Complex Issues. Foreign Trusts

Transcription

1 Complex Issues in Foreign Trusts Robert D. Colvin, Houston, TX Dina Kapur Sanna, New York, NY 13 th Annual International Estate Planning Institute March 23, 2017 Domestic vs Foreign Trusts Bias in favor of Foreign Trust Court test US court exercise primary supervision over administration of the trust Control test US persons control all substantial decisions of the trust 1

2 Accidental Foreign Trusts Domestic trustee but foreign person holds substantial power Directed Trust powers risks Trust Protector, investment advisor, etc. U.S. corporation as power holder? Naming foreign person as Trustee or Protector under a Will U.S. citizens living abroad QTIP Trusts & Family Trusts for kids Foreign courts exercise primary jurisdiction even if US citizen trustee (such as surviving spouse) Hybrid Domestic Foreign Trusts Foreign settlors CRS & FATCA motivations No foreign entities or financial accounts Grantor vs nongrantor trust Limitations on foreign person as owner of trust New Form 5472 reporting of US LLCs Estate tax property situs issues if estate inclusion Foreign blocker companies Section 2104 funding with US situs property Automatic domestication upon death of settlor avoids UNI accumulation period FBAR reporting by US trustee 2

3 Foreign Nongrantor Trusts Form 3520 & 3520A reporting Accumulated income distributions All treated as ordinary income Lose capital gains character Section 668 Interest Charge Use of trust property = foreign trust distribution FIRPTA withholding on US real property interests Section 1446 Partnership withholding Section 684 on trust expatriation The Pregnant Trust Problem Nongrantor Foreign Trust Accumulated Income/Gains 3

4 The Pregnant Trust Problem Accumulated income distributions All treated as ordinary income Lose capital gains character Section 668 Interest Charge Trust Distribution Ordering Rules DNI UNI Capital DNI - Current year trust income Retains original character UNI - Income accumulated in prior years All high tax ordinary income Interest charge Capital distributions Tax-free 4

5 Trust Distribution Ordering Rules (Example 1) Facts $100 of current year DNI $500 of UNI accumulated in prior years $200 of original capital $250 Distribution $100 current year DNI Retains original character $150 accumulated UNI Ordinary income plus interest charge Default Method of Determining UNI If no Foreign Nongrantor Trust Beneficiary Statement Prior three year distributions times 1.25, divided by 3 is current year ordinary income All is UNI if no prior trust distributions (i.e., no DNI element) No capital gain treatment Only the excess amount of the distribution is treated as an accumulation distribution Excess distribution is subject to interest charge based on half life of the trust (rounded to nearest half year) Default method required for all future years except year trust terminates 5

6 Pregnant Trust Split Trust Solution Foreign Trust Annually Decant Excess Income/Gains U.S. Income Trust SOLELY Corpus/Principal SOLELY Accumulated Income & Gains Investment Assets (stocks, bonds, etc.) Investment Assets (stocks, bonds, etc.) Pregnant Trust Decant & Domesticate Original Foreign Trust Decant DNI & UNI Foreign Trust 2 1. FT2 must be respected as separate trust 2. Domesticate cleansed Original FT SOLELY Corpus/Principal SOLELY Accumulated Income & Gains 3. FT2 remains a foreign trust 6

7 Trust Distribution Ordering Rules DNI FAI UNI Capital DNI - Current year income of trust Retains original character FAI - Fiduciary accounting income Tax-free in excess of current year DNI UNI - Income accumulated in prior years All high tax ordinary income Onerous interest charge Capital distributions Tax-free Trust Distribution Ordering Rules (Example 2) Facts $100 of current year DNI $250 current year FAI $500 of UNI accumulated in prior years $250 Distribution $100 DNI Retains original character $150 FAI Tax-free!!! $200 of original capital 7

8 Fiduciary Accounting Income Income pursuant to: Terms of the governing instrument Internal mark to market by trustee vs historical costs Applicable local law Accounting principles Corporate distribution provisions May differ from tax accounting income Timing Amount Fiduciary Accounting Income Opportunities Partnership income OID Instruments Insurance contracts that fail to meet US tax requirements Life policies Deferred variable annuities Depreciation & amortization differences 8

9 Three Gift Rule Exception Section 663(a)(1) requirements: Pursuant to the terms of the governing instrument Exercise of POA? Decant to new trust? A specific sum or money or specific property Shares of holdco Paid in no more than three installments Excludes any amounts that can only be paid from income But creditors in waiting and lose trust benefits? Intermediary Distribution Rules Attempts to avoid accumulation distributions by distributing to foreign person who makes gift to US beneficiary Recharacterizes purported gift as trust distribution Presumption of intermediary if trust distributions received 24 months before or after further distribution to US beneficiary Grantor is never an intermediary What about the grantor s estate? 9

10 GPOA Exception to Trust Distribution Rules Trust to trust distributions carryout DNI & UNI General Rule: Grantor of distributing trust is treated as the grantor of recipient trust Exception: GPOA power holder is treated as grantor in trust to trust transfers pursuant to a GPOA Treatment under local law & GPOA holders home country Still carries out DNI & UNI Recipient trust must be grantor trust to GPOA power holder to avoid tainting recipient trust Grantor vs Owner distinction The Pregnant Trust Problem GPOA Solution Non-U.S. Person Nongrantor Trust Exercise GPOA Grantor Trust Life Insurance Policy Accumulated Income & Gains Account Portfolio 10

11 Entity Distribution Trap Non-US Family Member Result 1. Presumption that taxable to U.S. beneficiary as a distribution from entity. Grantor Trust Corp/Ptshp Bank Acct Gift U.S. Beneficiary 2. Exception if grantor reports in his home country as a distribution from the entity followed by gift to beneficiary and U.S. beneficiary files Form 3520 reporting the gift. Entity Distribution Trap Simple Solution Non-US Family Member Corp/Ptshp Bank Acct Gift Gift U.S. Beneficiary Solution 1. Entity distributes to donor that in turn distributes to U.S. beneficiary. 2. Not taxable if a true gift. 3. Report on Form 3520 as direct gift if >$100,

12 Entity Distribution Trap Simple Solution Non-US Family Member Grantor Trust Corp/Ptshp Bank Acct Distribution U.S. Beneficiary Solution 1. Entity distributes to grantor trust that in turn distributes to U.S. beneficiary. 2. Not taxable due to grantor trust status. 3. Report on Form 3520 as trust distribution. Foreign Grantor Trust (Poor Non-U.S. Settlor) NRA U.S. Person 10% Seed Capital Foreign Grantor Trust < 90% loan 5 yr; interest only w/balloon Investments Qualified Obligation 12

13 Foreign Estate vs. Foreign Trust US citizen can have a foreign estate Residency of decedent at time of death Location of assets Location of executor and estate administration Foreign source income can be distributed tax-free (i.e., not constitute DNI) Capital gains of foreign estate not included in DNI except for the year of termination No UNI on income accumulated within a foreign estate Foreign Estate vs. Foreign Trust US citizen can have a foreign estate Foreign source income can be distributed tax-free (i.e., not constitute DNI) Capital gains of foreign estate not included in DNI except for the year of termination No UNI on income accumulated within a foreign estate 13

14 Foreign Estate vs. Foreign Trust US citizen can have a foreign estate Foreign source income can be distributed tax-free (i.e., not constitute DNI) Capital gains of foreign estate not included in DNI except for the year of termination Liquidate foreign companies within 30 days to avoid CFC status Careful re foreign tax issues (e.g., tax & basis adjustment) PFICs are more complicated No UNI on income accumulated within a foreign estate Foreign Estate vs. Foreign Trust US citizen can have a foreign estate Foreign source income can be distributed tax-free (i.e., not constitute DNI) Capital gains of foreign estate not included in DNI except for the year of termination No UNI on income accumulated within a foreign estate No interest charge on accumulation distributions Tax-free distributions of pre-taxed capital 14

15 Section 645 Elections Qualified Revocable Trusts ( QRT ) Section 676 powers held by decedent Does not include powers held by spouse Convert foreign trust to foreign estate Could be US based Hybrid Trust Only affects income tax, not estate tax Section 645 Elections Election lasts for two years from date of death or six months after final determination of estate tax liability if US estate tax return is required or filed Good to have US assets to extend filing period? Election made by trustee of QRT on or before first Form 1041 filing due date (including extensions), even if no Form 1041 is to be filed QRT must obtain an EIN QRT & Estate each treated as separate shares for calculating DNI on distributions Deemed distribution to new trust upon termination of election period Carries out DNI (including capital gains) Domesticate trust if US beneficiaries 15

16 Robert D. Colvin Robert D. Colvin & Associate 12 Greenway Plaza, Suite 1100 Houston, TX Direct: (713) Fax: (713) Dina Kapur Sanna Day Pitney LLP 7 Times Square New York, NY Direct: (212) Fax: (718) dksanna@daypitney.com 16