrongdoing." (Hotchkiss' prison sentence, by the way, is about par--tax dodgers in fraudulent trust cases typically serve two to three years.)

Even if the government doesn't get you, there's an obvious element of danger in entrusting your money to offshore financiers. "You'd better be darn careful who you're dealing with," says Lawrence Gibbs, a Washington, D.C., tax attorney and former commissioner of the IRS. In particular, warns Gibbs, you should stay away from experts who promise to take their fees as a percentage of tax savings. Offshore investment plans often turn out to be Ponzi schemes, and once you lose control of your money it's hard to find a sympathetic party to help.

An effort is under way to stop the offshore trust business altogether. In June the Paris-based Organization for Economic Cooperation and Development pointed out 35 countries that function as tax havens, signaling an effort to create international standards of disclosure for fair tax competition. Government and industry observers agree that the movement is already beginning to have an effect. Rothschild and others think that in the long term, the new environment will make the offshore world better for people hoping to get in on legitimate foreign investments. But if you're looking to the islands for a quick buck, you'd better be on guard. "Taxpayers should be very careful," says Mark E. Matthews, IRS chief of criminal investigation. "This can be a very expensive detour in someone's life."