(b) TAX BENEFITS OF A HYBRID TRUST. The following are some US Federal Tax benefits of a Hybrid Grantor Trust.

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1 NON RESIDENT ALIENS OF THE UNITED STATES AND HYBRID GRANTOR TRUSTS Last Updated: May 19, 2014 Article by Milagros Gomez Munoz of Milagros Gomez Munoz, P.A. I. HYBRID GRANTOR TRUSTS. (a) WHAT IS A HYBRID GRANTOR TRUST? A Hybrid Trust is a trust which is governed under the laws of a state within the United Stated (the US ), but which is treated as non US trust (and thus, a non US taxpayer) because a foreign person has the right to make a substantial decision with respect to the Hybrid Trust. A Hybrid Grantor Trust is typically a trust which is settled or created by a foreign person (a foreign person who settles or creates a trust and remains a foreign person till his or her death is referred to in this memo as the Settlor ) and which is either (1) revocable by the Settlor during his or her lifetime or (2) irrevocable by the Settlor during his or her lifetime but which only benefits the Settlor or his spouse during the Settlor s lifetime. A trust fitting either of these two categories is a Hybrid Grantor Trust for as long as the Settlor is alive. At the Settlor s death, the trust ceases to be a grantor trust, but could continue to be a Hybrid Trust depending on several factors, a discussion of which is beyond the scope of this article. Like the typical Hybrid Trust, a Hybrid Grantor Trust is also not treated as a US Taxpayer. In addition, the Hybrid Grantor Trust s assets are treated as owned by its Settlor during his or her lifetime. Thus, for US Federal tax purposes, the Hybrid Grantor Trust is ignored and/or is treated as a transparent vehicle. The following discussion deals with Hybrid Grantor Trusts (the Trust ) that fit into the former of these two categories namely, a Hybrid Trust which is (1) settled or created by the Settlor, (2) revocable by the Settlor during his or her lifetime and (3) a grantor trust because, among other things, the Settlor is alive. (b) TAX BENEFITS OF A HYBRID TRUST. The following are some US Federal Tax benefits of a Hybrid Grantor Trust. (1) During the time that the Trust is revocable by the Settlor, the Trust will not be subject to US Federal income taxes (see discussion below) as long as none of the income generated by the Trust is US Sources Income or income that is effectively connected with a US trade or business ( ECI, see discussion below). To avoid having US Source Income, what is typically done is that US investments that will generate US Source income are held through a non-us corporation (an Underlying Foreign Corporation). Page 1 of 7

2 Caveat: Care must be taken so that this Underlying Foreign Corporation be properly managed and maintained and that there be no co-mingling of assets between the corporation and its owner (i.e., the Settlor and/or the Trust) and the Trust s beneficiaries as there exists a strong likelihood that the IRS will ignore its existence if these corporate formalities are not observed. Note that ignoring the existence of an Underlying Foreign Corporation in the case of a Hybrid Grantor Trust would mean that (1) the US Source Income or ECI generated by the Underlying Foreign Corporation would become taxable to the Settlor and (2) any taxable US Situs Assets (as defined below) held by the Underlying Foreign Corporation would be included in the Settlor s US taxable estate (and become subject to the estate tax, which is discussed below) at the Grantor s death. (2) The Transfer Taxes (as defined below) will not apply at the death of the Settlor, as long as the Trust assets remain non-us Situs Assets. Having an Underlying Foreign Corporation as the owner of the Trust s US Situs Assets assures that the Trust Assets remain non-us Situs Assets. Caveat. An Underlying Foreign Corporation may not be suitable in every case and/or other structures may be more suitable depending on the type of US Situs Asset at issue and the residence and/or citizenship of the Settlor and future beneficiaries of the Trust. Thus, some analysis of the situation and structuring may be required. (3) If the Trust assets remain in Trust after the Settlor s death for the benefit of other beneficiaries such as the Settlor s children (and not directly owned by these beneficiaries), these assets should also not be subject to the Transfer Taxes for as long as the assets remain in Trust. Caveat. Further analysis, planning and structuring is required if the Trust is to have future US beneficiaries. As the use of a Hybrid Grantor Trust with and Underlying Foreign Corporation may not be suitable in these situations without further planning. In addition, other structures may be more advantageous if the Trust will have future US beneficiaries. (c) NON TAX BENEFITS OF THE TRUST. The following are some of non US Federal Tax benefits of a Hybrid Grantor Trust. (1) If the Trust is revocable during the Settlor s lifetime, flexibility exists in the Trust in that it can be modified, amended or terminated by the Settlor at any time during his or her life. (2) The Trust can also serve as an asset protection vehicle in that after the Settlor s death, creditors of beneficiaries cannot reach the assets that remain in trust. Page 2 of 7

