Generally speaking, an arrangement will be treated as a “trust” (as opposed to some other type of entity) under the Internal Revenue Code (IRC), if it can be shown that the purpose of the arrangement is to vest in trustees responsibility for the protection and conservation of property for beneficiaries who cannot share in the discharge of this responsibility. If this is the purpose, then the parties are not associates in a joint enterprise for the conduct of business for profit, which might be taxable as a partnership, or corporation, for example. An entity created to “operate a business” rather than to “protect or conserve assets” is not recognized as a trust for US tax purposes. Instead, entities conducting business activities are more properly classified as business entities.
Once it is established that there is a Trust, the next step is to determine –
1. Is it a domestic vs Foreign trust
2. Grantor vs non grantor trust
3. domestic grantor vs domestic non grantor trust
4. foreign grantor vs foreign non grantor trust
The type of trust is important in determining the taxability of the trust as well as related reporting obligations.
The IRS has issued International Practice Units (IPUs) –
Defining the Entity – Foreign Trusts
Foreign Grantor Trust Determinations – Part I – Section 679
Foreign Grantor Trust Determination – Part II – Sections 671-678
Failure to File the Form 3520/3520-A – Penalties
Whether a foreign trust is a “grantor” trust is determined specifically under provisions of the IRC (Sections 671-679). Any trust determined not to be a grantor trust will be treated as a non-grantor trust.
A FGT can be created when
1. a US person funds (or transfers assets to) the foreign trust and
2. there is potential for the trust to have a US beneficiary.
3. In this case, the US person is treated as the tax owner of the foreign trust under the so-called “grantor trust” rule of IRC § 679.
When a beneficiary receives something from the FGT, he is not taxed on it (but he will have reporting duties). The reason the beneficiary is not taxed is because for US tax purposes, the US person-grantor is treated as the tax owner and he must report all items of income, deduction, credits and loss on his personal income tax return (Form 1040).
A foreign trust can also qualify as a FGT when it is created or funded by a nonresident alien individual (NRA), provided that certain exacting requirements are met. See IRC Section 672(f). Typically a foreign trust created by a NRA that is fully revocable by him will meet the FGT requirements and the NRA will be treated as the tax owner of the trust. When a beneficiary receives something from this trust, it will be treated as a nontaxable “gift”, but the beneficiary will still have very critical US tax reporting duties (unless the beneficiary is the grantor).
BENEFITS OF THE FOREIGN REVOCABLE GRANTOR TRUST
• No U.S. estate tax going forward
• No U.S. gift tax on funding, as long as no U.S. situs assets transferred (i.e., intangible ok)
• With proper investing, U.S. income tax minimized
• Trust established for efficient tax planning for future generations
• Managed for basis step up on death (refreshing)
• Dynasty Trust – No future estate tax
• Use of USVI – China Benefits
• China’s CFC rules
• Public Registration
• Economic Substance rule
• SEC regulated
Issues to Consider:
• There may be more than one foreign
corporation for U.S. tax efficiency
• The proposed structure needs a corporate
• Investment management important to
maintain U.S. tax efficiency
• The foreign corporations are CFC to U.S.-
BENEFITS OF THE FOREIGN REVOCABLE GRANTOR TRUST AFTER GRANTOR’S PASSING
• Dynasty Trust is U.S. estate tax free
• Trustee can make a foreign estate election to incorporate two more years of tax efficiency
• If CFC or foreign investments, the two-year foreign estate elections can allow for restructure into 10/50 company option
• If 10/50 going forward, then:
• DRD, no GILTI, no Subpart F income
• Some asset protection
• Check the box electionAFTER GRANTOR’S PASSING
Issues to Consider:
• There may be more than one foreign corporation for U.S. tax efficiency
• The proposed structure needs a corporate trustee
• Investment management important to maintain U.S. tax efficiency
• Possible restructure for U.S.-based beneficiaries who are now indirect owners of CFCs