April 2, 2010 - Phil Hodgen

Jell-O Shot Number 008 – foreign trusts are evil and must be punished

The latest Jell-O Shot just went out.  If you’re not on the mailing list, shame on you.  Look to the right on your computer screen, find the sign-up widget, and, well, sign up.

Here it is, reformatted a bit.

Jell-O Shot Number 8

Hey, it’s Phil again.  I was in Singapore for Jell-O Shot Number 7, home for this one.  Number 9 will come from Saudi Arabia in a few weeks.

The government continues to make the international tax rules more complex while increasing the cost of failure.  For an incisive interview on why complex systems inevitably fail (this for the media business but the same logic can be applied to government), see Clay Shirky’s essay titled The Collapse of Complex Business Models.

Foreign trusts + U.S. real estate + U.S. beneficiaries = pain

Back to the topic at hand.

This month’s example is in the “foreign trusts which own U.S. real estate” department.  We have a metric ton of these in our office.

Real life scenario:  Mom, living outside the U.S., wants to help daughter, living in the U.S., to buy a house.  Mom sets up a foreign trust, puts money into it, the trust buys a house, and daughter lives there rent-free.

Until a couple of weeks ago, no problem.  Daughter didn’t pay rent, and she she could use the house without having any income tax exposure derived from the use of the house that she didn’t own.

Now the daughter living there rent-free is going to be treated as receiving income equal to the FMV of the use of the house.  If the house would rent on the open market for $5,000/month, the daughter now has taxable income of $5,000/month from the trust.  Without receiving cash.

This.  Is.  Not.  Good. Being taxed on money you never receive?  Ouch.

This new rule is not just for real estate.  If the trust owns a car and a U.S. beneficiary uses the car, the same idea applies:  “make pretend” income is taxable to the person using the car in a very painfully real way.

For you tax nerds, go look at Section 643(i).

Moral of the story

  • Find that foreign trust.
  • Does it have any U.S. beneficiaries?  Is there a possibility of naming a U.S. person as a beneficiary of the trust?
  • Are the U.S. beneficiaries using anything that the trust owns?
  • Fix the problem of accidental “make believe” income.

That’s what we will be busily doing in the next couple of months.  All you trust officers reading this, let’s figure out which trusts need to be fixed, and how to do this.

Meanwhile, back in the real world

My schedule for April-May is:

  • birthday – April 9 (heh; how about that shameless self-plug?)
  • Boy Scout campout – April 10 – 11 (north side of the Angeles National Forest)
  • Saudi Arabia – April 22 – 28 (Jeddah and Riyadh)
  • Boy Scout campout – May 1 – 3 (the boys will be climbing at Joshua Tree, one of my youthful rock-climbing haunts.  Can I do a 5.10b again?  I doubt it.)
  • Singapore/Hong Kong/Jakarta (tentative) – late May, and my wife is insisting on coming along this time!
  • Mt. Wilson Trail Race – I’m part of the finishing group that makes the top 90% possible.

I’m a people person 🙂

As always, mobile = +1 626 437 2500, and Twitter (caution:  potty mouth!) is @philiphodgen.


Speeches, Publications, and Events