3 (3) With the Trust, there is no need to initiate or open probate proceedings or other similar succession proceedings (and thus, the costs, delays and headaches associated with these procedures are eliminated) with respect to the assets held in Trust because the Trust automatically passes the assets held in trust to intended beneficiaries. (4) The Settlor can retain control of the Trust assets by naming himself or herself as the Trustee. (5) The Trust has no recurring costs or annual fees, such. Note that there is only a one time fee associated with the preparation and execution of the Trust (see below). In addition, Trustee fees are avoided during the Settlor/s lifetime if the Settlor is also the trustee of the Trust. (6) The Trust is governed by the laws of a State within the United States, which are a respected jurisdiction and not a blacklisted country pursuant to most, if not all, backlist legislations. (d) COSTS FOR THE HYBRID GRANTOR TRUST. The costs for preparing and finalizing such a trust should be no more than $3,000, unless significant drafting is involved. II. UNITED STATES FEDERAL TAXES. The following is intended to be a general discussion of the US Federal taxes and how they apply to persons who are not US citizens, US residents and US domiciliaries. The author believes that a discussion of these taxes is important to understand the benefits of the Hybrid Grantor Trust. (a) THE US INCOME TAX: (1) APPLICATION OF THE US INCOME TAX IN GENERAL. Only US Citizens ( US Citizens ) and US resident aliens ( Resident Aliens ) of the US are subject to US Federal income taxes on a world wide basis. A non Resident Alien is subject to US income taxes only on income which is characterized as US source income ( US Source Income ) and income which is derived from the Non Resident Alien s US trade or business. (2) US RESIDENTS AND NON RESIDENT ALIENS An individual is generally presumed to be a Resident Alien, and thus, subject to US Federal world wide income taxation, if: such individual holds a valid alien registration receipt card i.e., a green card; or the sum of (i) the number of days that the individual is physically present in the US during the current year, plus (ii) 1/3 of the number of days that the individual is physically present in the US during the first preceding Page 3 of 7

4 year, (iii) plus 1/6 of the number of days that the individual is physically present in the US during the second preceding year, equals or exceeds 183 days. However, an individual s days of presence in the US are not counted for purposes of determining if he or she has spent at least 183 days in the US if the person is in the US under an F-1 or an F-2 visa and the person has (i) substantially complied with his or her student visa and (ii) filed Form 8843 with the Internal Revenue Service (the IRS ) for each year he or she is claiming that his or her days of presence are not counted. 1 A non Resident Alien is a person who is neither a US citizen nor a US resident. (3) US SOURCE INCOME AND NON RESIDENT ALIEN INCOME TAXATION. As mentioned above, a Non Resident Alien is subject to US income taxes only on income which is characterized as US Source Income, unless the Non Resident Alien is engaged in a US trade or business. Thus, generally, income of a RA subject to US income tax may be divided into four categories: US source fixed or determinable annual or periodic income ("FDAP Income") that is not effectively connected with a US trade or business e.g., interest, dividends, rents, salaries, wages, premiums, annuities, compensation, and similar income. FDAP income is subject to US tax at the rate of 30% (or a lower treaty rate) on a gross basis. Note, however, that: (1) US bank deposits can generate US income tax-free interest income; and (2) some interest on some US corporate bonds can be received on a tax free basis (i.e., if the investment qualifies for the portfolio interest exception). Certain miscellaneous types of income which are taxed like FDAP Income e.g., income derived from certain timber, coal, and iron ore transactions; original issue discount income; and income derived from the sale or exchange of patents, copyrights, trade names, franchises, etc. Income in this category is also (provided it is not effectively connected with a US trade or business) subject to a 30% (or lower treaty rate) tax on a gross basis. US source capital gain income if not effectively connected with a US trade or business is not taxable to a Non Resident Alien. However, if a Non Resident Alien individual is physically present in the United States for at least 183 days during the year of the sale, non-effectively connected capital gains are subject to a 30% tax on a gross basis. A foreign person's income that is effectively connected with a US trade or business ("ECI") is taxable at the same graduated rates of tax applicable to Resident Aliens and US citizens. 1 Note that the presumption can be rebutted if: (1) the individual was not present in the US for one hundred eighty-three (183) days or more during the current calendar year; and (2) the individual can show that he she has a tax home in (generally considered the individual's primary place of business), and a closer connection to (generally based upon factual circumstances), a foreign country. Page 4 of 7

