Foreign Grantor Trust Planning: A Flexible Planning Structure for U.S. Income Tax

Tax specialists help families with members in multiple countries set up special trusts to avoid certain U.S. taxes and keep tax advantages. This can be really useful for families where a parent is not from the U.S. and has kids and grandkids who are. The trust helps the family save money on taxes and deal with the complicated rules of taxes for people in different countries. The FGT strategy is most beneficial for families whose settlor lives outside the U.S. This is because during the settlor’s lifetime, any income or gains from the trust are attributed to the settlor and they are responsible for taxes on that income. If the settlor is a non-U.S. person, they may be exempt from certain U.S. income taxes on the trust’s non-U.S. source income, U.S.-source capital gains, and interest income. This means that neither the trust nor its beneficiaries may be subject to U.S. income tax when the trust sells certain assets, unless it generates taxable U.S. income. U.S. beneficiaries also would not be taxed on any distributions from the trust. So, the FGT strategy can help families living outside the U.S. save on taxes and preserve their wealth. Using a FGT during their lifetime instead of owning assets directly can help foreign individuals transfer their wealth to their U.S. beneficiaries without incurring U.S. gift or estate taxes. This means that the beneficiaries won’t have to deal with taxes when they pass the wealth down to their own heirs. It’s a way for the wealth creator to ensure a seamless transfer of wealth for future generations. This approach can be particularly helpful for families with nominee arrangements, such as owning a family business and passing on shares to their children. By using a FGT, the settlor can confirm the nominee arrangement and ensure that their children will inherit the shares when they pass away. A grantor trust is when the person who sets up the trust is considered the owner of the trust’s income and may have to pay taxes on it. This can happen if the person can receive money from the trust while they’re alive or if they can take the trust’s assets back for themselves. However, if the person didn’t give anything away for free to the trust, they won’t have to pay taxes on the trust’s money. If the trust is made from another trust, the person who set up the first trust might still have to pay taxes on the second trust’s money unless the person who set up the first trust has a lot of control over the second trust. If the person who set up the trust is married and lives in a place where they share their money with their spouse, they need to be careful with how the trust is set up so that their spouse doesn’t end up owning part of the trust when they die. Trusts are categorized as either domestic or foreign for U.S. tax purposes based on whether they pass certain tests. A domestic trust meets both the court and control tests, while a foreign trust fails to satisfy either one. To pass the court test, a court within the U.S. must have primary authority over the trust’s administration. Clients may have set up foreign structures before speaking to a U.S.-based advisor, and in most cases, it is possible to convert these structures into a U.S. trust without facing U.S. taxes, depending on how the offshore structure is set up and the laws of the relevant jurisdiction. The control test for classifying a trust as domestic or foreign means that one or more U.S. people must have the power to make important decisions for the trust. These decisions can include things like giving out money from the trust, choosing who gets the money, and deciding how to invest the trust’s assets. If there are accidental changes that affect the control test, there’s a year to fix them. It’s important to follow these rules carefully because even a trust with some connections to the U.S. can still be considered foreign. In some cases, it might be helpful to set up a trust as foreign while the person creating it is still alive. To do this, certain powers are given to someone from another country. But when the person creating the trust dies and there are beneficiaries from the U.S., these powers might need to be taken away from the foreign person. When setting up a family trust, you have to decide if the money will be given to the beneficiaries right away or if it will be held for future generations. There are different tax implications for U.S. beneficiaries, so it’s important to consider this when making your decision. Some people prefer to have the trust continue after they die so they can control how future generations benefit from the money. Advisors might suggest creating multiple sub-trusts within the family trust to benefit different people and hold different assets. This can be complicated, but it can also make things more efficient in the long run. After someone dies, their assets may be split into different trusts for different beneficiaries. This can help minimize taxes for people living in different countries. For example, if someone in the US inherits real estate, it should be in a trust that follows US tax laws. Similarly, assets in other countries should be in trusts following those countries’ tax laws. The laws and location of the trustee can also affect how much tax is paid. It’s important to talk to a lawyer in each relevant country to make the best decision. A Foreign Grantor