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.
Philip D. W. Hodgen is the principal attorney of HodgenLaw PC, an international tax law firm based in Pasadena, California. He earned his undergraduate degree from Claremont McKenna College and his law degree from the School of Law at the University of California, Los Angeles. He then went on to earn a Master of Laws degree with a specialty in taxation from the University of San Diego School of Law. Admitted to the California bar in 1982, Phil spent nine years in law firms and with a large U.S. bank before starting his own firm in 1991.
Phil is a past chair of the International Tax Committee of the State Bar of California's Tax Section and was a member of the Executive Committee of the State Bar of California's Tax Section for 2004-2007. Phil frequently speaks on a variety of international tax, trust and estate topics to attorneys, accountants, and real estate professionals.
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Tax laws change over time, and the information in this post above may be less accurate today than it was at the time of the last revision. This post is not tax advice for your specific situation. Please contact an international tax professional to get personalized advice for your situation.