• Monte Silver, Tax lawyer

Can you trust a trust? US tax implications for US expats who use non-US trusts for estate planning

US tax implications for Americans abroad who use non-US trusts to accomplish estate planning goals

The use of non-US trusts by US expats would appear to be an effective strategy for estate planning, especially where there are reasons that the expat does not want to (or cannot) gift the assets to the receiver out-right. Such reasons may be recipients who are minors and too young to manage the asset, or gift tax limitations in the country of residence.


Yet, if the assets are appreciating in value, and/or the expat seeks to utilize the current $11.5M US gift tax exemption, the person may indeed wish to transfer the assets out of his/her estate.


What are the limitations that U.S. tax law imposes on the use of non-U.S. trusts?

The answer? Many significant limitations.


First, a grantor trust is generally deemed transparent for tax purposes. Thus, if the trust is a “grantor” trust, (i) assets transferred to the trust will still be considered owned by the expat grantor and considered part of his/her taxable estate upon death, and (ii) income earned by the trust is taxed to the grantor.  See [1]  and [2] below.


At a high level, a grantor trust is one in which the grantors controls, or has the right to control (i) the trust, (ii) who the beneficiaries are, or (iii) certain other core issues related to the trust. The grantor trust is often amendable or revocable, thus allowing the grantor a way to regain control over the assets.


Thus, a standard grantor trust – foreign or US – will probably not solve the estate planning objectives related to the US estate or income tax.

What about a foreign non-revocable trust which is not controlled by the grantor and who is not, and cannot be a trust beneficiary?


Here, the story just begins. Internal Revenue Code (IRC) 679 states that a U.S. person who transfers property to a foreign trust shall be treated as the owner for the taxable year in which there is a U.S. beneficiary of any portion of the trust.


IRC 679(c) and the corresponding regulations shed some light on the meaning of the above, but suffice it to say that generally, if a US Person (citizen, resident or green card holder) is or conceptually ever be a beneficiary of the trust, the grantor is deemed the owner of the property transferred. This is so even if the trust is completely discretionary as to who the beneficiaries can be.


Sounds tough, especially if the intended beneficiaries are US persons, which they often are as we are dealing with US expat grantors. Is there a way to overcome this hurdle for purposes of estate planning tax?  There are ways to overcome this hurdle. But see [2].


The second hurdle involves IRC 684. This section states that in the case of a transfer of property by a U.S. person to a trust, such transfer shall be treated as a taxable sale of the property. [3] This means that if the fair market value of the property is $1,000,000 at the time of transfer, and the cost basis of the property is $100,000, then the transfer generates a deemed profit of $900,000 which is immediately subject to US capital gains tax. [4]


The section then states that it will not apply so long as the trust is not deemed owned by the grantor under IRC 671-679. Thus, if the conditions of IRC 671-679 are met and the trust is not deemed owned by the grantor (for example, under IRC 679 there are no - and could never be – US beneficiaries), then it appears that the deemed sale will not occur and the tax under IRC 684 would not apply.


True?

No. Why? The relevant regulations state that once the grantor dies, IRC 684 applies at that time. And in the case of an appreciating asset, the deemed sale is based on the higher value of the assets at the time of death, not the time of gift. Very bad.


To summarize, US expats concerned with transferring assets to the next generation have many issues to address. US taxation is just one such issue, but it is a significant one. Each case has its own unique circumstances, but suffice it to say that the use of trusts - foreign or US – have significant benefits and costs that must be considered.  


In the future, we will explore issues involved in an expat using a US trust for estate planning. 


[1] Internal Review Code (IRC) 671-679 are the primary sections dealing with the issue of grantor trust taxation.


[2] If the assets transferred are shares in a foreign corporation, who owns the shares for purposes of GILTI, Transition tax, the 3.8% NIIT tax and the 962 election when dividends are distributed, and reporting on Form 5471? This is beyond the scope of this article.   


[3] Thus we are referred back to IRC 671-679 to determine whether the grantor is deemed the owner of the assets transferred to the IRC 684 foreign trust.


[4]  Of course, a gift of a minority share in an asset (such as minority shares in a company or real estate) give room for serious discounts in valuation that should be carefully utilized. 

NOTHING HEREIN SHALL BE CONSTUED AS LEGAL ADVICE

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