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U.S. TAX COMPLIANCE For Offshore Entities

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WealthFortress™ ASSET PROTECTION Los Angeles CA USA

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TAX COMPLIANCE AND REPORTING FOR OFFSHORE TRUSTS TABLE OF CONTENTS I. 

II. 

III. 

General Classifications of Offshore Trusts ......................................................................... 1  A.  In General................................................................................................................ 1  B.  Foreign Grantor Trust (Asset Protection Trust) ...................................................... 1  C.  Foreign Nongrantor Trust ....................................................................................... 1  1.  Foreign Non-Grantor Trust at Death of U.S. Settlor .................................. 1  2.  Can a U.S. Settlor Form a Foreign Non-Grantor Trust? ............................. 2  3.  Foreign Non-Grantor Trust Created by a Non-U.S. Person........................ 3  4.  Foreign Irrevocable Trust Created by a Non-U.S. Person .......................... 3  Foreign vs. Domestic Trusts ............................................................................................... 3  A.  In General................................................................................................................ 3  B.  Classification of a Trust as Domestic or Foreign.................................................... 3  1.  Court Test.................................................................................................... 4  2.  Control Test ................................................................................................ 4  C.  Domestication of Foreign Trusts ............................................................................ 5  D.  Questions under Court Test .................................................................................... 5  E.  Automatic Migration Provision .............................................................................. 5  F.  Jurisdiction of a U.S. Court..................................................................................... 5  G.  Mechanism to Remove Control by U.S. Persons .................................................... 6  H.  Reaction of Courts .................................................................................................. 6  I.  Respecting the Impossibility Defense ..................................................................... 6  J.  Attempts to Control Trusts by a Settlor–i.e., "Game Playing." .............................. 6  K.  Arguing That the Protection of the Trust is Destroyed ........................................... 7  L.  Including Controlling U.S. Persons as Defendants ................................................. 7  M.  Failed Domestication .............................................................................................. 7  N.  Conclusion .............................................................................................................. 8  Taxation of the Grantor of a Foreign Trust ......................................................................... 8  A.  Treating the Grantor as Owner ............................................................................... 8  1.  Reversionary Interests ................................................................................. 8  2.  Power to Control Beneficial Enjoyment ..................................................... 8  3.  Administrative Powers ................................................................................ 9  4.  Power to Revoke ......................................................................................... 9  5.  Income for Benefit of a Grantor.................................................................. 9  6.  Foreign Trust Having a U.S. Beneficiary ................................................... 9  7.  U.S. Transferor............................................................................................ 9  8.  U.S. Person.................................................................................................. 9 


IV. 

V. 

VI. 

9.  Property ....................................................................................................... 9  10.  Person Other Than Grantor Treated as Substantial Owner ......................... 9  B.  Grantor Defined ...................................................................................................... 9  1.  Gratuitous Transfer ..................................................................................... 9  2.  Nongratuitous Transfer ............................................................................. 10  C.  An Accommodation Party is not the Grantor Subject to Taxation ....................... 10  D.  Person with Power to Withdraw From Trust Settled by Another Person is Not a Grantor .................................................................................................................. 10  E.  Foreign Trust Having One or More U.S. Beneficiaries ........................................ 10  1.  The Foreign "Grantor" Trust ..................................................................... 10  2.  Direct or Indirect Transfer ........................................................................ 11  3.  Guarantee on a Loan for the Trust ............................................................ 11  4.  Satisfaction of an Obligation of a Foreign Trust ...................................... 11  5.  Transfer to an Entity Owned by the Trustee of the Foreign Trust ............ 11  6.  Domestic Trust Becoming a Foreign Trust ............................................... 11  7.  Definition of U.S. Beneficiary .................................................................. 11    Beneficiary Further Defined by Treas. Regs. ........................................... 12  9.  Attribution of Ownership from Controlled Foreign Corporations, Foreign Partnerships ............................................................................................... 12  Taxation of Foreign and Domestic Trusts ........................................................................ 12  A.  Simple Trust .......................................................................................................... 12  B.  Complex Trust ...................................................................................................... 13  C.  Income................................................................................................................... 13  D.  Accounting Income ............................................................................................... 13  Taxation of Foreign Non-Grantor Trusts .......................................................................... 13  A.  Distribution Deduction.......................................................................................... 13  B.  The Concept of Distributable Net Income ............................................................ 13  C.  Distributable Net Income of a Foreign Non-Grantor Trust .................................. 13  D.  Treatment of Capital Gains ................................................................................... 14  E.  Treatment of Beneficiaries With Respect to Distributable Net Income ............... 14  F.  Distributable Net Income of Complex Trust Exceeding Income Required to Be Distributed............................................................................................................. 14  Tax Return Compliance With Respect to a Foreign "Grantor" Trust. .............................. 14  A.  Events Requiring Filing ........................................................................................ 14  B.  Form 3520–Creating or Funding an Offshore Trust ............................................. 14  1.  Reportable Events ..................................................................................... 15  2.  Nonreportable Events–Nongratuitous Transfer ........................................ 15  3.  Responsible Party...................................................................................... 16  C.  Form 3520-A–Reporting by U.S. Owner for Trust Operations ............................ 16  1.  Information Statements to Owner and Beneficiaries ................................ 16  2.  More Than One Owner ............................................................................. 16  3.  Limited Agent for Service of Process ....................................................... 16  D.  Miscellaneous Tax Returns With Respect to Foreign "Grantor" Trust ................ 17  1.  SS-4 (Application for Federal Tax Identification Number) ...................... 17  2.  Form 56–Notice Concerning Fiduciary Relationship ............................... 17  3.  Form 709, U.S. Gift (and Generation-Skipping Transfer) Tax Return ..... 17 

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4.  5. 

II. 

III. 

IV. 

Form 1040, Schedule B, Part III ............................................................... 17  TD F 90-22.1–Report of Foreign Bank and Financial Accounts .............. 18  (d)  Financial Interest as Owner or Record of Legal Title................... 18  (e)  Financial Interest Through Nominee Entity or Trust .................... 18  (f)  Signature or Other Authority ........................................................ 18  6.  FinCEN Form 104 .................................................................................... 19  7.  FinCEN Form 105 .................................................................................... 19  8.  Withholding Forms ................................................................................... 19  Tax Return Compliance With Respect to a Foreign "Nongrantor" Trust ......................... 19  A.  Events Requiring Filing ........................................................................................ 19  B.  Form 3520–Creating or Funding a Foreign Nongrantor Trust ............................. 19  1.  Reportable Events ..................................................................................... 19  (a)  Creating Foreign Trust .................................................................. 19  (b)  Gratuitous Transfer ....................................................................... 19  2.  Responsible Party...................................................................................... 20  3.  Reporting Gain on Transfer of Appreciated Assets .................................. 20  C.  Miscellaneous Tax Returns With Respect to Foreign "Nongrantor" Trust .......... 20  1.  Form 56–Notice Concerning Fiduciary Relationship ............................... 20  2.  Form 709, U.S. Gift (and Generation-Skipping Transfer) Tax Return ..... 20  3.  Form 1040–Schedule B, Part III ............................................................... 20  4.  TD F 90-22.1–Report of Foreign Bank and Financial Accounts– Apparently Not Required .......................................................................... 20  Tax Consequences of Transferring Appreciated Property to a Foreign Trust .................. 21  A.  During Lifetime–Gain Not Recognized on Transfer to Foreign Grantor Trust .... 21  B.  During Lifetime–Gain Recognized on Transfers to Foreign Nongrantor Trust ... 21  C.  Tax Treatment at Death of the Grantor of a Foreign Grantor Trust ..................... 21  D.  Migration of a Domestic Trust to a Foreign Trust ................................................ 21  1.  Migration of Domestic Grantor Trust During Grantor's Lifetime ............ 21  2.  Migration of Domestic Grantor Trust Upon Death of Grantor ................. 22  E.  Avoiding Gain Recognition .................................................................................. 22  1.  Foreign Nongrantor Trust ......................................................................... 22  2.  Foreign Grantor Trust With Assets Excluded for Estate Tax Purposes.... 22  3.  Treating a Person Other Than Settlor as the Owner for Income Tax Purposes .................................................................................................... 22  4.  Use of Foreign Limited Partnerships or Foreign Limited Liability Companies................................................................................................. 23  F.  Inadvertent Migrations .......................................................................................... 23  G.  Filing Requirement for Migrations ....................................................................... 23  Reporting Requirements for U.S. Beneficiaries ............................................................... 23  A.  Attached Statements.............................................................................................. 23  B.  Distributions From a Foreign Grantor Trust ......................................................... 23  C.  Distributions from a Foreign Nongrantor Trust .................................................... 23  D.  Distribution Defined ............................................................................................. 24  1.  Loans ......................................................................................................... 24  2.  Exception to Treatment of Loan as a Distribution .................................... 24  3.  Distributions by Certain Foreign Trusts Through Nominees ................... 25 

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E.  F. 

V. 

General Rule–Foreign Person Not Treated as Owner........................................... 25  Special Rules for Treating a Foreign Person as Owner ........................................ 25  1.  Certain Revocable Trusts .......................................................................... 26  2.  Certain Trusts That May Distribute Only to Grantor or Grantor's Spouse 26  3.  Compensatory Trusts ................................................................................ 26  4.  Trusts Settled by Certain Foreign Corporations ....................................... 26  5.  An Accommodation Party is Not a Grantor .............................................. 27  6.  Foreign Person with Right to Withdraw–Not a Grantor ........................... 27  7.  Special Rule Where Grantor is Foreign Person ........................................ 27  8.  Recharacterization of Purported Gifts ...................................................... 27  G.  Consequences of Not Filing Foreign Nongrantor Trust Beneficiary Statement ... 28  H.  Foreign Trust Treated as Having a U.S. Beneficiary ............................................ 28  I.  Foreign Trust Acquiring a U.S. Beneficiary ......................................................... 29  U.S. Person Receiving Certain Gifts or Bequests From a Foreign Person ....................... 29  A.  Bequests From a Nonresident Alien or a Foreign Estate ...................................... 29  B.  Gifts From Foreign Corporations or Foreign Partnerships ................................... 29  C.  Foreign Donor Acting as Nominee or Intermediary ............................................. 29 

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TAX COMPLIANCE AND REPORTING FOR OFFSHORE TRUSTS The following material is substantially from Tax Compliance and Reporting for Offshore Trusts, ASSET PROTECTION STRATEGIES: PLANNING WITH DOMESTIC AND OFFSHORE ENTITIES, Chapter 17 (Real Property, Probate and Trust Law Section of the American Bar Association) (2002), J. Richard Duke (author), but has been updated due to changes in the law, final Treasury Regulations and updates to Internal Revenue Service forms and instructions. I.

General Classifications of Offshore Trusts

A. In General. U.S. persons who establish or are beneficiaries of foreign trusts are taxed according to the tax classification of the particular foreign trust.1 The legal classification and tax classification may not be the same. For example, a Liechtenstein or Panamanian foundation whose founder is a U.S. person will be recognized in accordance with the laws of Liechtenstein or Panama for legal purposes; however, the foreign foundation must be classified for U.S. tax purposes as either a foreign trust or a foreign corporation based on the language in the foundation documents.2 B. Foreign Grantor Trust (Asset Protection Trust). A foreign grantor trust, which is generally referred to as an asset protection trust, is one that is established and funded by direct or indirect transfers of property by a U.S. person or persons and which includes one or more U.S. beneficiaries. This trust is treated as a so-called grantor trust (a tax neutral trust) and all trust income, gains and losses are passed through to the grantor.3 The IRS defines a grantor trust as "any trust to the extent that the assets of the trust are treated as owned by a person other than the trust. See the grantor trust rules in sections 671 through 679. A part of the trust may be treated as a grantor trust to the extent that only a portion of the trust assets are owned by a person other than the trust."4 C. Foreign Nongrantor Trust. A foreign non-grantor trust is a trust in which the income of the trust is not taxed to the grantor, or to any other U.S. person such as a U.S. beneficiary.5 A foreign non-grantor trust is taxed as a nonresident alien individual and is subject to income tax as an individual. The Internal Revenue Service (hereinafter "IRS") defines a nongrantor trust as "any trust to the extent that the assets of the trust are not treated as owned by a person other than the trust."6 1. Foreign Non-Grantor Trust at Death of U.S. Settlor. Upon the death of a grantor of a foreign trust, the foreign trust ceases to be a grantor trust (since the grantor is deceased) and becomes a foreign non-grantor trust. However, if, after the settlor's death, the trust instrument grants powers, stated under the provisions of Internal Revenue Code (hereinafter "I.R.C.") §§ 672-678, to U.S. beneficiaries, such beneficiaries shall be treated as grantors of the foreign trust, for income tax purposes. The typical asset protection trust does not give such powers to U.S. beneficiaries. In addition, even if powers are not included in the trust causing any one or more U.S. beneficiaries to be treated as a grantor under I.R.C. § 672-678 and if one or more of the beneficiaries in fact control the trustee, such beneficiary or beneficiaries may be treated as grantors under one or more of the provisions of I.R.C. § 672-678.


