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May 23, 2010 - Phil Hodgen

New foreign trust tax rules, Part 6 – all foreign trusts have U.S. beneficiaries

This is a doozy.  All foreign trusts established by U.S. persons will be deemed to have U.S. beneficiaries unless the person creating the trust tells the IRS a bunch of stuff.  In writing.  On paper.

This is the latest edition of my review of U.S. tax law updates as they apply to foreign trusts.  Here is where to find the earlier stuff: Part 1 – OverviewPart 2 – Using Trust Property For FreePart 3 – expanding the grantor trust rulesPart 4 – new presumptions for discretionary trusts, Part 5 – Letters of Wishes are useless.

Background

The IRS likes all income to be taxed in the United States.  Now.

When assets are placed into a foreign trust by a U.S. person, the possibility arises that the income derived from the foreign trust will NOT be immediately taxable in the United States.  That makes the IRS sad.

The solution — from the government’s point of view — is found in the grantor trust rules.  These rules say “If a U.S. person creates a foreign trust and there is a U.S. beneficiary, then the U.S. person creating the foreign trust is taxable on the trust’s income even though he/she never receives it.”

The way to prevent a trust from being a grantor trust is to draft the trust document in such a way that there is no beneficiary who is a U.S. person.

Now that job just became harder.  In addition to doing the trust document correctly, you also have to notify the IRS.

What the HIRE Act says

The new law says this about that.  (That’s a veiled Nixon reference BTW).

SEC. 532. PRESUMPTION THAT FOREIGN TRUST HAS UNITED STATES BENEFICIARY.

(a) In General – Section 679 is amended by redesignating subsection (d) as subsection (e) and inserting after subsection (c) the following new subsection:

‘(d) Presumption That Foreign Trust Has United States Beneficiary – If a United States person directly or indirectly transfers property to a foreign trust (other than a trust described in section 6048(a)(3)(B)(ii)), the Secretary may treat such trust as having a United States beneficiary for purposes of applying this section to such transfer unless such person—

‘(1) submits such information to the Secretary as the Secretary may require with respect to such transfer, and

‘(2) demonstrates to the satisfaction of the Secretary that such trust satisfies the requirements of subparagraphs (A) and (B)of subsection (c)(1).’ .

(b) Effective Date – The amendments made by this section shall apply to transfers of property after the date of the enactment of this Act.

What it means

Simply put, a foreign trust is a grantor trust if a U.S. person creates it.  In order for the foreign trust to be a nongrantor trust, Paperwork Must Be Filed.

Tax and Trusts