Your Guide to Foreign Trusts

This article aims to serve as your comprehensive guide to understanding the nuances of foreign trusts. Whether you’re a trustee, 委托人, 财产授与者, or beneficiary, we’re here to unravel the complexities and shed light on potential pitfalls and opportunities within the realm of cross-border trust taxation.

Demystifying ‘US Person’

Classification before delving into the specifics of foreign trusts, it’s crucial to understand who falls under the umbrella of a ‘US person’ for tax purposes. In this context, a US person includes US citizens, green card holders, or individuals meeting the threshold of days’ presence in the US, thereby establishing US residency.

Decoding Foreign Trusts

The foundational step in this intricate process is discerning whether the entity at hand qualifies as a trust. While this might seem straightforward, exceptions exist. For an entity to be deemed a trust:

  • There must be an arrangement, either written or oral.
  • The arrangement must be established through a will or an intervivos (lifetime) declaration.
  • 受托人 must have the entitlement to take title to property, safeguarding it for the beneficiaries.
  • Beneficiaries cannot participate in discharging the trustees’ responsibilities.

Having ascertained that an entity is indeed a trust, the subsequent task is determining its ‘foreign’ status. A foreign trust encompasses any trust failing both the ‘Court’ and ‘Control’ tests.

The Court Test

The Court Test hinges on whether a US court can exercise primary supervision over the trust’s administration. This entails exclusive authority to resolve issues pertaining to the trust’s administration, involving the fulfilment of duties dictated by the trust instrument and applicable law.

The Control Test

The Control Test is met if one or 更多的 US persons possess the authority to control all ‘substantial decisions’ of the trust. ‘Control’ implies the power to make substantial decisions without being subject to the veto of any other person. ‘Substantial decisions’ are those authorized or required under the trust instrument.

It’s noteworthy that a seemingly domestic trust can be classified as foreign if, for instance, a foreign person holds the power to veto trust decisions. Additionally, if a US trust transforms into a foreign trust due to a trustee ceasing to be a US person, there is typically a 12-month grace period for rectification.

Distinguishing Trust Types

Foreign trusts fall into two primary categories: Foreign Grantor Trusts and Foreign Non-Grantor Trusts.

Foreign Grantor Trust with US Grantor

A trust initiated by a US person typically qualifies as a ‘委托人 trust’ if the US 委托人 retains specific ‘委托人 trust powers.’ These might include control over beneficial enjoyment or the authority to distribute income for the 委托人 or their spouse.

If the 委托人 has no 委托人 trust powers but the trust is ‘foreign,’ it automatically attains 委托人 trust status if income or principal could potentially be distributed to US persons in the future. This rule prevents US persons from utilizing foreign trusts to shield income from US taxation.

Foreign Grantor Trust with Non-US Grantor

When the 委托人 is a non-US person, 委托人 trust status is contingent upon circumstances such as revocability or exclusive payments to the 委托人 or their spouse. The income is deemed to belong to the non-US 委托人, subjecting them only to US tax on US source income. Foreign Non-Grantor Trust (with US or Non-US Grantor)

Taxation of a Foreign Non-Grantor Trust mirrors that of a non-US individual. A Foreign Non-Grantor Trust is not taxed by the US on its foreign-sourced income, but certain US-sourced income may be subject to US withholding tax or income tax.

Navigating Distributions and Tax Implications

Distributions from a Foreign Non-Grantor Trust to US beneficiaries entail a complex set of rules. Tax attaches to any distributable net income (DNI) which is distributed, while undistributed net income (UNI) might trigger a ‘throwback tax.’ The fair rental value of foreign trust property used by a US beneficiary is treated as a distribution as are loans to US beneficiaries that fail to meet certain “qualified loan” requirements.

Ownership of Foreign Corporations and Reporting Requirements

Particular attention is needed when a Foreign Trust has an interest in foreign corporations meeting the criteria of a ‘controlled foreign corporation’ (CFC) or ‘passive foreign investment company’ (PFIC). Stock ownership by a trust in such entities may trigger additional tax and reporting obligations for US owners and US beneficiaries, even without receiving distributions.

Compliance and Reporting Obligations

Apart from the need to file a US tax return, US 委托人s, beneficiaries, and trustees may be required to file additional information returns. This includes Forms 3520, 3520-A, FBARs, and Form 8938. Appointing a US agent for a foreign trust can be advantageous, preventing unilateral IRS determination of taxable income for US beneficiaries.

Planning Strategies and Mitigation Techniques

Considering the intricate tax consequences for US beneficiaries, several planning techniques can be employed to mitigate adverse outcomes. This includes establishing structures meeting 委托人 trust criteria, careful distribution planning, and utilizing elections and exemptions.

A Call to Pro-Active Action

受托人, 设立人, and beneficiaries are urged to comprehend and proactively address the implications of a foreign trust having ties to the US. This involves staying informed about residency changes, potential migration of trusts, and adopting strategic planning measures. By navigating the complexities of US tax rules for foreign trusts, stakeholders can optimize outcomes and ensure compliance with evolving regulations while retaining the benefits of planning with trusts. Contact us to discuss trust planning.

Article written by Tasleem Meghani