5 (b) THE US FEDERAL TRANSFER TAXES. (1) THREE TYPES TAXES. The US imposes three types of transfer taxes (the Transfer Taxes ), namely: the US estate tax (the "Estate Tax"); the US gift tax (the "Gift Tax"); and The US generation skipping Transfer Tax (the "GST Tax"). (c) US CITIZENS, US DOMICILLIARIES AND NON-US DOMICILIARIES. Only US Citizens and persons who have a domicile in the US are subject to the Transfer Taxes on a world wide basis regardless of the location of the assets at the time of the transfer. Persons who have a domicile outside of the US are only subject to the Transfer Taxes to the extent that they make a gift, devise or bequest of assets that are located in the US or that are deemed to have a US situs. (d) US DOMICILE. A person will generally have a "domicile" in the US for purposes of the Transfer Taxes if he or she: lives in the US or has lived in the US even if only for a brief period of time; with No definite present intention of leaving the US. It is important to emphasize that for a person to be deemed to have a domicile in the US, both of these factors (or tests) must be met. In order to determine whether these factors are met, the IRS will generally look at the facts and circumstances of each particular case. The domicile determination is highly subjective and, generally speaking, as long as it can be subjectively shown that an alien has no intention to make the US his or her permanent home, he or she should not be deemed to be domiciled in the US. Note that a person who files an application to obtain a green-card may be deemed to be a domiciliary of the US (as long as he or she also lives or has lived in the US) because the green card application itself requires an assertion that such person s intention is to remain in the US. (e) APPLICATION OF THE TRANSFER TAXES TO THE NON DOMICILLIARY IN GENERAL. (1) THE ESTATE TAX. Only US situs assets ( US Situs Assets ) owned by a person who is a non-us domiciliary at death are subject to the Estate Tax. The Estate Tax is imposed on the date of death fair market value of these US Situs Assets. US Situs Assets for purpose of the Estate Tax includes (among other types of assets) US real estate, US mutual funds, tangible personal property located in the US, notes receivable from a US individual debtor (not of a portfolio debt type), funds in a US safe deposit and shares of stock in US corporations. Deposits with US banks and savings and loan associations Page 5 of 7

6 and life insurance paid by, and amounts left at interest with, US insurance companies are non-us Situs Assets for purpose of the Estate Tax. Non US stocks and bonds are also not US Situs Assets. Note that the first Sixty Thousand Dollars ($60,000) of a non-us domiciliary s US Situs Assets are exempt from the Estate Tax. In addition a full marital deduction (the "Marital Deduction") is available to shield property passing outright (or in certain trusts) to a US citizen surviving spouse from the Estate Tax. The Marital Deduction is, however, only available in connection with property passing to a surviving spouse who is a US citizen, unless: (i) it is left to the surviving spouse in a special trust called a Qualified Domestic Trust ("QDOT ); or (ii) the surviving spouse becomes a US citizen before the decedent spouse s Estate Tax return is filed and was domiciled in the US at all times from the date of the decedent s death to the date he or she becomes a US citizen. (2) THE GIFT TAX: Gifts of non-exempt US Situs Assets are subject to the Gift Tax. The Gift Tax situs rules are similar but not identical to those of the Estate Tax, with the primary difference being that gifts of US intangible personal property (e.g., stock in US corporations and promissory notes) are exempt from the Gift Tax. In addition, gifts of deposits in US banks are also not subject to the Gift Tax. However, please note that although this is the rule with respect to deposits in US banks, the IRS generally holds that a gift by a non-us domiciliary of currency located in the US is a gift of tangible US situs property subject to the Gift Tax. Further, it is not clear whether the gift by a non-us domiciliary of a check drawn on a US bank and cashed in the US will be considered tangible US situs property subject to the Gift Tax. For this reason, most conservative tax practitioners recommend that a non-us domiciliary make a gift of money by means of a wire transfer from the donor s foreign bank account to the donee s foreign bank account. Finally, the following will apply to gifts of US Source Assets made by a non-us domiciliary: (1) the Sixty Thousand Dollar ($60,000) Estate Tax exemption mentioned above does not apply to gifts; (2) tax-free transfers may be made of a present interest in any US Situs Asset of Fourteen Thousand Dollars ($14,000) (adjusted for inflation) or less per year in money or property, to any person; and, effective for 2014, of One Hundred Forty Five Thousand Dollars ($145,000) (adjusted for inflation) or less per year to a non-us citizen spouse; (3) the Marital Deduction is only available if the spouse receiving the gift is a US citizen (the QDOT is not available for gifts); and (4) in special circumstances, unlimited gifts may be made for medical and educational purposes, but very specific rules must be followed. (3) GST TAX. In the case of a non-us domiciliary, the GST Tax only applies if the transfer is subject to either the Gift Tax or Estate Tax Page 6 of 7

7 i.e., if the property transferred was a US Situs Asset at the time of the gift or death, and in the case of a gift, only if the asset is tangible property. The GST Tax Exclusion is also available to non-us domiciliary and, in most cases you can make gifts of present interests in any US Situs Asset of Fourteen Thousand Dollars ($14,000) or less and certain limited gifts for medical and educational purposes to skip persons without incurring a GST Tax. * * * * * We hope that the foregoing has been informative and useful. However, should you have any questions or require any information from us, please feel free to contact Milagros Gomez Munoz at (cellular) or (office). Page 7 of 7