2. Can a U.S. Settlor Form a Foreign Non-Grantor Trust? The issue is whether a foreign trust that specifically states that it can have no U.S. beneficiary in accordance with the provisions of I.R.C. § 679(b) until one taxable year after the deaths of the grantor and the grantor's spouse may be classified for tax purposes as a foreign non-grantor trust.7 (a) Position Apparently Contrary to IRS. The grantor trust provisions relate to taxation of a "grantor" for income tax purposes. The settlor of a trust, domestic or foreign, is taxed as the "grantor" under the provisions of I.R.C. §§ 671-678 and 679 (foreign trust with a U.S. beneficiary). (b) Definition of U.S. Beneficiary During Settlor's Lifetime. The definition of a U.S. beneficiary with respect to a foreign trust, including the cited legislative history, relates to a living "grantor." The focus here in this chapter is on a settlor who dies and the trust instrument specifically excludes U.S. persons as beneficiaries until one taxable year after the deaths of the settlor and the settlor's spouse. (c) Trust Becomes a Foreign Non-Grantor Trust at Settlor's Death. At the settlor's death, the trust becomes a foreign non-grantor trust (settlor is deceased). The trust has no grantor, both for legal purposes and tax purposes. Now the question is whether the trust has a U.S. beneficiary at the settlor's death. I.R.C. § 679(b) is entitled "Trusts Acquiring United States Beneficiaries" and provides: If–(1) subsection (a) [I.R.C. § 679(a)] applies to a trust for the transferor's taxable year, and (2) subsection (a) would have applied to the trust for his immediately preceding taxable year but for the fact that for such preceding taxable year there was no United States beneficiary for any portion of the trust, then … the transferor shall be treated as having income for the taxable year … equal to the undistributed net income (at the close of such immediately preceding taxable year) attributable to the portion of the trust referred to in subsection (a). (d) Apparent Meaning of I.R.C. § 679(b). This provision appears to state that if the foreign trust specifically provides that no U.S. person can become a beneficiary for one taxable year following the deceased transferor's death, income taxation under I.R.C. § 679(a) is not applicable. I.R.C. §§ 679(b) and 672(e)(1), for a married settlor, appear to provide the solution to avoiding classification of that trust as a grantor trust (to the grantor's estate) at the grantor's death. (e) Grantor Trust Provisions. I.R.C. §§ 671-679 are the "grantor" trust provisions and tax the grantor of (or transferor to) a trust. A settlor who sets up a foreign trust is subject to these provisions (primarily I.R.C. § 679) and is treated as the grantor. At the death of this settlor, however, the foreign trust becomes a foreign non-grantor trust. Although the provisions8 that determine whether a foreign trust has a U.S. beneficiary apply both before and after the death of the settlor, the foreign trust becomes a non-grantor trust at the death of the

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settlor. The window provided by I.R.C. §§ 679(b) and 672(e)(1) appears to foreclose the foreign trust from being treated as a "grantor" trust at the settlor's (and spouse's) death. (f) Planning for the Accumulation of Income Problem. If this contrary position is correct, one problem remains. Under I.R.C. § 679(c)(1)(A), no income can be "accumulated during the taxable year for the benefit of a United States person." To deal with this concern while both or either the settlor and the settlor's spouse are living, the trust assets can be invested in capital appreciation assets with low income and all of the income can be distributed to the non-U.S. beneficiary each year in which earned. Thus, no income is accumulated for later distribution to a U.S. beneficiary. The Instructions to Form 3520 address this planning. (g) IRS Omission. The IRS, in writing the Treas. Regs. under I.R.C. § 679, failed to refer to I.R.C. § 679(b). Based on conversation of this author with the IRS, it appears to be dangerous to rely upon the reasoning of the foregoing paragraphs (see "Position Apparently Contrary to IRS," supra).9 3. Foreign Non-Grantor Trust Created by a Non-U.S. Person. A foreign trust created by a non-U.S. person that includes no U.S. beneficiary is a foreign non-grantor trust and the U.S. has no tax authority or jurisdiction over such trust or beneficiaries unless the trustee of the trust invests in the U.S., which may subject certain types of passive income on those investments to withholdings and some trade or business income to withholdings.10 A foreign non-U.S. person may also create a foreign non-grantor trust that includes a U.S. beneficiary. 4. Foreign Irrevocable Trust Created by a Non-U.S. Person. An irrevocable trust, as opposed to a revocable trust, created by a non-U.S. person that includes one or more U.S. beneficiaries is classified for tax purposes as a foreign non-grantor trust.11 II.

Foreign vs. Domestic Trusts

A. In General. A trust formed by a U.S. person outside the U.S. is commonly referred to as an offshore trust, international trust, foreign grantor trust, or a foreign non-grantor trust.12 The I.R.C. uses the words, "foreign trust."13 The I.R.C., as amended by the Small Business Job Protection Act of 1996,14 provides two tests, as discussed below, to determine whether a trust is a domestic trust. If either of these tests is failed, the trust is a foreign trust. Unlike earlier law, the focus now is on the legal and fiduciary control over a trust, not on the source of trust income or the residency of the parties.15 B. Classification of a Trust as Domestic or Foreign. Effective for tax years beginning after December 31, 1996, I.R.C. § 7701(a)(30) classifies a trust for tax purposes as domestic if two tests are met.16 A trust is treated as a domestic trust if: (i) a court within the U.S. can exercise primary supervision over the administration of the trust, and (ii) one or more U.S. persons have the authority to control all substantial decisions of the trust.17 As stated, if either of the foregoing conditions is not satisfied, the trust is treated as a foreign trust.18 The House of Representatives indicates that the first test generally is satisfied if the trust instrument is governed by the laws of a state in the U.S.19 The second test is satisfied only if U.S. persons

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make all substantial decisions with no other person having the power to veto any substantial decisions.20 These two tests are referred to as the "court test" and the "control test." 1. Court Test. The court test is satisfied for a trust if (i) the trust instrument does not direct that the trust is to be administered outside the U.S.; (ii) the trust is in fact administered exclusively in the U.S.; and (iii) the trust is not subject to an automatic migration provision.21 A court within the U.S. does not have primary supervision over the administration of a trust if the trust instrument provides that an attempt by a U.S. court to assert jurisdiction or otherwise supervise the administration of the trust, directly or indirectly, causes the trust to migrate from the U.S. to a foreign jurisdiction (a "flee" clause).22 However, an automatic migration provision does not fail the court test if the trust instrument provides that the trust migrates from the U.S. only upon a foreign invasion of the U.S. or upon widespread confiscation or nationalization of property in the U.S.23 2. Control Test. The control test is met if U.S. persons have the authority to "control all substantial decisions" of the trust. (a) Substantial Decisions. Those decisions that persons are authorized or required to make under the terms of the trust instrument and applicable law that are not ministerial are deemed substantial decisions.24 Substantial decisions include, but are not limited to, the following:25 (i) whether and when to distribute income or corpus; (ii) the amount of any distributions; (iii) the selection of a beneficiary; (iv) whether a receipt is allocable to income or principal; (v) whether to terminate the trust; (vi) whether to compromise, arbitrate, or abandon claims of the trust; (vii) whether to sue on behalf of the trust or to defend suits against the trust; (viii) whether to remove, add, or replace a trustee; (ix) whether to appoint a successor trustee to succeed a trustee who had died, resigned, or otherwise ceased to act as a trustee, even if the power to make such a decision is not accompanied by an unrestricted power to remove a trustee, unless the power to make such a decision is limited such that it cannot be exercised in a manner that would change the trust's residency from foreign to domestic, or vice versa; and (x) investment decisions. However, if a U.S. person under I.R.C. ยง 7701(a)(30) hires an investment advisor for the trust, investment decisions made by the investment advisor will be considered substantial decisions controlled by the U.S. person if the U.S. person can terminate the investment advisor's power to make investment decisions at will. (b) Ministerial Decisions. Ministerial decisions include details such as bookkeeping, collection of rents and the execution of investment decisions.26 (c) Definition of Control. Control means having the power, by vote or otherwise, to make all substantial decisions of the trust with no other person having the power to veto any of the substantial decisions. Control is determined by looking at U.S. persons, not just U.S. fiduciaries, who have authority to make all substantial decisions of the trust.27 U.S. persons are not deemed to be in control of all substantial decisions if an attempt by any governmental agency or creditor to collect information from or assert a claim against the trust causes one or more substantial decisions of the trust to be no longer controlled by such U.S. persons.28

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C. Domestication of Foreign Trusts.1 A properly drafted foreign asset protection trust for a U.S. settlor provides for: (i) the governing law (trust law of a jurisdiction outside the U.S.) and (ii) the law governing the administration of the trust. The jurisdictions for the foregoing may be the same or different. In order to avoid filing requirements for a U.S. settlor of a foreign trust, such as Forms 3520 and 3520-A, some practitioners recommend that a U.S. settlor domesticate a foreign trust for U.S. income tax purposes. The domestication of a foreign trust is the attempt to avoid these trust filing requirements, yet maintain foreign status of the trust for legal purposes in the event that a claim is filed against a U.S. settlor. D. Questions under Court Test. A serious concern arises when domesticating a foreign trust under the court test because the Internal Revenue Code (hereinafter referred to as I.R.C.) does not refer to primary supervision over the administration of the trust with respect to "income tax matters" in the U.S. I.R.C. § 7701(a)(30)(E)(i) states that the term "United States Person" means "any trust if--a court within the United States is able to exercise primary supervision over the administration of the trust, and ... " The court test under the I.R.C. is not determined by supervision over the tax administration; it is determined by supervision over the administration of the trust. The House of Representatives indicates that the court test is generally satisfied if the trust instrument is governed by the laws of a state in the U.S.2 If a claim is filed in a Circuit Court where the settlor of a domesticated foreign trust is resident, it appears that the U.S. court has jurisdiction not only over the settlor but also the trust and the trust assets, as discussed below. The domesticated trust grants the U.S. court primary supervision over the administration of the trust. In addition, under the trust instrument of a domesticated foreign trust, U.S. persons have authority to control all substantial decisions of the trust, including, specifically, the powers to determine whether and when to distribute income or principal and the amount of any such distributions. The U.S. court can order these controlling U.S. persons to distribute income, and principal if permitted by the trust instrument, to the claimant in satisfaction of the claim. E. Automatic Migration Provision. If the trust instrument contains a provision that causes the trust to migrate from the U.S. to a foreign jurisdiction in the event a U.S. court attempts to assert jurisdiction, or to otherwise exercise primary supervision over the administration of the trust, directly or indirectly, the trust is not domesticated for U.S. income tax purposes.3 Thus, an automatic migration provision cannot be included in the trust instrument if domestication of a foreign trust is desired. F. Jurisdiction of a U.S. Court. Upon the filing of a court action against the settlor, a U.S. court can exercise its authority over the primary supervision of the administration of the trust. In addition, the U.S. court may order U.S. persons having authority to control all 1

See J. Richard Duke, Domestication of Foreign Trusts, 119 OFFSHORE INVESTMENT 44 (Sept. 2001).

2

The Small Business Job Protection Act of 1996, Pub. L. No. 104-188, Rep. No. 3348, 104th Cong., 2nd Sess. (1996) amending I.R.C. §§ 7701(a)(30) and 7701(a)(31). 3

Treas. Reg. § 301.7701-7(c)(4)(ii).

