This is the fifth installment of my review of new U.S. tax laws affecting foreign trusts. Previous scintillating episodes of this saga are: Part 1 – Overview, Part 2 – Using Trust Property For Free, Part 3 – expanding the grantor trust rules, Part 4 – new presumptions for discretionary trusts.
Routine lawyering practice outside the United States is to write a document that contains the trust itself, which is remarkably devoid of specific language that applies to you, the client, who is actually creating the trust. There are some interesting bits attached to the back end of this trust document (and incorporated by reference) in some Schedules.
That’s all one document. Trustees rightly look at this as their instruction manual — the document instructs the trustee exactly what to do and not do.
There is usually another document. This is viewed — by non-U.S. trustees, their lawyers, and the clients who create the trusts — as “nonbinding” instructions to the trustee. It expresses the Settlor’s preferences. Boil away the formalities, and this Letter of Wishes says something like:
I know you aren’t required to do XYZ. And I know that I have absolutely no control over what happens in the administration of this trust. But gee whiz! If it were up to me, I’d really like to see XYZ happen.
I’m not telling you that you have to do XYZ, and I know that you can ignore this letter if you want to. But XYZ would be cool.
Love and kisses,
ps: I really like XYZ
My experience in the real world? Trustees slavishly follow Letters of Wishes.
The new tax law stops all of this tomfoolery in a specific situation: where the Settlor is a U.S. person. Section 531(c) of the HIRE Act says:
(c) Clarification That Certain Agreements and Understandings Are Terms of the Trust- Subsection (c) of section 679, as amended by subsection(b), is amended by adding at the end the following new paragraph:
‘(5) CERTAIN AGREEMENTS AND UNDERSTANDINGS TREATED AS TERMS OF THE TRUST – For purposes of paragraph (1)(A), if any United States person who directly or indirectly transfers property to the trust is directly or indirectly involved in any agreement or understanding (whether written, oral, or otherwise) that may result in the income or corpus of the trust being paid or accumulated to or for the benefit of a United States person, such agreement or understanding shall be treated as a term of the trust.’ .
If you have a U.S. settlor for a foreign trust, the U.S. tax authorities will interpret the trust by looking at all of the formal and informal instructions, agreements, wink-wink-nudge-nudge moments, etc.
The U.S. tax authorities are doing this in an attempt to characterize the foreign trust as having a U.S. beneficiary. They want to recharacterize the trust in that way in order to make its income currently taxable on the personal U.S. income tax return of the U.S. settlor of the trust.
I think Letters of Wishes are a waste of time, quite apart from the slowly-closing tax door here in the United States.
Yes, I understand that under the trust laws of the various jurisdictions that Letters of Wishes may be considered by a court to be exactly that — an expression of a desire, nonbinding on the trustee.
But still. Reality beckons. There is no corporate trustee on the planet which will ignore a Letter of Wishes. Future business requires fanatical attention to the settlor’s desires. If it becomes known that RandomBank’s trust officers do whatever they want despite the language of a Letter of Wishes, ask yourself a simple question: would you hire RandomBank as your trustee? No, I think not.
Additionally, why make your life more complex by having to look at a bunch of documents to see the whole picture of how a trust should operate? Why not put it all in one place? By doing this you reduce risks for lost documents. And you make it more likely that you will have internal consistency amongst all of the provisions.
Don’t. Just don’t. If you are creating a trust, put all the stuff you want into one document. Don’t get clever, don’t use wink-wink-nudge-nudge.