This is the final installment in my overview of the HIRE Act and its provisions affecting foreign trusts. Previous installments are here:
Part 1 - Overview,
Part 2 - Using Trust Property For Free, Part 3 - expanding the grantor trust rules,
Part 4 - new presumptions for discretionary trusts,
Part 5 - Letters of Wishes are useless,
Part 6 - all foreign trusts have U.S. beneficiaries,
Part 7 - more paperwork,
Part 8 - bigger penalties.U.S. tax laws have added another layer of complexity for those of us who deal with foreign trusts. We can whine all we want, but the grown-up reaction is "What action step do I take?"Here are my suggestions:
Define scope of trust agreement
Recall that the new rule in Section 679 (for foreign trusts established by U.S. persons) is that the provisions of the trust consist of the trust document plus the letter of wishes plus whatever other written or informal agreements exist. Draw a line around that.Do a bit of work. Collect all of the documents floating around and collect them in one place. The trustee then might make some sort of affirmative stand to define the scope of these items: "The only things we look at are the Deed of Trust and the Letter of Wishes. We view the Letter of Wishes as a nonbinding statement of intent under local trust law, but recognize that it will be viewed as a binding part of the overall trust for U.S. tax purposes.The reason for this action: limit the scope of a potential IRS fishing expedition outside the specifically-identified documents. Draw a boundary around the known universe. This is nonbinding on all parties, but some type of written document signed by all parties in 2010 will be powerfully persuasive when you get into a fight with the IRS in 2025 about what should or should not be included in the operative provisions of a trust.Note: the concept of "everything is binding" that has been introduced into Section 679 should not be seen as limited to foreign trusts with U.S. settlors. Assume this rule applies (for U.S. tax purposes) to trusts established by settlors who are not U.S. persons.
Who are the beneficiaries?
A number of presumptions have been introduced. The impact of these presumptions is transform possible into definite: if it is conceiveably, remotely possible to someday, somehow have a beneficiary who is a U.S. person, then the trust will be treated as having a U.S. beneficiary now.Since the downside for having U.S. beneficiaries can be profound, the trustee might consider looking at the provisions of the trust -- especially the grant of discretion to the trustee to add or remove beneficiaries -- and consider whether changes are appropriate to prevent the inadvertent existence of a U.S. beneficiary for U.S. tax purposes.
Reconsider free use of trust property
Use of trust property by a beneficiary can cause a phantom trust distribution to that beneficiary equal to the value of the property used for free. For the U.S. beneficiary, this may cause a tax problem: the phantom trust distribution might be treated as having been made out of current income of the trust. Or worse yet, it could be treated as coming out of accumulated income. Both events would cause the U.S. beneficiary to have a tax liability which has to be paid with real cash, despite the fact that no cash was actually given to the beneficiary by the trust. This is a recipe for cash flow problems.
Consider migrating trusts to USA
All of these problems are eliminated if the trust is a domestic trust. A U.S. beneficiary can live in a house owned by a domestic trust, rent-free. He can no longer live in a house rent-free if the house is owned by a foreign trust. The trustee of a foreign trust might consider establishing a domestic trust to eliminate the tax problems.Migrating the entire foreign trust to the United States is one possibility. Migrating only specific assets into a U.S. trust is another. Our firm has employed both of these strategies.
Yet another job for trustees
I believe the trustees in traditional jurisdictions (the Channel Islands, the Caymans, Switzerland, Singapore, etc.) should take the effort to run a quick due diligence check through their inventory of trusts. Look especially for instances where there is the possibility of a U.S. beneficiary existing in the picture. Take the necessary pro-active steps, or at least understand the implications. I think it is a safe assumption to start your analysis with the idea that as far as the U.S. government is concerned there is a U.S. beneficiary. :-)
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