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substantial decisions with respect to the trust to distribute income and principal, if authorized by the trust instrument, to the settlor and other U.S. beneficiaries on behalf of a creditor. G. Mechanism to Remove Control by U.S. Persons. Apparently, most foreign trusts that are domesticated for U.S. tax purposes include mechanisms causing: (i) the U.S. court to lose primary supervision over the administration of the trust; and (ii) U.S. persons to lose the authority to control all substantial decisions of the trust. The mechanism for avoiding jurisdiction of a U.S. court may be through an amendment by the trust protector or a co-trustee that is foreign, that changes the U.S. court's primary supervision over the administration of the trust to foreign court supervision. The trust instrument may also authorize the trust protector or a co-trustee that is foreign to remove the authority of U.S. persons to control all substantial decisions of the trust. For example, the trust instrument may provide that the trust protector or foreign co-trustee may appoint successor foreign persons with the authority to control all substantial decisions of the trust. H. Reaction of Courts. Practitioners cannot expect a U.S. court to accept these mechanisms of stripping supervision by a U.S. court over the administration of the trust and the authority of U.S. persons to control all substantial decisions of the trust. U.S. courts will not accept the impossibility defense raised by the settlor because the settlor has created the impossibility through the above mechanisms. The exercise of these mechanisms will irritate U.S. courts. The argument that the trust was domesticated only for U.S. income tax purposes in order to avoid filing tax returns with respect to foreign trusts will fall on deaf ears in U.S. courts. A court action filed by a claimant against the settlor does not involve issues of taxation; it involves a legal liability claim or claims. A U.S. court has several options in ignoring the mechanism that created the selfimposed impossibility defense: (i) order the settlor to demand the trustee to repatriate the assets; (ii) order the U.S. persons with apparent stripped authority to control all substantial decisions of the trust to require distribution of income, and principal if permitted, on behalf of the settlor to the claimant; and (iii) treat the settlor as the principal and require him to demand that his agent (the trustee) repatriate the trust assets. A foreign trustee will ignore orders of a U.S. court. The result of this "game playing" by the U.S. settlor may be contempt of court and incarceration. I. Respecting the Impossibility Defense. The impossibility defense is respected where game playing is absent. Game playing is absent where: (i) the governing law of the trust and the law governing administration of the trust are both foreign to the U.S.; (ii) the settlor does not control the foreign trustee; (iii) the settlor gives up control of the trust assets at the inception and is not deemed thereafter to maintain control of the trust assets; and (iv) no mechanism exists to make changes or amendments to the trust upon the occurrence of an Event of Duress (threat or claim filed against the settlor). J. Attempts to Control Trusts by a Settlor–i.e., "Game Playing." Game playing is the attempt to control the trust and/or the trustee and include mechanisms in the trust instrument that cause loss of control by U.S. persons upon the occurrence of an Event of Duress. The attempt by a settlor to take advantage of the impossibility defense after attempting to retain

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control and then rely on some mechanism to cause loss of control will be met with harsh treatment by a U.S. court. A U.S. court can look through the niceties and find game playing where the facts show that the settlor was attempting to maintain control, and then all of the sudden give up the control when faced with litigation. A U.S. court, as shown by the language in the opinions in the Anderson4 and Lawrence5 cases, will not accept game playing with respect to foreign trusts. Clients who receive proper advice regarding the potential consequences of using game playing methods of maintaining control over a foreign trust–such as domesticating foreign trusts–must decide to either go offshore completely or implement domestic trusts under state laws. K. Arguing That the Protection of the Trust is Destroyed. During litigation, a plaintiff will strongly argue that a settlor who controls a foreign trust destroys the trust relationship and creates a principal-agency relationship. If the settlor is found to be the principal and the foreign trustee is found to be the agent, the U.S. court has jurisdiction over the principal and may order the principal to command that his agent follow the court's order. A further argument is that the date of the real transfer of assets to the trust, for legal purposes, including applicable fraudulent transfer or conveyance state laws, is the moment that the settlor loses real control--when the mechanisms are implemented. The inclusion of mechanisms on behalf of the settlor that serve to strip a U.S. court of its primary supervision over the administration of the trust and to strip a U.S. person from controlling all substantial decisions of the trust (including powers to distribute the income and principal to settlors and other U.S. beneficiaries), is suspect at best. It can be expected that a U.S. court will either ignore these mechanisms in which the settlor is attempting to maintain control over the foreign trust or find that the trust relationship began when these mechanisms, created in the trust instrument that the settlor signed, are removed as a result of the settlor being threatened with a law suite or having a law suit filed against him. L. Including Controlling U.S. Persons as Defendants. Due to the supervision granted to a U.S. court and the authority of control given to U.S. persons by the trust instrument for a domesticated foreign trust, a claimant against a settlor may also include the controlling U.S. persons as defendants in a court action. It can be expected that a U.S. court will make note of the fact that mechanisms in the deed are implemented simply because a court action has commenced. It can be further expected that a U.S. court will ignore these mechanisms stripping U.S. persons of their control and will permit claims to be filed against such controlling U.S. persons, especially one who is a trustee or co-trustee. M. Failed Domestication. A foreign trust that contains language that provides a U.S. court with primary supervision over tax matters and U.S. persons with control over all substantial decisions relating to tax matters does not domesticate a foreign trust for income tax purposes. 4

FTC v. Affordable Media, LLC, 179 F.3d 1228 (9th Cir. 1999).

5

In re Stephan Jay Lawrence, 251 B.R. 630, Lexis 14790 (S.D. Fla. Bkrpt. 2000), vacated and remanded by 244 B.R. 868, 2000 U.S. Lexis 1616 (S.D. Fla. 2000), aff'd by sub nom. Lawrence v. Goldberg, 279 F.3d 1294 (11th Cir. 2002).

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The following language, if included in a foreign trust, fails to meet the requirements for the domestication of a foreign trust for U.S. income tax purposes: THIS DEED OF DOMESTICATION IS made as of the inception date of the trust by and among the trustees and the settlor/s of the captioned trust, a trust created under the laws of the Isle of Man, and the undersigned. WHEREAS, the parties wish to insure that a court within the United States is able to exercise primary supervision over the administration of the Trust with respect to income tax matters in the USA; and to qualify the trust as a domestic trust for US tax purposes. N. Conclusion. Professional advisors must fully explain the adverse legal consequences of settlors attempting to maintain "control" over foreign trusts, foreign trustees or the trust assets. Attempting to maintain "control," yet provide some mechanism to cause loss of that "control" when an Event of Duress occurs, is playing games with the law. Professionals cannot expect a U.S. court to accept game playing by a U.S. settlor. III.

Taxation of the Grantor of a Foreign Trust

A. Treating the Grantor as Owner. Where the settlor or another person, such as a beneficiary, is classified as the "grantor" of a trust, that grantor is treated as the owner of the assets of the trust and the income from the trust assets is taxed to the grantor or another person who is treated as the owner of the trust assets.29 The grantor or another person is treated as the owner for income tax purposes if certain interests, controls or powers are retained over the trust.30 Treating the settlor as the owner of a trust, for tax purposes, causes confusion and misunderstanding because a trust is a relationship, not an entity. Upon formation of an entity, the owner or owners transfer assets in exchange for ownership interests, such as stock certificates, partnership interests or membership interests. When a trust is created (or settled), the result is a relationship between the settlor of the trust, the trustee and the beneficiaries. Upon creation of the trust, the settlor receives no evidence of ownership because the trustee is the legal owner of the trust assets and holds the trust assets as a fiduciary, in a fiduciary capacity, for the benefit of the beneficiaries, pursuant to the trust relationship. The following is a brief discussion of the powers that may be retained by the settlor or another person that causes the tax classification of that trust as a grantor trust, causing the grantor to be treated as the owner of the trust assets and taxed on all income, gains and losses. 1. Reversionary Interests. The grantor is treated as the owner of any portion of a trust in which he has a reversionary interest in either the corpus or income thereof if, at the inception, that portion of the trust exceeds five percent in value.31 2. Power to Control Beneficial Enjoyment. The grantor is treated as the owner of any portion of a trust in which the beneficial enjoyment of the corpus or the income is subject to a power of disposition, exercisable by the grantor or a non-adverse party, or both, without the approval or consent of an adverse party.32 The definitions of non-adverse party and adverse party are provided under I.R.C. ยง 672.

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3. Administrative Powers. The grantor is treated as the owner of any portion of a trust in which he has the power to deal for less than adequate and full consideration, the right to borrow without interest or security and certain other powers retained over the trust.33 4. Power to Revoke. The grantor is treated as the owner of any portion of a trust for any time that the power to revest title to the grantor in such portion is retained by the grantor, and is exercisable by the grantor or a non-adverse party, or both.34 Such a trust is generally referred to as a revocable trust. 5. Income for Benefit of a Grantor. The grantor is treated as the owner of any portion of a trust whose income, without the approval or consent of any adverse party or in the discretion of the grantor or adverse party, may be distributed to the grantor or the grantor's spouse, held or accumulated for future distribution to the grantor or grantor's spouse, or applied to the payment of premiums on policies of insurance on the life of the grantor or the grantor's spouse.35 6. Foreign Trust Having a U.S. Beneficiary. Special rules apply to foreign trusts established or funded by a U.S. person with a U.S. beneficiary. See "Foreign Trust Having One or More U.S. Beneficiaries," supra. 7. U.S. Transferor. A U.S. transferor means any U.S. person who directly, indirectly or constructively transfers property to a foreign trust.36 For purposes of I.R.C. § 679, "transferor" and "grantor" are the same.37 8. U.S. Person. The definition of a U.S. person is determined under I.R.C. § 7701(a)(30) and includes individuals and entities, as well as individuals who elect, under I.R.C. § 6013(g) to be treated as a U.S. resident and an individual who is a dual resident taxpayer within the meaning of Treasury Regulation (hereinafter "Treas. Reg.") § 301.7701(b)-7(a).38 9.

Property. The term "property" means any asset or assets, including

39

cash.

10. Person Other Than Grantor Treated as Substantial Owner. A person, other than the grantor, shall be treated as the owner of any portion of a trust in which such person has a power exercisable solely by himself to vest the corpus or income in himself, or such person has previously partially released or otherwise modified such a power, and after such release or modification, retained such control that subjects him to grantor trust treatment under I.R.C. §§ 671-677.40 B. Grantor Defined. A grantor is a person to the extent such person either creates a trust, or directly or indirectly makes a gratuitous transfer of property to a trust.41 In the event a person creates or funds a trust on behalf of another person, both persons are treated as grantors of the trust.42 1. Gratuitous Transfer. A gratuitous transfer is any transfer other than a transfer for fair market value.43 A transfer of property to a trust may be considered a gratuitous

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transfer whether or not the transfer is a gift for gift tax purposes.44 A transfer is for fair market value only to the extent of the value of the property received, services rendered, or the right to use property of the trust.45 2. Nongratuitous Transfer. A person who makes a nongratuitous transfer to a trust he settled is not treated as the owner of any portion of the trust under I.R.C. §§ 671-677 or 679.46 A nongratuitous transfer to a foreign trust by a U.S. person must be reported on form 3520.47 A gratuitous transfer to a trust does not include a distribution to a trust with respect to an interest held by such trust in certain described trusts48 or an entity (such as a distribution to a trust by a corporation with respect to stock in a transaction described under I.R.C. § 301).49 If a trust makes a gratuitous transfer to another trust, the grantor of the transferor trust is treated as the grantor of the transferee trust.50 However, if the transferor trust grants a general power of appointment to another person, who in fact exercises the power in favor of another trust, the power holder is treated as the grantor of the transferee trust.51 C. An Accommodation Party is not the Grantor Subject to Taxation. If one person creates or funds a trust for another person, both persons are treated as grantors of the trust and are subject to the reporting requirements of I.R.C. § 6048. However, a person who creates a trust but makes no gratuitous transfer to the trust is not treated as the owner of any portion of the trust under I.R.C. §§ 671-677 or 679.52 In addition, a person who funds a trust with an amount that is directly repaid to such person within a reasonable period of time, and who makes no other transfers to the trust that constitute gratuitous transfers, is not treated as owner of any portion of a trust for income tax purposes under I.R.C. §§ 671-677 or 679.53 For example, if an attorney creates a trust and nominally funds the trust for the benefit of his client and client's children with the trust naming the attorney as grantor, followed by the client reimbursing the attorney, the client is treated as the owner; however, both the client and the attorney are subject to the tax reporting requirements of I.R.C. § 6048.54 In this example, the attorney is a grantor, but he is not treated as an owner because he makes no gratuitous transfer to the trust.55 D. Person with Power to Withdraw From Trust Settled by Another Person is Not a Grantor. If a person creates a trust and retains no powers causing income taxation to him, and the trust grants an unrestricted power to withdraw to another person, that other person is not treated as owner of the portion of the trust that is subject to the withdrawal power because that other person neither settled the trust nor made a gratuitous transfer to the trust.56 E. Foreign Trust Having One or More U.S. Beneficiaries. A U.S. person who directly or indirectly transfers property to a foreign trust is treated as the owner of the portion of such trust attributable to such property if, during the taxable year, there is a U.S. beneficiary of any portion of such trust.57 Under the general grantor trust rules of I.R.C. §§ 671-678, the word "grantor" is used. However, under I.R.C. § 679, the word "transferor" is used. 1. The Foreign "Grantor" Trust.58 Special rules render a foreign trust a "grantor trust" for U.S. tax purposes. Under these rules, a U.S. person is treated as the owner of a trust or the portion thereof, if (1) the U.S. person transfers, directly or indirectly, property to a foreign trust and (2) there is a U.S. beneficiary for such year for any portion of the trust.59 U.S. person is treated as owner of the trust to the extent property is transferred by him to the trust. If

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the trust has a U.S. beneficiary, the transferor is taxed not only on income of the trust during the year, but income for all previous years since the trust was created.60 Under regulations, the grantor trust rules of ยง 679 supersede other rules, so that if another person is treated as being the owner of the trust under ยง 678, the U.S. transferor will nonetheless be treated as the owner under ยง 679.61 2. Direct or Indirect Transfer. Any direct or indirect transfer is taken into account in determining whether there is a transfer to a foreign trust, as illustrated by the following rules: Transfers from a grantor trust are treated as a transfer from the U.S. grantor.62 A transfer by an intermediary to whom a U.S. person transferred property is treated as an indirect transfer by the U.S. person if one of the principal purposes of the transfer (or the plan of which the transfer is part) is the avoidance of U.S. tax. In most circumstances, the principal purpose will be deemed to be the avoidance of U.S. tax.63 Where applicable, the intermediary will be treated as the agent of the U.S. transferor, who will instead be treated as having made the transfer to the trust.64 3. Guarantee on a Loan for the Trust. If a U.S. person (that is, a related 65 person to the trust) guarantees a loan made to a foreign trust by a third party, the U.S. guarantor is treated as having made a transfer to the trust in the amount of the loan.66 4. Satisfaction of an Obligation of a Foreign Trust. Any assumption or satisfaction of an obligation of a foreign trust (to a third party) by a U.S. person is treated as a constructive transfer by the U.S. person to the foreign trust in the amount of that obligation.67 5. Transfer to an Entity Owned by the Trustee of the Foreign Trust. A transfer by a U.S. person (that is, a related person to the trust)68 to an entity owned by the foreign trust is treated as a transfer to the foreign trust followed by a transfer to the entity by the foreign trust.69 6. Domestic Trust Becoming a Foreign Trust. A domestic trust that becomes a foreign trust can also be subject to the rules of I.R.C. ยง 679 at the date the trust becomes a foreign trust. The amount deemed transferred includes undistributed net income.70 7. Definition of U.S. Beneficiary. A U.S. beneficiary includes a "U.S. person," defined as a U.S. citizen or U.S. resident, a domestic partnership, a domestic corporation, or any estate or trust other than a foreign estate or foreign trust.71 The definition of a U.S. beneficiary is extremely broad and includes a U.S. person who has a future economic interest.72 Further, the trust will have a U.S. beneficiary even if there is merely the possibility that the trust instrument may be amended to include a U.S. beneficiary in the future.73 Thus, the law governing the trust must not allow the trust to be amended to add a U.S. beneficiary in contravention of the trust instrument.74 These rules, which are reflected in the legislative history,

