When a Grantor Trust is a Nongrantor Trust

Here is a quick discussion of an important topic for those of you who handle expatriations. What you think is a grantor trust might, for exit tax purposes, be classified as a nongrantor trust.

IRC 877A(f) is the provision that talks about distributions from nongrantor trusts to covered expatriates. These distributions may trigger recognition of gain, and the trustee may have a withholding requirement. IRC §877A(f)(1).

IRC §877A(f)(3) defines nongrantor trust like this:

Notice 2009-85, Section 7.A rephrases this in an easy-to-understand way, eliminating some of the embedded ambiguities:

The expatriation date, of course, is the expatriation date of the covered expatriate. IRC §877A(g)(3). 

Three Kinds of Trusts

The Internal Revenue Code classifies trusts like this:

• A trust has an owner, as defined in the grantor trust rules (IRC §§671 - 679). We call these “grantor trusts.”
• A trust does not have an owner, as defined in the grantor trust rules (IRC §§671 - 679). We call these “nongrantor trusts.”

IRC §877A(f)(3) says:

• If a trust has an owner, and the owner is NOT the covered expatriate who is receiving a distribution from the trust, then the portion of the trust that is not owned by the covered expatriate is a “nongrantor trust.”

If you put those two ideas together, you have three types of trusts:

• A grantor trust that has the covered expatriate as an owner. For IRC 877A(f), this is a grantor trust.
• A grantor trust that has someone other than the covered expatriate as the owner. For IRC 877A(f), this is a nongrantor trust.
• A nongrantor trust. For IRC 877A(f), this is a nongrantor trust. 

Grantor Trust IRL, Nongrantor Trust for IRC 877A(f) 

A simple example of the second bullet point. Parent is a U.S. citizen, and creates a grantor trust. Parent is the owner of the trust as defined in IRC §671. Child is the beneficiary. Child renounces U.S. citizenship and is a covered expatriate.

The portion of the trust owned by Child is 0%, because Parent owns 100% of the trust. The portion not owned by Child (i.e., 100% of the trust) is a nongrantor trust.

Implications for the Covered Expatriate

If a covered expatriate receives a distribution from a nongrantor trust (including a grantor trust owned by someone else), you have to deal with:

• Withholding requirements imposed on the trustee (IRC 877A(f)(1)(A));
• Gain recognition triggered for the trust by the distribution (IRC 877A(f)(1)(B)); and
• Form W-8CE delivery to the Trustee (Notice 2009-85, Sections 7.C., 8).