Foreign Trusts With U.S. Beneficiaries. Mistakes Made in Drafting and Administration and How to Avoid Them. By: Kathryn von Matthiessen May 31, 2013

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1 Foreign Trusts With U.S. Beneficiaries Mistakes Made in Drafting and Administration and How to Avoid Them By: Kathryn von Matthiessen May 31, 2013

2 Topics Foreign Trust Definition Grantor Trusts: Incapacity of the Settlor Jointly-Settled Trusts Step-up in Basis for Trusts Foreign/Domestic Flip Trusts Powers of U.S. Beneficiary Common Mistakes Made in Administration

3 Foreign Trust Definition

4 Definition of Foreign Trust Under U.S. law, a trust is a foreign trust unless both of the following conditions are satisfied: (1) A court within the U.S. exercises primary supervision over the administration of the trust; and (2) One or more U.S. persons have the authority to control all substantial decisions of the trust These are called the Court Test and the Control Test

5 Grantor Trusts: Basic Principles

6 Grantor Trust Rules Generally, the grantor trust rules in the IRC dictate when the income of a trust will treated as earned by the owner (regardless of who in fact receives the income) because such person is treated as the owner of the assets of the trust These rules are based upon whether the owner has retained or is granted any of an enumerated series of economic interests in the trust or administrative powers over the trust

7 Grantor and Owner A person is a grantor to the extent such person has created the trust or made a gratuitous transfer of property to the trust A person is an owner to the extent such person is treated as the owner of the assets of the trust for U.S. federal income tax purposes Some grantors cannot be treated as owners reimbursement or no gratuitous transfers An owner does not have to be a grantor

8 Non-Compensatory Grantor Trusts with NRA Owner For non-compensatory trusts, an NRA must be a grantor to be an owner: power to revest absolutely in the grantor title to the trust property to which such portion is attributable is exercisable solely by the grantor without the approval or consent of any other person or with the consent of a related or subordinate party who is subservient to the grantor OR the only amounts distributable from such portion (whether income or corpus) during the lifetime of the grantor are amounts distributable to the grantor or the spouse of the grantor

9 To achieve grantor trust status via a grantor and/or spouse sole beneficiary trust, be mindful of: Power to add beneficiaries Power to pay to new trusts Power to appoint in further trust Power to amend Power to terminate trust or shorten trust period

10 Incapacity of the Settlor

11 Incapacity of NRA Grantor/Owner if the power to revest absolutely in the grantor title to such portion is exercisable solely by the grantor (or, in the event of the grantor's incapacity, by a guardian or other person who has unrestricted authority to exercise such power on the grantor's behalf) without the approval or consent of any other person, then the grantor can be continuously treated as the owner of the trust assets under the grantor trust rules.

12 Solutions for Incapacity of NRA Grantor/Owner of Trust Power to revoke Dispositive provisions sole beneficiary trust Pitfalls to avoid o Look to local laws for guardian or agent o Definition of incapacitated

13 Jointly-Settled Trusts

14 To What Extent is Each Settlor a Grantor? Who created the trust? Who made a gratuitous transfer of property to the trust? o actual ownership o community property-look to local law o other ownership rights o indirect o nominee o Is transferor different than settlor?

15 To What Extent is Each Settlor an Owner? While both of the settlors are alive and neither of them is incapacitated joint or several power of revocation While both settlors are alive but one or both of them is incapacitated look to incapacity provisions After the death of the first of the settlors to die surviving spouse should have power to revoke entire trust (owner must be grantor)

16 When One of the Settlors Dies Grantor trust issues and indirect transfer issues IRC Sec Power to revoke (or otherwise revest) IRC Sec. 678: "... A person other than the grantor shall be treated as the owner of any portion of a trust with respect to which such person has a power exercisable solely by himself to vest the corpus or the income therefrom in himself, or... IRC Sec. 672(f)(2)(A)

17 Solutions General Power of Appointment for Surviving Spouse: If a person with a general power of appointment over a trust exercises that power in favor of another trust, then such person will be treated as the grantor of the transferee trust. See Treas. Regs (e) General Power of Appointment: Power to appoint in favor of powerholder, powerholder s estate, powerholder s creditors or the creditors of the powerholder s estate