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are consistent with the statute, which provides that a trust will be treated as having a U.S. beneficiary unless both of the following conditions are met: 1. No part of "the income or corpus of the trust may be paid or accumulated during the taxable year to or for the benefit of a U.S. person"; and 2. If the trust were terminated at any time during the tax year, no part of the income or principal of the trust could be paid to or for the benefit of a U.S. person.75 8. Beneficiary Further Defined by Treas. Regs.76 The regulations take the same position. Further, the conduct of the parties related to the trust is also taken into account in determining whether the trust has a U.S. beneficiary.77 However, a person who is not named and is not within a defined class of beneficiaries is not taken into consideration in determining whether a trust has a U.S. beneficiary, if it is proved to the Service that that person's interest is so remote as to be negligible.78 The regulations provide some guidance for what constitutes a remote interest for this purpose.79 A trust will also be treated as having a U.S. beneficiary if the trustee has the discretion to select a U.S. person as beneficiary. The regulations give as an example discretion of a trustee to benefit any person who studies ancient Greece. Since "any person" includes a U.S. person, a U.S. person could benefit under this standard. Consequently, the trust is treated as having a U.S. beneficiary.80 This example also states that the remote interest exception does not apply to the trustee's discretion. Another example concludes that the power to change the beneficiary to a U.S. person will result in the trust being treated as having a U.S. beneficiary.81 A non–U.S. person can become a U.S. person, and thereby cause the trust to be treated as having a U.S. beneficiary, but this rule applies only in the tax year in which the person actually becomes a U.S. person. This rule does not apply, however, if the beneficiary becomes a U.S person more than five years after the date of transfer to the foreign trust by the U.S. transferor.82 If the trust gains a U.S. beneficiary, the U.S. transferor will have additional income equal to the trust's undistributed net income from the preceding year.83 Conversely, if the trust no longer has a U.S. beneficiary, the U.S. transferor ceases to be treated as the owner, unless he is so treated pursuant to the other grantor trust rules.84 If the trust is no longer treated as a grantor trust, a deemed taxable sale or exchange can occur pursuant to I.R.C. § 684.85 9. Attribution of Ownership from Controlled Foreign Corporations, Foreign Partnerships. To determine whether the trust has a U.S. beneficiary, there is attribution of ownership from controlled foreign corporations, foreign partnerships that have U.S. partners, and foreign trusts or foreign estates that have a U.S. beneficiary.86 Further, the beneficiary is not treated as a U.S. beneficiary if he becomes a U.S. person more that five years after the date of the transfer of property.87 IV. Taxation of Foreign and Domestic Trusts. Taxation of Trusts. Foreign and domestic trusts are classified, for income tax purposes, either as simple or complex.88 A. Simple Trust. A simple trust is a trust that is required to distribute all income currently, does not provide for charitable contributions, and makes no distributions other than current income (makes no distribution of principal in the year of characterization).89 All income

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of a foreign non-grantor trust that is classified as a simple trust is taxed to the beneficiaries and the trust receives a deduction from its current income that must be distributed, whether or not the income is actually distributed.90 The amount included in the beneficiaries' gross income and the amount of the deduction by the trust are each limited by the distributable net income of the trust.91 B.

Complex Trust. A complex trust is a trust that is not classified as a simple trust.92

C. Income. Income, as it relates to simple and complex trusts, generally refers to accounting income, not taxable income.93 D. Accounting Income. Trust accounting income is generally the amount required or permitted to be distributed to current trust beneficiaries where the trust instrument requires or permits trust income, but not principal, to be distributed to such beneficiaries.94 Accounting income is income that is defined under the terms of the trust instrument or the applicable local law.95 A simple trust may have accumulated taxable income, even though required to distribute all accounting income currently. V. Taxation of Foreign Non-Grantor Trusts. A foreign non-grantor trust has no grantor for income tax purposes.96 Distributions of accumulated income from foreign non-grantor trusts to U.S. beneficiaries are subject to the complicated throwback rules. U.S. beneficiaries of a foreign non-grantor trust are subject to complex rules and reporting requirements, along with high taxation, if all net income of the trust is not distributed each year to the beneficiaries. A. Distribution Deduction. The deduction for a simple trust is allowed only for accounting income required to be distributed currently.97 The deduction for a complex trust is allowed for currently distributable accounting income in addition to other amounts properly paid, credited or required to be distributed.98 A distribution deduction reduces the taxable income of the trust.99 The distribution deduction for both simple and complex trusts is limited by the distributable net income of the trust.100 The computation of distributable net income relates to foreign and domestic trusts. B. The Concept of Distributable Net Income. Distributable net income places a ceiling on the distribution deduction in determining the taxation of trusts.101 In addition, distributable net income limits the amount of tax to beneficiaries.102 In limiting the distribution deduction, distributable net income for a domestic trust is the taxable income of the trust without the: (i) distribution deduction;103 (ii) personal exemption;104 and (iii) undistributed capital gains and losses allocated to corpus.105 C. Distributable Net Income of a Foreign Non-Grantor Trust. The distributable net income of a foreign non-grantor trust begins with the worldwide taxable income of the trust, including both U.S. source and foreign source income.106 The distributable net income of a foreign trust (foreign grantor or foreign non-grantor) is computed the same as for a domestic trust, except that undistributed capital gains and losses are allocated to corpus for a foreign trust. This is because distributable net income of a foreign trust includes capital gains,107 foreign source income,108 income that is exempted by treaty,109 and extraordinary dividends or taxable

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stock dividends allocated to corpus in good faith for trusts distributing current income only.110 Capital gains are included in the distributable net income of a foreign non-grantor trust, irrespective of whether capital gains are allocated to income or to corpus under the trust instrument or the governing law and irrespective of whether currently distributed.111 The inclusion of capital gains, for example, in distributable net income of a foreign trust preserves the taxation to the beneficiaries of the trust. Thus, U.S. beneficiaries of a foreign trust (foreign grantor or foreign non-grantor) are taxed at such time as distributions are made.112 The U.S. beneficiaries are taxed, upon distribution, on those foreign trust gains from the sale or exchange of capital assets, foreign source income and income exempted from treaty, notwithstanding that the foreign non-grantor trust is generally not subject to income taxation. D. Treatment of Capital Gains. A domestic trust generally allocates capital gains to its corpus. Thus, the domestic trust pays the tax on the gains and later distributes those gains without taxation to the beneficiaries. Because the foreign trust allocates its capital gains to distributable net income, if the capital gains of the trust are not currently distributed, these gains become a part of the undistributed net income of the trust. Upon distribution, the gains lose their capital character and are taxed as ordinary income to the beneficiaries.113 E. Treatment of Beneficiaries With Respect to Distributable Net Income. If the amount of income distributions that must be made exceeds the distributable net income of a simple trust or complex trust, each beneficiary shares in the distributable net income of the simple trust or complex trust in the proportion that amount of income required to be distributed to each beneficiary bears to the amount of income required to be distributed to all beneficiaries.114 F. Distributable Net Income of Complex Trust Exceeding Income Required to Be Distributed. The distributable net income of a complex trust may exceed the amount of income required to be distributed to the beneficiaries. In such case, if other amounts of income are either required to be distributed or are properly distributed to a beneficiary, such beneficiary shares in the remaining distributable net income of the complex trust in the proportion that the amount of the distribution (or required distribution) of the complex trust to that particular beneficiary bears to the amount of all distributions (or required distributions) to all beneficiaries.115 VI.

Tax Return Compliance With Respect to a Foreign "Grantor" Trust.116

A. Events Requiring Filing. I.R.C. § 6048, and Notice 97-34117 set forth the reporting requirements for three events relating to a foreign grantor (asset protection) trust: (i) creating or funding a foreign grantor trust by a U.S. person; (ii) reporting by a U.S. grantor (under the grantor trust rules) as owner of a foreign grantor trust; and (iii) distributions to U.S. beneficiaries of a foreign grantor trust. B. Form 3520–Creating or Funding an Offshore Trust. A "responsible party" is required to provide written notice of a "reportable event."118 The "responsible party" is required to file Form 3520 with his or her federal income tax return. In addition, a copy must be sent to the Philadelphia Service Center, Philadelphia, PA 19255.119

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1.

Reportable Events. A "reportable event" includes any one of the

following: (a)

Creating Foreign Trust. The creation of any foreign trust by a

120

U.S. person;

(b) Gratuitous Transfer. A "gratuitous transfer" of money or property, directly or indirectly, to a foreign trust (including a transfer at death).121 In addition, a distribution from one trust to another trust that is a beneficiary of the first trust is a gratuitous transfer.122 Also, notwithstanding other guidance provided in Notice 97-34,123 a gratuitous transfer includes any direct or indirect transfer that is structured with a principal purpose of avoiding the application of I.R.C. §§ 679 or 6048.124 (c) Death of Grantor of Foreign Grantor Trust. The death of a U.S. resident or citizen who, at death, was treated as the owner of any portion of a foreign trust under the grantor trust rules (foreign grantor trust);125 or (d) Trust Assets Includable in Estate. The death of a grantor whose gross estate includes any portion of a foreign trust.126 2.

Nonreportable Events–Nongratuitous Transfer. Nonreportable events

include: (a) Fair Market Sale–Qualified Obligation. A transfer involving a fair market sale to a foreign trust is not considered a gratuitous transfer.127 Under the statute, the following transactions are not considered to be reportable events: (i) fair market value sales; (ii) certain transfers to deferred compensation trusts and charitable trust; and (iii) corporate or partnership distributions described in I.R.C. §§ 301, 302, 305, 355, 356, or 731.128 In determining whether a sale to a trust is a fair market value sale, the obligations of the trust are ignored, unless the Secretary makes available a safe harbor.129 The Secretary treats a "qualified obligation" as a safe harbor in satisfying the fair market value requirement for assets transferred to a foreign trust. A "Qualified Obligation" is one meeting the following requirements:130 (i) it is reduced in writing; (ii) the term of the obligation does not exceed 5 years (including options to renew and rollovers) and it is repaid within the 5-year term; (iii) all payments on the obligation are denominated in U.S. dollars; (iv) the yield to maturity of the obligation is not less than 100 percent of the applicable federal rate under I.R.C. § 1274(d) for the day on which the obligation is issued and not greater than 130 percent of the applicable federal rate; (v) the U.S. person agrees to extend the period for assessment of any income or transfer tax attributable to the transfer and any consequential income tax changes for each year that the obligation is outstanding, to a date not earlier than 3 years after the maturity date of the obligation, unless the maturity date of the obligation does not extend beyond the end of the U.S. person's tax year and is paid within such period (this is done on Part I, Schedule A, and Part III, as applicable); and (vi) the U.S. person reports the status of the obligation, including principal and interest payments, on Part I, Schedule C, and Part III, as applicable, for each year that the obligation is outstanding. Thus, even though the obligation is treated as transferred for fair market value, the

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reporting requirements are not avoided. Form 3520 requires reporting for the creation of the obligation as well as the status of the obligation for each year that the obligation is outstanding.131 (b) Corporate or Partnership Distributions. Corporate partnership distributions that are described in I.R.C. §§ 301, 302, 305, 355, 356 or 731.132

or

(c) Foreign Deferred Compensation or Charitable Trust. Transfers of property to a foreign deferred compensation trust or foreign charitable trust.133 3. Responsible Party. A "responsible party" includes the settlor of an inter vivos trust,134 a transferor (except by reason of death) of a foreign trust,135 and executor of a decedent's estate.136 C. Form 3520-A–Reporting by U.S. Owner for Trust Operations. A U.S. person who is treated as the owner of any portion of a foreign trust under the grantor trust rules of I.R.C. §§ 671-679 is responsible to ensure that the trust files an annual report (Form 3520-A) in order to provide: (i) a full and complete accounting of all the trust activities and operations for the tax year; (ii) the name of the U.S. agent for the trust; and (iii) other information as prescribed by the IRS.137 A complete Form 3520-A is filed with the IRS Center, Philadelphia, PA 19255, and is due on the 15th day of the third month after the end of the trust's tax year.138 An extension of time to file Form 3520-A (including the statements) may be granted upon proper filing of a Form 2758.139 1. Information Statements to Owner and Beneficiaries. In addition, the trust is required to transmit a Foreign Grantor Trust Beneficiary Statement to the owner, and a Foreign Grantor Trust Owner Statement to any beneficiary who receives a distribution (discussed below). Copies of the Foreign Grantor Trust Owner Statement and the Foreign Grantor Trust Beneficiary Statement must be furnished to the U.S. owners and U.S. beneficiaries by the 15th day of the third month after the end of the trust's tax year.140 2. More Than One Owner. Each U.S. person treated as an owner of a foreign trust under I.R.C. §§ 671-679 is responsible for ensuring that the trust provides information to U.S. persons who are treated as owners of any portion of the trust or who receive any distribution from the trust.141 3. Limited Agent for Service of Process. If a U.S. person is treated as the owner of any portion of a foreign trust, the IRS may determine the amount to be taken into account by a U.S. person under the grantor trust rules of I.R.C. §§ 671-679, unless a U.S. person is appointed as agent for service of process.142 A U.S. person must be authorized to act as a limited agent for the trust, with respect to any request by the IRS, to examine records or take testimony in any summons for those records or testimony in connection with the tax treatment of any items relating to the trust.143 The grantor of the trust may act as the limited agent.144 The appearance of persons or production of records by a U.S. person acting as the limited agent does not subject that person or record to legal process for any purpose other than determining the correct tax treatment of the amounts required to be taken into account by U.S. persons.

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Furthermore, a foreign trust that appoints such an agent is not considered to have an office or a permanent establishment in the U.S., or to be engaged in a U.S. trade or business solely because of the agent's activities.145 Evidence of the appointment of an agent must be attached to Form 3520-A. See Exhibit A, an approved form.146 D.

Miscellaneous Tax Returns With Respect to Foreign "Grantor" Trust.

1. SS-4 (Application for Federal Tax Identification Number). Form SS-4 is filed with the Philadelphia Service Center, Philadelphia, PA 19255, in order to obtain a federal tax identification number for the foreign trust. 2. Form 56–Notice Concerning Fiduciary Relationship. This form is filed when a fiduciary relationship is created. This form serves to place the IRS on notice of the correct address and identity of the trustees of the foreign trust. 3. Form 709, U.S. Gift (and Generation-Skipping Transfer) Tax Return. Treas. Reg. §§ 25.2511-2(b) and (j) require the grantor to file a Form 709, even where transfers are not completed gifts. Form 709 is filed with the IRS Center where the grantor's federal income tax return is filed and is due on April 15 following the year of any transfer. Treas. Reg. § 25.2511-2(j) states that if the donor takes the position that a power is of such a nature as to render a gift incomplete and, thus, not subject to the gift tax, the transaction "shall be disclosed in the return and evidence showing all relevant facts, including a copy of the instrument of transfer, should be submitted." Treas. Reg. § 25.2511-2(b) provides that "but, if upon a transfer of property (whether in trust or otherwise) the donor reserves any power over its disposition, the gift may be wholly incomplete … or partially incomplete … For example, if a donor transfers property to another in trust to pay the income to the donor or accumulate it in the discretion of the trustee, and the donor retains a testamentary power to appoint the remainder among his descendants, no portion of the transfer is a completed gift. On the other hand, if the donor had not retained the testamentary power of appointment, but instead provided that the remainder should go to X or his heirs, the entire gift would be a completed gift …" Where a foreign grantor (asset protection) trust includes the provision granting a testamentary (sometimes inter vivos) special power of appointment to change the disposition of assets after the death of the grantor, the gift is incomplete for gift tax purposes. 4. Form 1040, Schedule B, Part III. Form 1040, Schedule B, Part III, Line 7a, asks "did you have an interest in or a signature or other authority over a financial account in a foreign country, such as a bank account, securities account, or other financial account?" Line 7a of this Schedule must be answered in the affirmative for a foreign grantor trust. Line 7b of this Schedule then requires entering the name of the foreign country for where the foreign account, established by the trust, is located. Line 8 of this Schedule asks "did you receive a distribution from, or were you the grantor of, or transferor to, a foreign trust?" This also must be answered in the affirmative since the person who establishes the trust is both a grantor and a transferor to the trust. Line 8 then states, with respect to an affirmative answer, that "you may have to file Form 3520." Answering Lines 7 and 8 of this Schedule in the affirmative clearly requires the filing of Form TD F 90-22.1. Answering Line 8 in the affirmative also requires the filing of Form 3520.

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5. TD F 90-22.1–Report of Foreign Bank and Financial Accounts. This report is filed by each U.S. person who has a financial interest in, or signature authority or other authority over, any financial accounts, including bank, securities or other financial accounts, in a foreign country exceeding $10,000 in the aggregate at any time during a calendar year.147 A U.S. person means a citizen or resident of the U.S., a domestic partnership, a domestic corporation, or a domestic estate or trust.148 A "financial account" generally includes any bank, securities, securities derivatives or any financial instruments accounts. Such accounts generally also encompass any accounts in which the assets are held in a commingled fund, and the account owner holds an equity interest in the fund. The term also means any savings, demand, checking, deposit, time deposit, or any other account maintained with a financial institution or other person engaged in the business of a financial institution.149 An account in a foreign country includes all geographical areas located outside the U.S., Guam, Puerto Rico, and the Virgin Islands.150 A "financial interest" includes a financial interest in a bank, securities, or other financial account in a foreign country and means an interest described in either of the following two paragraphs: (d)

Financial Interest as Owner or Record of Legal Title.

(1) A U.S. person has a financial interest in each account for which such person is the owner of record or has legal title, whether the account is maintained for his or her own benefit or for the benefit of others including non-U.S. persons. If an account is maintained in the name of two persons jointly, or if several persons each own a partial interest in an account, each of those U.S. persons has a financial interest in that account. (e)

Financial Interest Through Nominee Entity or Trust.

(2) A U.S. person has a financial interest in each bank, securities, or other financial account in a foreign country for which the owner of record or holder of legal title is: (a) a person acting as an agent, nominee, attorney, or in some other capacity on behalf of the U.S. person; (b) a corporation in which the U.S. person owns directly or indirectly more than 50 percent of the total value of shares of stock; (c) a partnership in which the U.S. person owns an interest in more than 50 percent of the profits (distributive share of income); or (d) a trust in which the U.S. person either has a present beneficial interest in more than 50 percent of the assets or from which such person receives more than 50 percent of the current income.151 (f) Signature or Other Authority. Signature or other authority over an account means a person having signature authority over an account if such person can control the disposition of money or other property in it by delivery of a document containing his or her signature (or his or her signature and that of one or more other persons) to the bank or other person with whom the account is maintained. Other authority exists in a person who can exercise comparable power over an account by direct communication to the bank or other person with whom the account is maintained, either orally or by some other means.152 The TD F 90-22.1 is filed on or before June 30 for the previous calendar year and is mailed to: U.S. Department of the Treasury, P. O. Box 32621, Detroit, MI 48232-0621.

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6. FinCEN Form 104. This currency transaction report is filed for deposits, withdrawals, exchange of currencies or other payment or transfer of more than $10,000 per year. 7. FinCEN Form 105. This report is filed for international transportation of currency or monetary instruments. 8. Withholding Forms. New withholding Treasury Regulations went into effect January 1, 2001.153 These Treasury Regulations permit foreign institutions to become qualified intermediaries (referred to as "QIs").154 These withholding Treasury Regulations apply to U.S. source income of foreign persons and require U.S. persons who are treated as owners of or have beneficial interests in foreign trusts and entities. For example, if a foreign trust has U.S. source income, the settlor and any beneficiaries (who receive distributions) are required to file Form W-9 (Request for Taxpayer Identification Number and Certification) that is used to certify to certain payors that the individual, corporation, partnership or trust has a U.S. taxpayer identification number. A Form W-9 is required for a trust that is treated as either a "grantor" trust or a U.S. trust for U.S. tax purposes. In addition, other forms may be due, such as Form W8BEN (Certificate of Foreign Status of Beneficial Owner for United States Tax Withholding); W-8ECI (Certificate of Foreign Person's Claim for Exemption From Withholding on Income Effectively Connected with the Conduct of a Trade of Business in the United States); W-8EXP (Certificate of Foreign Government or Other Foreign Organization for United States Tax Withholding); or W-8IMY (Certificate of Foreign Intermediary, Foreign Partnership, or Certain U.S. Branches for United States Tax Withholding). II.

Tax Return Compliance With Respect to a Foreign "Nongrantor" Trust.

A. Events Requiring Filing. I.R.C. § 6048 includes reporting requirements for two events relating to a foreign non-grantor trust: (i) creating or funding the foreign non-grantor trust by a U.S. person; and (ii) distributions to U.S. beneficiaries from a foreign non-grantor trust. B. Form 3520–Creating or Funding a Foreign Nongrantor Trust. A "responsible party" is required to provide written notice of a "reportable event."155 The "responsible party" is required to file Form 3520 with his or her federal income tax return. In addition, a copy must be sent to the Philadelphia Service Center, Philadelphia, PA 19255.156 1.

Reportable Events. A "reportable event" includes any one of the

following: (a) 157

U.S. person;

Creating Foreign Trust. The creation of any foreign trust by a

or

(b) Gratuitous Transfer. A "gratuitous transfer" of money or property, directly or indirectly, to a foreign trust (including by reason of death).158 The transfer of assets by a U.S. person to a foreign grantor trust may or may not be a completed gift for gift tax purposes, as discussed below.159 The transfer of assets by a U.S. person to a foreign non-grantor trust is a completed gift for gift tax purposes. Form 3520, Part I, Line 7a, requires the foreign

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non-grantor trust or foreign person to be acknowledged as the owner of the transferred assets after the transfer.160 2. Responsible Party. A "responsible party" includes the settlor of a foreign non-grantor trust161 and a transferor (except by reason of death) to a foreign non-grantor trust.162 3. Reporting Gain on Transfer of Appreciated Assets. The transfer of appreciated assets by a U.S. person to a foreign non-grantor trust results in the recognition of gain for tax purposes.163 Instructions to Form 3520 make the following note: "With respect to any transfer by a U.S. person to a foreign non-grantor trust after August 4, 1997, the transfer is treated as a sale or exchange and the transferor must recognize as a gain the excess of the FMV [fair market value] of the transferred property over its adjusted basis. Although the gain is not reported on Form 3520, it is to be reported on the appropriate form or schedule of the transferor's income tax return. See Section 684." Presumably, this instruction also applies to the migration of a domestic trust to a foreign trust, unless the domestic trust is a grantor trust.164 C.

Miscellaneous Tax Returns With Respect to Foreign "Nongrantor" Trust.

1. Form 56–Notice Concerning Fiduciary Relationship. This form is filed when a fiduciary relationship is created. This form serves to place the IRS on notice of the correct address and identity of the foreign trust. 2. Form 709, U.S. Gift (and Generation-Skipping Transfer) Tax Return. When a U.S. person transfers assets to a foreign non-grantor trust, he retains no rights or powers that cause him to be classified as a grantor,165 and generally parts with dominion and control so there is a completed gift and the assets are generally excluded from his estate for estate tax purposes. The transfer of property to a foreign non-grantor trust requires a Form 709 to be filed with the IRS Center where the federal income tax return is filed and is due on April 15 following the year of any transfer. 3. Form 1040–Schedule B, Part III. The U.S. person who creates and funds a foreign non-grantor trust has no interest in, or signature or other authority over, the trust so the answer to Line 7a of this Schedule is in the negative. However, Line 8 asks "Were you the grantor of, or transferor to, a foreign trust … whether or not you have any beneficiary interest in it?" A U.S. person who creates a foreign non-grantor trust and makes transfers to it is a transferor and Line 8 of this Schedule must be answered in the affirmative. It is recommended that an explanation be written below Line 8 of this Schedule, or attached to this Schedule, stating "No U.S. person has any financial interest in the foreign trust or any foreign account established by the foreign trust. The person filing this Form 1040 settled a foreign non-grantor trust, made a transfer or transfers, as transferor, to the trust. The person filing this Form 1040 retained no beneficial interest in this trust, and the trust includes no U.S. beneficiaries who will receive any distributions (directly, indirectly or constructively)." 4. TD F 90-22.1–Report of Foreign Bank and Financial Accounts– Apparently Not Required. A foreign non-grantor trust is treated as the owner of assets, for income tax purposes, not the grantor, due to the grantor retaining no rights or powers that cause

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the grantor to be treated as the owner for income tax purposes.166 This Form apparently is not due since no "financial interest" or "signature authority" is retained by a U.S. person over any account established by the trustee of a foreign non-grantor trust.167 However, signature authority includes the ability to control the disposition of money or property in the foreign account by oral or written instructions to the signatory or titleholder in the account.168 It is recommended that a U.S. person who discusses asset management issues or investment management issues, including allocations of investments, with the asset manager or the trustee file a Form TD F 90-22.1 to avoid an argument with the IRS that the report is due and to avoid potential severe penalties. III.

Tax Consequences of Transferring Appreciated Property to a Foreign Trust.

A. During Lifetime–Gain Not Recognized on Transfer to Foreign Grantor Trust. Except as may be provided in Treasury Regulations, the transfer of appreciated property by a U.S. person, who is treated as the owner, for tax purposes, to a foreign grantor trust is not subject to any recognition of gain.169 B. During Lifetime–Gain Recognized on Transfers to Foreign Nongrantor Trust. The transfer of appreciated property by a U.S. person to a foreign nongrantor trust is treated as a sale or exchange and gain is recognized equal to the excess of the fair market value over the adjusted basis of the property transferred.170 Gain is recognized because the grantor of a foreign nongrantor trust is not treated as the owner for tax purposes.171 However, no loss is recognized on the transfer of property to a foreign trust and losses may not offset gains realized on the transfer of appreciated property to a foreign trust.172 C. Tax Treatment at Death of the Grantor of a Foreign Grantor Trust.173 Treasury Regulations under I.R.C. § 684 provide an exception from gain recognition for transfers by a U.S. person to a foreign trust at death if two conditions are met.174 First, the property transferred to the foreign trust must be included in the transferor's gross estate for federal estate tax purposes; and, second, the basis of the property in the hands of the foreign trust must be determined under I.R.C. § 1014(a). Both conditions are met for a typical asset protection (foreign grantor) trust. These conditions are also met for life insurance proceeds that are included in the insured's estate, whether passing to a designated beneficiary or to the trustee of a trust, due to the step-up in basis of the insurance policy to the fair market value (policy proceeds) under I.R.C. § 1014(a). These conditions are met where insurance proceeds pass to a trust that was revocable for tax purposes, at the insured's death,175 or where the insured retained any incidents of ownership over the policy.176 D. Migration of a Domestic Trust to a Foreign Trust. I.R.C. § 684(c) determines the tax consequences of a migration of a domestic trust that has appreciated assets, to a foreign trust. If a U.S. person transfer assets to a domestic trust that later becomes a foreign trust, the domestic trust is treated as having transferred (immediately before becoming a foreign trust)177 all of its assets to the foreign trust and is required to recognize immediate gain on the transfer178 under Treasury Regulation § 1.684-1(a). 1. Migration of Domestic Grantor Trust During Grantor's Lifetime. If a U.S. settlor forms a domestic U.S. trust with U.S. beneficiaries and the trust becomes a foreign

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trust with U.S. beneficiaries during the settlor's lifetime,179 no gain results from the transfer of appreciated property at migration180 because the foreign trust181 is a grantor trust.182 2. Migration of Domestic Grantor Trust Upon Death of Grantor. I.R.C. § 684(c) provides that if a domestic trust becomes a foreign trust, the domestic trust is treated (for purposes of determining whether gain is due under I.R.C. § 684(c)) as having transferred, immediately before becoming a foreign trust, its appreciated assets to a foreign trust. The meaning of "immediately before becoming a foreign trust" under I.R.C. § 684(c) is unclear. The Treasury Regulations dealing with outbound migration of domestic trusts183do not deal with migrations at death.184 This is confirmed by the Treasury Regulations under I.R.C. § 679.185 It appears, however, that no gain is recognized on a migration, at death, if the two conditions for avoiding gain under I.R.C. § 684(b) are met.186 E.

Avoiding Gain Recognition.

1. Foreign Nongrantor Trust. A U.S. person who transfers appreciated property to a foreign nongrantor trust is subject to immediate gain recognition because the settlor is not treated as the owner for income tax purpose.187 Property in a foreign nongrantor trust that is further appreciated at the death of the settlor is not subject to gain under I.R.C. § 684(a) because a foreign nongrantor trust has no grantor and, hence, no transfer (by a grantor at death) is made. Thus, offshore life insurance proceeds paid to a foreign nongrantor trust at the death of the insured are not subject to gain under I.R.C. § 684(a). However, this discussion assumes that a foreign trust is classified as a foreign nongrantor trust for U.S. tax purposes.188 2. Foreign Grantor Trust With Assets Excluded for Estate Tax Purposes. An offshore trust may be classified as a grantor trust for income tax purposes yet the trust assets may be excluded from the gross estate of the grantor for estate tax purposes. An example of such an offshore trust is one that includes a U.S. beneficiary but includes no powers under I.R.C. §§ 2036-38 that causes inclusion in the grantor's estate for estate tax purposes. If assets are appreciated at the death of a grantor of such a trust, gain is recognized under I.R.C. § 684(a) because the first condition for avoiding gain is not met.189 Thus, additional planning may be required for these trusts to avoid recognition of gain, at death, under I.R.C. § 684(a). This additional planning includes treating another person as owner for income tax purposes, as discussed immediately below.190 3. Treating a Person Other Than Settlor as the Owner for Income Tax Purposes. The surviving spouse or other person may be granted a withdrawal right under I.R.C. § 678 by the offshore trust so that another person is treated as owner for income tax purposes.191 However, a person holding a withdrawal right is subject to income taxation under I.R.C. § 678 and estate taxation under I.R.C. § 2041. This withdrawal right can be granted to the trustee of a domestic irrevocable trust, thereby avoiding income taxation to an individual and avoiding estate taxation to an individual. The granting of a withdrawal right under I.R.C. § 678 by the offshore trust causes the offshore trust to be owned by another person and gain is avoided at the death of the settlor of a foreign grantor trust whose assets are excluded from the settlor's estate for estate tax purposes.192

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4. Use of Foreign Limited Partnerships or Foreign Limited Liability Companies. To avoid issues under I.R.C. § 684 related to taxation of offshore life insurance proceeds passing at the settlor's death to the trustees of foreign trusts, foreign limited partnerships or foreign limited liability companies may be formed to be the owner and beneficiary (and possibly the applicant) of offshore life insurance policies.193 F. Inadvertent Migrations. A trust may avoid gain recognition in the event of an inadvertent migration by complying with certain procedures set forth under Treasury Regulation § 301.7701-7(d)(2).194 G. Filing Requirement for Migrations. A U.S. person who is treated as making a deemed transfer195 for a migration of a domestic trust to a foreign trust is required to report such transfer as of the date of the deemed transfer.196 IV. Reporting Requirements for U.S. Beneficiaries. A U.S. person receiving any distribution, directly or indirectly, from a foreign trust is required to disclose the following information: (i) the name of the trust;197 (ii) the aggregate amount of the distributions received during the tax year;198 and (iii) other information that the IRS prescribes (Form 3520).199 A. attached.200

Attached Statements. Form 3520-A requires one or more statements to be

B. Distributions From a Foreign Grantor Trust. Under the grantor trust rules, the owner of a foreign trust must ensure that a "Foreign Grantor Trust Beneficiary Statement" is furnished to each U.S. beneficiary who receives a distribution from the foreign trust during the tax year.201 A U.S. beneficiary who receives a distribution from a foreign grantor trust is required to complete Part III–Distributions to a U.S. Person From a Foreign Trust During the Current Tax Year, of Form 3520, including disclosing the amount and nature of any distribution, and whether a U.S. limited agent for service of process is appointed for the beneficiary. Also, a Foreign Grantor Trust Beneficiary Statement (Form 3520-A, page 4) must be attached. The Foreign Grantor Trust Beneficiary Statement must include six items:202 (i) the first and last day of the taxable year of the foreign trust to which the statement applies; (ii) an explanation of the facts necessary to establish that the foreign trust should be treated for U.S. tax purposes as owned by another person (the explanation is required to identify which I.R.C. section treats the trust as owned by another person); (iii) a statement identifying whether the owner of the trust is an individual, corporation, or partnership; (iv) a description of property (including cash) distributed or deemed distributed to the U.S. person during the taxable year, and the fair market value of the property distributed; (v) a statement that the trust will permit either the IRS or the U.S. beneficiary to inspect and copy the trust's permanent books of account, records, and such other documents that are necessary to establish that the trust should be treated for U.S. tax purposes as owned by another person (the statement is not necessary if the trust has appointed a U.S. agent); and (vi) a statement as to whether the foreign trust has appointed a U.S. agent. If the trust has a U.S. agent, the name, address, and taxpayer identification number of the agent must be included. C. Distributions from a Foreign Nongrantor Trust. A U.S. beneficiary who receives a distribution from a foreign non-grantor trust is also required to complete Form 3520,

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Part III–Distributions to a U.S. Person From a Foreign Trust During the Current Tax Year. In addition, a Foreign Non-grantor Trust Beneficiary Statement (no prescribed form) must include six items:203 (i) the first and last day of the taxable year of the foreign trust to which the statement applies; (ii) an explanation of the appropriate U.S. tax treatment of any distribution or deemed distribution for U.S. tax purposes, or sufficient information to enable the U.S. beneficiary to establish the appropriate treatment of any distribution or deemed distribution for U.S. tax purposes; (iii) a statement identifying whether the owner of the trust is a partnership or a foreign corporation; (iv) a statement that the trust will permit either the IRS or the U.S. beneficiary to inspect and copy the trust's permanent books of account, records, and such other documents that are necessary to establish that the trust should be treated for U.S. tax purposes as owned by another person (the statement is not necessary if the trust has appointed a U.S. agent); (v) a description of property (including cash) distributed or deemed distributed to the U.S. person during the taxable year, and the fair market value of the property distributed; and (vi) a statement as to whether the foreign trust has appointed a U.S. agent. If the trust has a U.S. agent, the name, address, and taxpayer identification number of the agent must be included. D. Distribution Defined. Except as provided by Treas. Regs., a distribution from a foreign trust includes any gratuitous transfer of money or other property from a trust, whether the trust is treated as owned by another person under the grantor trust rules, and without regard to whether the recipient is designated as a beneficiary by the terms of the trust. A distribution includes the receipt of trust corpus and the receipt of a gift or bequest described in I.R.C. § 663(a).204 A distribution also includes constructive transfers from a trust. For example, if charges made on a credit card are paid by a foreign trust or guaranteed or secured by the assets of a foreign trust, the amount charged will be treated as a distribution by the foreign trust. Similarly, if checks are written on the bank account of the foreign trust, the amount will be treated as a distribution. Also, if you receive a payment from a foreign trust in exchange for property transferred to the trust for services transferred to the trust, and the fair market value of the payment received exceeds the fair market value of the property transferred or services rendered, the excess will be treated as a distribution.205 1. Loans. Loans of cash or marketable securities from a related foreign trust to a U.S. person, whether direct or indirect, are treated as a distribution.206 The amount of a loan is its issue price.207 Related parties are determined under the provisions of I.R.C. §§ 267 or 707(b).208 I.R.C. § 267 broadly defines related parties, and for purposes of application here, I.R.C. § 267(c)(4) is applied as if the family of an individual includes his or her spouse. 2. Exception to Treatment of Loan as a Distribution. If a loan meets the requirements for a "qualified obligation,"209 such a loan is not treated as a distribution. The requirements are: (i) it is reduced in writing; (ii) the term does not exceed five years; (iii) all payments are denominated in U.S. dollars; (iv) the yield is between 100 percent of the applicable Federal rate under I.R.C. § 1274(d) and 130 percent of the applicable Federal rate for the day in which the obligation is issued; (v) the U.S. obligor extends the period for assessment of any income or transfer tax attributable to the loan and any consequential income tax changes for each year that the obligation is outstanding, to a date not earlier than three years after the maturity date of the obligation, unless the maturity date does not extend beyond the end of the U.S. person's taxable year and is paid within such period;210 and (vi) the U.S. obligor reports the status of the

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obligation, including principal and interest payments, on Form 3520 for each year that the obligation is outstanding.211 Thus, even though the obligation is treated as a loan instead of a distribution, the reporting requirements are not avoided. Form 3520 requires reporting for the creation of the obligation as well as the status of the obligation for each year that the obligation is outstanding.212 3. Distributions by Certain Foreign Trusts Through Nominees. Any amount paid to a U.S. person, whether the amount is derived directly or indirectly from a foreign trust, of which the payor (person or entity) is not the grantor, is treated as if paid by the foreign trust directly to the U.S. person.213 Thus, a payor, who is not the grantor of the foreign trust, is ignored for tax purposes if the payor distributes income, derived directly or indirectly from a foreign trust, to a U.S. person.214 The Treas. Regs. under I.R.C. § 643(h) treat any property (including cash)215 that is transferred to a U.S. person by an intermediary as transferred directly by the foreign trust to the U.S. person if the intermediary received the property from the foreign trust pursuant to a plan, one of the principal purposes of which is the avoidance of U.S. income tax.216 The Treas. Regs. under I.R.C. § 679 follow the regulations under I.R.C. § 643(h).217 The provisions of I.R.C. § 643(h) do not apply in three situations: (i) nongratuitous transfers from the foreign trust to the intermediary or the transfer from the intermediary to a U.S. person;218 (ii) the intermediary is the grantor of the portion of the trust from which the property that is transferred is derived;219 and (iii) if, during the taxable year of the U.S. person, the aggregate fair market value of all property transferred to such person from all foreign trusts, directly or indirectly, through one or more intermediaries, does not exceed $10,000.220 These provisions primarily apply to a grantor trust where the grantor is treated as the owner under I.R.C. § 679(a). E. General Rule–Foreign Person Not Treated as Owner. I.R.C. § 672(f), entitled "Subpart not to Result in Foreign Ownership," provides that the grantor trust rules under I.R.C. §§ 671-679 apply only to the extent that income, if any, that is currently taken into account (directly or through one or more entities) is reported by a citizen or resident of the U.S. or a domestic corporation.221 F. Special Rules for Treating a Foreign Person as Owner. A foreign person is not treated as the owner of a foreign trust for tax purposes,222 subject to three exceptions:223 (i) the foreign trust includes an absolute power to the foreign grantor to revest title of the trust assets in himself. This power may be exercised solely by the grantor without the approval or consent of any other person or with the consent of a related or subordinate party, subservient to the grantor (such a trust is revocable to the foreign grantor meaning that the foreign grantor may terminate the trust or leave the assets at his death to his desired beneficiaries); (ii) the foreign trust specifically states that distributions can only be made to the grantor or the grantor's spouse; or (iii) a trust making distributions that are taxable and reported by a U.S. person as compensation for services rendered. If the requirements of one of the three exceptions are not met, the I.R.C. finds some U.S. person or persons to tax or treats the trust as a foreign non-grantor trust subject to the accumulation distribution rules,224 and subjects distributions to an interest charge.225 These three exceptions to the general rule of not treating a foreign person as owner of a trust,226 are clarified by Treas. Regs. as follows:

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1. Certain Revocable Trusts. To the extent that a foreign grantor has the power to revest, absolutely in himself, title to any portion of a trust, which power is exercisable solely by the foreign grantor (or, in the event of the grantor's incapacity, by a guardian or other person with unrestricted power to exercise such power on the grantor's behalf) without the approval or consent of any other person, the foreign person is treated as owner for income tax purposes of such foreign trust.227 However, the foreign grantor is treated as having the power to revest for a taxable year only if such power exists for a total of one hundred eighty-three or more days during the taxable year of the trust. If the first or last taxable year of the trust (including the year of the foreign grantor's death) is less than one hundred eighty-three days, the grantor is treated as having a power to revest, causing him to be treated as the owner for income tax purposes, only if the grantor has such power for each day of the first or last taxable year.228 Certain revocable trusts in existence on September 1995 are grandfathered.229 2. Certain Trusts That May Distribute Only to Grantor or Grantor's Spouse. A foreign grantor may be treated as owner of a trust for income tax purposes if, at all times during the lifetime of the grantor, the income or principal of the trust are distributable only to the grantor or the grantor's spouse.230 Payment of amounts that are nongratuitous transfers231 are not amounts that are deemed to be distributable. In other words, if the foreign person did not fund the trust, he cannot be treated as a grantor. In addition, an accommodation party cannot be a grantor.232 A trust (or portion of a trust) that distributes amounts in discharge of the legal obligation of the grantor or the grantor's spouse does not cause the foreign grantor to fail to be treated as the owner for income tax purposes.233 A legal obligation is defined as one that is enforceable under the local law of the jurisdiction in which the grantor (or the spouse of the grantor) resides.234 An obligation to a person who is a related person235 (other than an individual who is legally separated from the grantor under a decree of divorce or of separate maintenance) is not a legal obligation, unless it is contracted bona fide and for adequate and full consideration in money and money's worth.236 However, amounts that are distributable from the trust (or a portion thereof) to support the following are considered a legal obligation: (i) an individual is treated as a dependent of the grantor or the grantor's spouse under I.R.C. §§ 152(a)(1)-(9), without regard to the requirement that over half of the individual's support be received from the grantor or the grantor's spouse, and the person is permanently and totally disabled within the meaning of I.R.C. § 22(e)(3) or is less than nineteen years old;237 and (ii) the fact that amounts may become distributable from a trust (or a portion of the trust) in discharge of a potential obligation under local law to support an individual (other than an individual who is a dependent or permanently and totally disabled under Treas. Reg. § 1.672(f)-3(b)(2)(ii)(B)(1)) is disregarded if such potential obligation is not reasonably expected to arise under the facts and circumstances.238 Certain I.R.C. § 677 trusts in existence on September 1995 are grandfathered.239 3. Compensatory Trusts. A foreign person can be treated as owner of certain compensatory trusts for income tax purposes.240 4. Trusts Settled by Certain Foreign Corporations. I.R.C. § 672(f)(3) provides that the rules of I.R.C. § 672(f)(1) do not apply to a controlled foreign corporation or a passive foreign investment company. The Treas. Regs. expand these rules to include foreign

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personal holding companies. These provisions prevent such corporations from forming foreign trusts in order to avoid U.S. tax, and provide that such entities are treated as a domestic corporation for purposes of applying the general rule of Treas. Reg. § 1.672(f)-1.241 5. An Accommodation Party is Not a Grantor. If a person creates or funds a trust for another, both persons are treated as grantors for income tax purposes.242 However, a person who creates a trust but makes no gratuitous transfer to the trust is not treated as the owner of any portion of the trust under I.R.C. §§ 671-677 or 679.243 In addition, a person who funds a trust with an amount that is directly repaid to such person within a reasonable period of time, and makes no other transfers to the trust that constitute gratuitous transfers, is not treated as owner of any portion of the trust for income tax purposes under I.R.C. §§ 671-677 or 679.244 6. Foreign Person with Right to Withdraw–Not a Grantor. A foreign person who is given an unrestricted power to withdraw any amount contributed to a foreign trust established and funded by a U.S. person is treated as an owner of the trust under I.R.C. § 678 due to the withdrawal power. However, the foreign person is not a grantor245 of the foreign trust since the foreign person neither settled the foreign trust nor made a gratuitous transfer to the trust.246 7. Special Rule Where Grantor is Foreign Person. If a foreign person would be treated as the owner of any portion of a trust under one of the three exceptions247 and such a trust has a U.S. beneficiary, such beneficiary is treated as the grantor of such portion to the extent the beneficiary makes transfers of property, directly or indirectly, (other than sales for full and adequate consideration) to such foreign person, to the extent the yearly value of the transfer is a taxable gift under I.R.C. § 2503(b).248 8. Recharacterization of Purported Gifts. A purported gift or bequest is defined as any transfer of property by a partnership or foreign corporation other than a transfer for fair market value (within the meaning of Treas. Reg. § 1.671-2(e)(2)(ii)) to a person who is not a partner in the partnership or a shareholder of the foreign corporation (or to a person who is a partner in the partnership or a shareholder of the foreign corporation, if the amount transferred is inconsistent with the partner's interest in the partnership or the shareholder's interest in the corporation).249 In the case of any transfer, directly or indirectly, from a partnership or foreign corporation that the transferor treats as a gift, the Secretary may recharacterize such transfer as the Secretary determines to be appropriate to prevent the avoidance of taxation to a U.S. person.250 Prior to this provision, the transfer of funds from a foreign corporation or foreign partnership to a U.S. donee was treated as a gift. Now, this receipt of corporate or partnership funds is treated as income to a U.S. donee251 unless it comes within one of the exceptions set forth under Treas. Reg. § 1.672(f)-4(b): (i) the U.S. donee establishes that a U.S. citizen or resident alien treated the purported gift for U.S. tax purposes as a distribution from the partnership or corporation and as a subsequent gift or bequest to the U.S. donee; or (ii) the nonresident alien who directly or indirectly holds an interest in the partnership or foreign corporation treats and reports the purported gift or bequest under the tax laws of the nonresident alien individual's country of residence as a distribution to such individual and a subsequent gift or bequest to a U.S. donee, and the U.S. donee complies with the reporting requirements of I.R.C. § 6039F, if applicable.252 In addition, the purported gift or bequest from a domestic partnership is not recharacterized as income if the U.S. donee can establish that all beneficial

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owners (within the meaning of Treas. Reg. § 1.1441-1(c)(6)) of the partnership are U.S. citizens, residents or domestic corporations.253 Also, a purported gift or bequest is not recharacterized to the extent that a U.S. corporate donee can establish that the purported gift or bequest is treated, for U.S. tax purposes, as a contribution to the capital under I.R.C. § 118.254 Also, certain charitable transfers and certain transfers from trusts to which a partnership or foreign corporation has made a gratuitous transfer will not be recharacterized as purported gifts.255 G. Consequences of Not Filing Foreign Nongrantor Trust Beneficiary Statement. Failure to attach a Foreign Non-grantor Trust Beneficiary Statement or to provide adequate records of the foreign trust, results in subjecting the distribution received by the U.S. beneficiary to the tax on accumulation distributions (throwback rules),256 which is an extremely complicated and confiscatory tax on accumulations, and also subjects distributions to an interest charge (imposed at the tax rate for underpayments of income tax) on accumulation distributions from the foreign trust.257 Partial avoidance of this severe treatment may be available if the U.S. beneficiary treats a portion of the distribution received as a distribution of current taxable income, based on the average distribution from the trust to the U.S. beneficiary over the three most recently elapsed taxable years.258 The excess over the average is treated as an accumulation distribution and is subject to the accumulated throwback tax and the interest charge, as stated above.259 This partial default treatment is not affected by the calculation of distributable net income of the trust.260 The method of calculation and the interest factors permitting the taxpayer to make the calculations required by these rules are included in Form 3520, Part III, Distributions to a U.S. Person From a Foreign Trust During the Current Tax Year, Schedule A–Default Calculation of Trust Distributions, Schedule B–Actual Calculation of Trust Distributions, and Schedule C–Calculation of Interest Charge. If the beneficiary receives a Foreign Non-grantor Trust Beneficiary Statement, he completes either Part III, Schedule A–Default Calculation of Trust Distributions (Lines 31-38) of Form 3520, or Part III, Schedule B–Actual Calculation of Trust Distributions (Lines 39-47); however, if the beneficiary does not receive a Foreign Nongrantor Trust Beneficiary Statement, he completes Part III, Schedule A–Default Calculation of Trust Distributions (Lines 31-38). Once Schedule A is completed by a U.S. beneficiary in any tax year, that beneficiary is required to continue to complete for all future years, whether or not that beneficiary can answer affirmatively to Line 30 of Form 3520 for all future years.261 The only exception to this requirement to report on Schedule A in future years is that Schedule B may be used in the year that a trust terminates, if Line 30 is answered affirmatively.262 H. Foreign Trust Treated as Having a U.S. Beneficiary. A foreign trust shall be treated as having a U.S. beneficiary for a taxable year unless: (i) under the terms of the trust, no part of the income or corpus may be paid or accumulated during the taxable year to or for the benefit of a U.S. person; and (ii) if the trust were terminated at any time during the taxable year, no part of the income or corpus can be paid to or for the benefit of a U.S. person.263 The Treas. Regs. under I.R.C. § 679 ignore the existence of I.R.C. § 679(b) by stating that a foreign trust states that it will not terminate until the year following the settlor's death, and only then make a distribution to a U.S. person, has a U.S. beneficiary because principal may be held for future distribution to a future U.S. beneficiary, causing the foreign trust to have a U.S. beneficiary.264 For purposes of determining whether a U.S. beneficiary exists, in accordance with the foregoing, attribution of ownership rules apply: (i) in the case of a foreign corporation, if it is a controlled foreign corporation as defined in I.R.C. § 957(a);265 (ii) in the case of a foreign partnership, a

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U.S. person is a partner of such partnership;266 or (iii) in the case of a foreign trust or estate, such trust or estate has a U.S. beneficiary (as defined by I.R.C. § 679(c)(1)(A) and (B)).267 If a foreign person transfers property to a foreign trust more than five years before becoming a U.S. person, such beneficiary is not classified as a U.S. beneficiary.268 I. Foreign Trust Acquiring a U.S. Beneficiary. If a transfer of foreign trust assets occurs in a year where there is a U.S. beneficiary and the trust, for the immediately preceding taxable year, would have been taxed as a grantor trust except there was no U.S. beneficiary, then the transferor shall be treated as having income for the taxable year equal to the undistributed net income at the close of the immediately preceding taxable year.269 The amount of the additional income is equal to the undistributed net income of the trust, as defined in I.R.C. § 665(a), at the end of the U.S. transferor's immediately preceding taxable year and is subject to the rules of I.R.C. § 658, providing for an interest charge on accumulation distributions from foreign trusts.270 V.

U.S. Person Receiving Certain Gifts or Bequests From a Foreign Person.

