The U.S. income taxation of a foreign trust depends on whether the trust in question is a grantor or non-grantor trust. In this regard, U.S. foreign grantor trusts may be of benefit in certain circumstances where non-U.S. persons are passing wealth to beneficiaries who are subject to U.S. taxation.
Foreign Grantor Trust is a term applied by the U.S. to trusts that possess certain features (described below) and which therefore may avail of a particular tax status under the U.S. tax code.
This blog posting is intended as a general overview of U.S. foreign and foreign grantor trusts and some of their key features and associated benefits.
Foreign Trust – Test
- Control Test:
- This test looks to whether U.S. persons control all of the substantial decisions of the trust;
- Court Test:
- The Court Test looks to whether a court within the U.S. is able to exercise primary supervision over the administration of the trust.
However, if the Trust passes both tests, then it will be considered to be a U.S. trust and will be subject to U.S. taxation on a worldwide income and gains basis.
The U.S. taxation of the income and distributions from a foreign trust will depend on the type of foreign trust and the status of the trust’s beneficiaries at the time of distribution.
Foreign Grantor Trust Status
A Foreign Grantor Trust will exist where either:
- The Grantor reserves the right to revoke the trust solely or with the consent of a related party; or
- The Grantor and his/her spouse (if applicable) are the sole beneficiaries of the trust during the grantor’s lifetime.
Where the grantor is not a U.S. taxpayer, non U.S. source income arising from the foreign grantor trust will not be subject to U.S. taxation at the grantor level (although he/she will need to ensure compliance in their jurisdiction of residence in respect of any such income). U.S. source income (e.g. dividends from U.S. securities) will be subject to U.S. taxation with such taxation generally being satisfied through withholding taxes applied on the dividend payment(s).
Distributions to a U.S. beneficiary by a foreign grantor trust during the grantor’s lifetime will generally be treated as ‘non-taxable gifts’ but may be subject to U.S. tax reporting obligations.
Where such distributions arise, the trustee should provide the relevant U.S. beneficiary/ies with a foreign grantor trust beneficiary statement that reports the beneficiaries distributed share of the trusts income and gains.
Death of Grantor
Following the passing of the Grantor, a foreign grantor trust will automatically become a foreign “non grantor” trust (provided the trust remains in a non-U.S. jurisdiction) and any U.S. beneficiaries will become subject to U.S. taxation on any income and gains distributed to them from such a trust.
U.S. estate tax issues should not arise upon the passing of the grantor unless the trust directly holds U.S. situs assets (which includes amongst others, U.S. real estate; tangible personal property located in the U.S.; stocks of U.S. corporations etc.), however, the holding of such assets via certain appropriately structured non U.S. corporations may provide planning opportunities in this area.
An appropriately structured trust arrangement may assist with the holding and ultimate passing of assets to beneficiaries in a tax efficient manner, as well as affording protections from certain creditor claims.
Disclaimer: This blog is intended for information purposes only, is based on our current understanding, and should not be construed nor acted upon as any form of legal and/or taxation advice. Appropriate professional advice should always be sought in advance of undertaking personal/ corporate wealth, taxation or succession planning.