18 Solutions (Cont d.) Distribution and recontribution o Timing o Watch out: If there can be beneficiaries other than surviving spouse must have a power of revocation over the new trust to be treated as an owner

19 Step-Up in Basis for Trusts

20 Step-up in Basis for Revocable Trusts Catch-all provision does not apply to foreign situs property acquired from NRNC Step-up in basis applies to property transferred by the decedent during his lifetime in trust to pay the income for life to or on the direction of the decedent, with the right reserved to the decedent at all times prior to his death to revoke the trust. o Issues related to income o Issues related to incapacity of decedent

21 Step-Up in Basis for Irrevocable Trusts Step-up in basis also applies, with respect to decedents dying after December 31, 1951, to property transferred by the decedent during his lifetime in trust to pay the income for life to or on the direction of the decedent, with the right reserved to the decedent at all times prior to his death to make any change in the enjoyment thereof through the exercise of a power to alter, amend, or terminate the trust. Issues of qualifying trust as a grantor trust when only grantor or spouse may be a beneficiary

22 Foreign/Domestic Flip Trust

23 Foreign/Domestic Flip Trusts Trust intended to be foreign grantor trust during foreign grantor s lifetime, with a flip to a domestic trust for a U.S. beneficiary after the death of the foreign grantor Typically sitused in U.S. jurisdiction to ease transition

24 Substantial Decisions Watch out for substantial decisions in the hands of an NRA after the flip. Substantial decisions are non-ministerial decisions which include: Whether to remove and replace trustee (protector power) Selection of beneficiary Investment decisions Note that if a U.S. Person hires an investment advisor, investment decisions made by the investment advisor will be deemed within the control of the U.S. Person if the U.S. Person can terminate the investment advisor s power to make substantial decisions at will

25 Flip Trust If a foreign grantor trust in a domestic jurisdiction, remember to file FBAR

26 Powers of U.S. Beneficiary Make sure no U.S. estate tax concern, i.e., unrestricted power to remove and replace trustee Fiduciary standard of Investment Advisor Make sure a power to consent to distributions does not trigger gift tax or estate tax exposure Be aware of indemnifications of trustee

27 Common Mistakes Made in Administration

28 Grandfathered Foreign Grantor Trust Losing grandfathered status key date: September 19,1995

29 Funding of Trust Transfer of U.S. situs property o Gift tax exposure o U.S. tangible or real property o Wire transfer o Estate tax exposure Transfer of foreign situs property

30 CFCs and PFICs Failure to recognize and plan for CFC or PFIC issues o o Controlled Foreign Corporation ( CFC ) More than 50% of vote or value owned by United States shareholders Applies only to 10% shareholders - a U.S. person who owns 10% or more of the total combined voting power Passive Foreign Investment Company ( PFIC ) 75% or more of gross income is passive income or average percentage of assets which produce or are held for production of passive income is at least 50% No minimum threshold of ownership

31 Respecting The Structure Failure to maintain companies properly Transfer from account owned by foreign corporation or foreign partnership directly to beneficiary rather then through trust

32 Distributions Remember revocation and gift option o If a foreign grantor trust, minimize filing for U.S. beneficiary if grantor partially revokes trust or otherwise receives a distribution and makes a gift to a beneficiary, rather than the trust making a distribution. In the former scenario, a 3520 will only be required if all gifts to beneficiary from the foreign individual exceed $100,000 during the calendar year. In the latter scenario, a 3520 will be required with much more detailed information concerning the trust distribution. o Failure to treat certain loans or property use as distributions

33 Who Is A U.S. Beneficiary?

34 Identify U.S. Beneficiaries Green Card Physical presence Substantial presence Election Exceptions: Closer connection Treaty-based position Days not counted

35 Compliance Failure to take into consideration U.S. accounting standards

36 Compliance (Cont d.) Failure to file U.S. reporting requirements on a timely basis

37 U.S. Treasury Department Form TD F (June 30) IRS Form 3520 IRS Form 3520-A (March 15) Foreign Grantor/Nongrantor Trust Beneficiary Statement IRS Form 5471 IRS Form 8621 IRS Form 8938 Important Forms

38 Contact Information Kathryn von Matthiessen Cantor & Webb, P.A Brickell Bay Drive Suite 3112, Miami, FL Phone: (305) Fax: (305) Website: