What are Foreign Trusts and Can You Take Advantage of One?
By: Barry E. Haimo, Esq.
October 22, 2020
The world has gotten a lot smaller over the past few decades, and everyone is becoming a part of an expanding global society. This shows itself in a variety of ways, including the strategies some use in their estate planning. Foreign trusts are a valid instrument for U.S. citizens who have family or friends in foreign jurisdictions or who are themselves beneficiaries of trusts in other countries.
If you have financial ties in other countries or trusts from outside the U.S. requiring tax reporting in the United States, then you need to learn more about foreign trusts, their advantages, and how they can be put to work for you.
Foreign Trusts: What Are They?
In general, a foreign trust is the legal title assigned to property that is transferred from the grantor, or owner, to the trustee, or the other party. That trustee then administers the property for the benefit of the beneficiary. Under United States law, if a trust originates in a foreign country, then it’s subject to that country’s courts and laws as a foreign trust.
How Does the United States Tax a Foreign Trust?
For the purposes of the U.S. tax system, trusts are taxed as non-grantor and grantor trusts. When a grantor of a trust retains ownership over the assets transferred, it is treated as a grantor trust under tax law. Its capital gains and income are taxed to the grantor like the assets were never transferred.
If the grantor gives up ownership of the assets transferred in the trust, then it’s taxed as a non-grantor trust similar to the way individuals are taxed. A foreign trust can be taxed as either a non-grantor or grantor trust.
Why Would Someone Be a Beneficiary or Owner of a Foreign Trust?
Many people who pay taxes in the United States moved here from another country or still have family in other countries. Because of this, they may own or be the beneficiaries of trusts that were created in other countries.
Worldwide, trust arrangements are actually very common because they allow for certain benefits such as asset protection, a way to carry on philanthropic or humanitarian investments, or to preserve property for future generations.
When Do Foreign Trusts Require U.S. Tax Reporting?
If the foreign trust has a U.S. beneficiary or owner, then U.S. tax reporting is mandatory. Distributions from, annual income and expenses, and transfers to foreign trusts all must be reported as appropriate, filed annually, and based on U.S. accounting principles.
Remember, U.S. citizens, as well as permanent residents, are taxed on their worldwide income, not simply income that is earned in the U.S. A foreign trust should never be used as a way to defer tax payments or avoid taxes altogether. If you are out of compliance with the accurate and timely filing of any information related to foreign trusts on your taxes, then you risk being audited by the IRS.
If you want to find out more about foreign trusts, contact Haimo Law today.
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