Pre-immigration planning and the foreign trust GARY FORSTER J.D., LL.M.
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or U.S. income tax purposes, foreign trusts are treated as non-residents/ non-citizens (NRNC), subject to U.S. income tax only on U.S. source income. An effective strategy for a foreign individual with family in the U.S. is to fund a foreign trust with offshore assets and U.S. intangibles. Funding the trust triggers no U.S. gift tax and the trust shelters all income earned on foreign assets and U.S. capital gains. The foreign trust may also allow for tax free distributions to the foreign grantor’s family in the U.S. Many offshore grantors intend to move to the U.S. to be close to loved ones. This article discusses how to move to the U.S. without sacrificing the income and transfer tax benefits of fund28
ing a foreign trust for U.S. beneficiaries.
INCOME TAX AND THE U.S. GRANTOR Internal Revenue Code (IRC) §679 (deemed grantor status) and §684 (deemed sales provisions) prevent U.S. grantors from sheltering foreign offshore income in foreign trusts (taxable as an NRNC). Section 684 taxes the gratuitous transfer of property by a U.S. person to a foreign trust (with no U.S. beneficiary). The transfer is treated as a deemed sale or exchange of the assets placed in trust. Section 684 triggers taxable gain (but not loss) on the excess of fair market value over tax basis. A deemed sale of assets contributed to a foreign trust is deferred during the grantor status of the foreign trust.
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Grantor trusts are disregarded for U.S. income tax purposes. Trust assets are therefore treated as owned by the grantor for tax purposes. The foreign trust may be taxed as grantor pursuant to either §676 (power to revoke) and §672(f) (based on retained control of trust assets by the grantor) or §679. Thus, the funding of a foreign trust by a U.S. citizen or permanent resident, for the benefit of any U.S. beneficiary (including the grantor) has no immediate U.S. income tax implications. Deemed grantor status of foreign trusts (under §679) funded by U.S. settlors (avoiding a §684 deemed sale) does not apply to foreign trusts with no U.S. beneficiary. If a U.S. beneficiary is added, deemed sale may be avoided. If a foreign
trust is amended to add a U.S. beneficiary, trust assets will be deemed recontributed upon the U.S. residency of the beneficiary. If a foreign trust ceases to have a U.S. beneficiary, the U.S. grantor is treated as having made a taxable transfer to the foreign trust. Capital gains tax is triggered on the first day of the first taxable year following the last taxable year the trust had a U.S. beneficiary. The gain triggered by a deemed sale of trust assets (under §684) includes appreciation since contribution to the trust.
DEATH OF U.S. GRANTOR During the life of the U.S. grantor, grantor trust assets generate taxable U.S. income, including income from foreign situs assets, to the U.S. grantor. A deemed