Trust (FGT) can be set up to help future generations avoid U.S. estate tax and provide asset protection from creditors. It can also exempt from U.S. capital gains tax on certain U.S. assets. However, there are U.S. estate tax issues that need to be addressed, and the tax implications depend on the individual’s domicile. Non-resident aliens are subject to transfer taxes when they give away property located in the U.S. during their lifetime or after their death. This includes things like real estate, stocks in U.S. companies, and money owed by U.S. residents. However, there are some exceptions, like for giving away stock in a U.S. company as a gift during their lifetime. To avoid these taxes, a foreign grantor trust often holds onto U.S. assets, like real estate or stock in a U.S. company, in a way that prevents the IRS from taxing it when they die. The best way to do this depends on the type of U.S. asset and the laws in the person’s home country. For example, real estate might be held through a foreign company that owns a U.S. company, while stocks are often held directly through a foreign company. The Foreign Grantor Trust (FGT) can help non-U.S. citizens who own assets outside the U.S. avoid U.S. taxes on their non-U.S. income. For example, if a person owns a family business in their home country, they can gift it to a trust so that their children can benefit from it without paying U.S. taxes. It’s important to carefully plan the trust’s administration to avoid U.S. taxation on non-U.S. income. This may involve creating multiple trusts, with some being administered outside the U.S. for non-U.S. beneficiaries. Foreign Grantor Trust (FGT) planning can be very beneficial for U.S. beneficiaries. Since the trust is set up as a grantor trust, the person who created the trust still owns the assets for tax purposes. This means that U.S. beneficiaries can receive money from the trust without being taxed in the U.S. They may need to report these distributions, but they won’t have to pay taxes on them. This can be really helpful if the person who created the trust is not a U.S. citizen but wants U.S. people to benefit from the trust. The FGT can also be set up in a way that, when the person who created the trust dies, it becomes a U.S. trust for tax purposes, so the beneficiaries won’t be taxed when they receive money from the trust. This kind of trust is called a “transformer trust.” “Setting the board” means doing extra tax planning when someone who set up a trust is expected to pass away. For example, some non-U.S. trust creators own interests in non-U.S. companies that are treated as corporations for U.S. taxes. These companies can’t usually change their tax status, but some can if they’re not on a special list. Changing the tax status can save the people who will inherit the trust a lot of money. It’s usually best to do this when the trust is first set up. If it’s done right, it can save a lot of taxes after the trust creator dies. When someone sets up a trust and then dies, the way the trust is organized can affect how much tax the beneficiaries have to pay. If the trust has stock in a family company, the tax rules can be tricky. It’s important to reorganize the company’s structure when setting up the trust to make sure the beneficiaries don’t have to pay too much tax later on. If you inherit money from someone outside the U.S., you may need to report it on a special form for taxes. If the trust that gave you the money becomes a foreign trust after the person dies and you get money from it, you might have to pay taxes on the income. If the trust keeps the income, it has to pay taxes on it. But if it gives the income to you, you have to pay taxes on it. The trust also has to follow special rules when giving you money that it earned in past years. You might have to pay taxes at a lower rate on any investment profits you get from the trust. If a foreign trust pays out more money to beneficiaries than it earns in a year, it can have negative tax consequences for U.S. beneficiaries. To avoid this, it’s important to carefully plan the structure of the trust. For non-U.S. beneficiaries, it may be beneficial to keep the trust as a foreign trust after the person who set it up has passed away. In some cases, it may be best to split the trust into separate parts for U.S. and non-U.S. beneficiaries to minimize taxes. Overall, careful planning is needed to minimize taxes for all beneficiaries. In simple terms, a Foreign Grantor Trust (FGT) is a way for someone from another country to pass their wealth to their kids without paying a lot of taxes. It also helps them avoid paying taxes on certain types of income. This can be a good way to save money and make sure the next generation gets the most out of the inheritance. This text explains different tax regulations and rules related to international taxation and wealth planning. It also mentions the qualifications and accomplishments of Christopher R. Callahan, an expert in this field. He provides advice to wealthy clients and businesses, teaches taxation, and holds leadership positions in various tax-related organizations. Scott Snyder is a lawyer who helps rich people with their taxes and estate planning, especially if they have international assets. This column was written by the Tax Section.

Source: https://www.floridabar.org/the-florida-bar-journal/foreign-grantor-trust-planning-a-flexible-planning-structure-for-u-s-income-tax/