A. Bequests From a Nonresident Alien or a Foreign Estate. During each tax year, gifts or bequests totaling more than $100,000 are required to be reported by a U.S. recipient on Form 3520, Line 54. If the donors are related, columns (a) through (c) for each gift must be reported under Line 54.271 B. Gifts From Foreign Corporations or Foreign Partnerships. I.R.C. § 6039F requires the reporting by a U.S. person who receives foreign gifts from a foreign corporation or partnership that, in the aggregate, exceed $12,097 (as adjusted for the cost-of-living) that are treated as a gift or bequest.272 Purported gifts from a foreign corporation or a foreign partnership are reported on Line 55 of Form 3520. In addition to gifts from foreign corporations or foreign partnerships, gifts from any persons that are related to such foreign corporations or foreign partnerships must be reported.273 Gifts from foreign corporations or foreign partnerships are subject to recharacterization as income to the donee by the IRS under I.R.C. § 672(f)(4).274 C. Foreign Donor Acting as Nominee or Intermediary. If a foreign donor, in making any gift or bequest to a U.S. person as described at Line 54 and 55 of Form 3520, is acting as a nominee or intermediary for any other person, this information must be reported on Line 56 of Form 3520.275 If the ultimate donor, on whose behalf the reporting donor is acting, is a foreign corporation or foreign partnership, an explanation must be attached to Form 3520 that includes the following: the ultimate donor's name, address, identification (if any) and status as a corporation or partnership.276 If the ultimate donor is a trust, the amount received must be treated as a distribution from a foreign trust and the distribution must be reported on Part III– Distributions to a U.S. Person From a Foreign Trust During the Current Tax Year, beginning at Line 24 of Form 3520.277

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Exhibit A AUTHORIZATION OF AGENT

__________________ [name of foreign trust] hereby expressly authorizes _____________ [name of U.S. agent] to act as its agent solely for purposes of ยง 7602, ยง 7603, and ยง 7604 of the Internal Revenue Code with respect to any request to examine records or produce testimony related to the proper treatment of amounts required to be taken into account under the rules of ยง 6048(b)(1)(A) or to any summons for such records or testimony. I certify that I have the authority to execute this Authorization of Agent to act on behalf of the _______________________ [name of foreign trust].

__________________________________________ Signature of Trustee (or other authorized person)

__________________________________________ (Title)

__________________________________________ (Date)

_______________________________ Your Name (type or print)

_______________________________________ Identification Number (if any)

__________________________________________ Address

__________________________________________

________________________ [name of agent] accepts this appointment to act as agent for ___________________ [name of foreign trust] for the above purpose. I certify that I have the authority to execute this Authorization of Agent to act on behalf of ______________________ [name of foreign trust] and agree to accept service of process for the above purposes.

__________________________________________ Signature of Agent


__________________________________________ (Title)

__________________________________________ (Date)

_______________________________ Your Name (type or print)

_______________________________________ Identification Number (if any)

__________________________________________ Address

__________________________________________

1

See J. Richard Duke, U.S. Tax Treatment of Low-Tax Jurisdictions, in INTERNATIONAL TAXATION OF LOW-TAX TRANSACTIONS (Bureau of Nat’l Affairs 1996); Alan R. Eber, Creative Use of Foreign Entities for Asset Protection and Tax Planning, 1, 1, ASSET PROTECTION J., 12 (1999). 2

See J. Richard Duke, The Use of the Panamanian Foundation in Asset Protection Planning and Related Tax Issues, ASSET PROTECTION JOURNAL, vol. 1 no. 4, A Panel Publication, Aspen Publishers, Inc., (1999). 3

I.R.C. § 679(a).

4

Instructions for Forms 3520 and 3520-A, Definitions, 3 (2004) and 2 (2004), respectively.

5

I.R.C. §§ 673-678. If the trust instrument provides certain powers to a beneficiary, or the beneficiary in fact exercises certain powers stated in one or more of the foregoing I.R.C. provisions, the beneficiary may be treated as the "grantor" of the trust and may be taxed on all income, gains and losses of that trust. 6

Instructions for Forms 3520 and 3520-A, Definitions, at 3 (2004) and 2 (2004), respectively. Legally, a trust consists of pieces of paper that cannot own anything. The legal owner of the trust assets of a trust is the trustee. When a trust is created or settled, a relationship is created consisting of the settlor, the trustee who as the legal owner holds the trust assets in a fiduciary capacity for the benefit of the beneficiaries, and the beneficiaries who are the beneficial owners. 7

I.R.C. §§ 679(b) and 672(e)(1).

8

I.R.C. §§ 679(b) and (c).

9

See "Foreign Trusts Having One or More U.S. Beneficiaries," supra.

10

See Tax Rules Regarding Foreign Non-Grantor Trusts Formed by Non-U.S. Persons, supra.

11

I.R.C. § 672(f)(2)(A). See also "Special Rules for Treating a Foreign Person as Owner," "Certain Revocable Trusts," supra.

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12

See General Classifications of Offshore Trusts, supra.

13

I.R.C. §§ 7701(a)(30)(E) and 7701(a)(31)(B).

14

The Small Business Job Protection Act of 1996, Pub. L. No. 104-188, H.R. Rep. No. 3348, 104th Cong., 2nd Sess. (1996), amending I.R.C. §§ 7701(a)(30) and 7701(a)(31).

15

Treas. Reg. § 301.7701-7(a).

16

The Small Business Job Protection Act of 1996, Pub. L. No. 104-188, H.R. Rep. No. 3348, 104th Cong., 2nd Sess. (1996), amending I.R.C. §§ 7701(a)(30) and 7701(a)(31).

17

I.R.C. § 7701(a)(30)(E).

18

I.R.C. § 7701 (a)(31)(B).

19

The Small Business Job Protection Act of 1996, Pub. L. No. 104-188, Rep. No. 3348, 104th Cong., 2nd Sess. (1996), amending I.R.C. §§ 7701(a)(30) and 7701(a)(31).

20

Treas. Reg. § 301.7701-7(d)(1)(iii).

21

Treas. Reg. § 301.7701-7(c)(1).

22

Treas. Reg. § 301.7701-7(c)(4)(ii).

23

Treas. Reg. § 301.7701-7(c)(4)(ii).

24

Treas. Reg. § 301.7701-7(d)(1)(ii).

25

Treas. Reg. § 301.7701-7(d)(1)(iii).

26

Treas. Reg. § 301.7701-7(d)(1)(iii).

27

Treas. Reg. § 301.7701-7(d)(1)(iii).

28

Treas. Reg. § 301.7701-7(d)(3).

29

I.R.C. § 671.

30

I.R.C. §§ 673-678. Such powers cause the grantor to be treated as the owner of the assets of a trust for income tax purposes, whether the trust is domestic or foreign.

31

I.R.C. § 673(a).

32

I.R.C. § 674(a).

33

I.R.C. § 675.

34

I.R.C. § 676(a).

35

I.R.C. § 677(a).

36

Treas. Reg. § 1.679-1(c)(1).

37

Treas. Reg. § 1.671-2(e)(1). In defining a grantor who makes a gratuitous transfer, the definition includes a

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grantor making transfers to a foreign trust under I.R.C. § 679, which uses the word "transferor." 38

Treas. Reg. § 1.679-1(c)(2).

39

Treas. Reg. § 1.679-1(c)(4).

40

I.R.C. § 678(a).

41

Treas. Reg. § 1.671-2(e)(1).

42

Treas. Reg. § 1.671-2(e)(1).

43

Treas. Reg. § 1.671-2(e)(2)(i).

44

Treas. Reg. § 1.671-2(e)(2)(i).

45

Treas. Reg. § 1.671-2(e)(2)(ii).

46

Treas. Reg. § 1.671-2(e)(1).

47

I.R.C. § 6048(a)(3)(A)(ii).

48

These certain trusts include investment trusts, liquidating trusts or environmental remediation trusts described in Treas. Reg. §§ 301.7701-4(c), 301.7701-4(d), and 301.7701-4(e).

49

Treas. Reg. § 1.671-2(e)(2)(iii).

50

Treas. Reg. § 1.671-2(e)(5).

51

Treas. Reg. § 1.671-2(e)(5).

52

Treas. Reg. § 1.671-2(e)(1).

53

Treas. Reg. § 1.671-2(e)(1).

54

Treas. Reg. § 1.671-2(e)(6), Example 3.

55

Treas. Reg. § 1.671-2(e)(6), Example 3; see also Treas. Reg. § 1.671-2(e)(1).

56

Treas. Reg. § 1.671-2(e)(6), Example 4. In addition, Treas. Reg. § 1.671-2(e)(1) requires a person to either create a trust or directly or indirectly make a gratuitous transfer of property to the trust in order to be treated as a grantor for income tax purposes.

57

I.R.C. § 679(a)(1).

58

See Peter Spero, ASSET PROTECTION: LEGAL PLANNING, STRATEGIES AND FORMS, Vol. 1, ¶ 7.04[10][a] (Warren Gorham & Lamont, 2005).

59

I.R.C. § 679(a)(1).

60

I.R.C. § 679(b).

61

Treas. Reg. § 1.679-1(b).

62

Treas. Reg. § 1.679-3(b)(1).

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63

Treas. Reg. § 1.679-3(c). (2) Principal purpose of tax avoidance deemed to exist. For purposes of paragraph (c)(1) of this section , a transfer is deemed to have been made pursuant to a plan one of the principal purposes of which was the avoidance of United States tax if— (i) The U.S. person is related (within the meaning of paragraph (c)(4) of this section) to a beneficiary of the foreign trust, or has another relationship with a beneficiary of the foreign trust that establishes a reasonable basis for concluding that the U.S. transferor would make a transfer to the foreign trust; and (ii) The U.S. person cannot demonstrate to the satisfaction of the Commissioner that— (A) The intermediary has a relationship with a beneficiary of the foreign trust that establishes a reasonable basis for concluding that the intermediary would make a transfer to the foreign trust; (B) The intermediary acted independently of the U.S. person; (C) The intermediary is not an agent of the U.S. person under generally applicable United States agency principles; and (D) The intermediary timely complied with the reporting requirements of section 6048 , if applicable.

64

Treas. Reg. § 1.679-3(c)(3). Generally, the transfer is deemed to occur when the property is made available or transferred to the trust. The transfer can occur when the transfer is made to the intermediary, if the taxpayer can demonstrate to the IRS that the intermediary is the agent of the U.S. transferor under the applicable rules of the U.S. agency.

65

The applicable attribution rules are broad. See Treas. Reg. § 1.679-1(c)(5).

66

Treas. Reg. § 1.679-3(e).

67

Treas. Reg. § 1.679-3(d).

68

The applicable attribution rules are broad. See Treas. Reg. § 1.679-1(c)(5).

69

Treas. Reg. § 1.679-3(f) (this result is avoided if the U.S. person demonstrates to the satisfaction of the Commissioner that the transfer to the entity is properly attributable to the U.S. person's ownership interest in the entity).

70

Treas. Reg. § 1.679-6.

71

I.R.C. § 7701(a)(30).

72

See Note Staff of the Joint Comm. on Tax'n, 94th Cong., 2d Sess., "General Explanation of the Tax Reform Act of 1976," at 222 (a settlor who entered into a collateral agreement with a friendly trustee to assure that a specific U.S. person is added by the trustee to the list of beneficiaries would be treated as constituting the creation of a trust with a U.S. beneficiary).

73

See Note Staff of the Joint Comm. on Tax'n, 94th Cong., 2d Sess., "General Explanation of the Tax Reform Act of 1976," at 222.

74

See Note Staff of the Joint Comm. on Tax'n, 94th Cong., 2d Sess., "General Explanation of the Tax Reform Act of 1976," n.8.

75

I.R.C. § 679(c)(1) (emphasis added).

76

Id.

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77

Treas. Reg. 1.679-2(a)(4)(i). The Section 679 regulations are generally effective as of August, 2000. Treas. Reg. § 1.679-7.

78

Treas. Reg. § 1.679-2(a)(2)(ii).

79

Compare Treas. Reg. § 1.679-2(a)(2)(iii), Example 7 (where one of two first cousins is a U.S. person, the fact that the U.S. person could be a beneficiary of the trust under the rules of intestate succession is so remote as to be negligible, where several non–U.S. persons would take before the remote U.S. beneficiary) with Treas. Reg. § 1.679-2(a)(2)(iii), Example 8 (contingent U.S. beneficiary interest is not negligible where he takes upon the death of the grantor provided that one non–U.S. person does not survive the grantor).

80

I.R.C. § 679(a)(4)(A); Treas. Reg. § 1.679-2(a)(2)(iii), Example 10.

81

Treas. Reg. § 1.679-2(a)(2)(iii), Example 11.

82

Treas. Reg. § 1.679-2(a)(3)(i).

83

Treas. Reg. § 1.679-2(c)(1). The net income is determined under I.R.C. § 665(a) and is subject to the interest charge of I.R.C. § 668.

84

Treas. Reg. § 1.679-2(c)(2).

85

Treas. Reg. § 1.679-2(c)(2). ("The U.S. transferor is treated as making a transfer of property to the foreign trust on the first day of the first taxable year following the last taxable year of the U.S. transferor during which the trust was treated as having a U.S. beneficiary. The amount of the property deemed to be transferred to the trust is the portion of the trust attributable to the prior transfer to which paragraph (a)(1) of this section applied.")

86

I.R.C. § 679(c)(2).

87

I.R.C. § 679(c)(3).

88

I.R.C. §§ 651 and 661.

89

I.R.C. § 651; Treas. Reg. § 1.651(a)-1.

90

I.R.C. §§ 651(a) and 652.

91

I.R.C. §§ 651(b) and 652(a).

92

I.R.C. § 661.

93

See I.R.C. § 643(b); Treas. Reg. § 1.643(b)-1.

94

Provisions in trusts that include definitions of income departing fundamentally from local law are not recognized for purposes of defining accounting income. Treas. Reg. § 1.643(b)-1. 95

Treas. Reg. § 1.651(a)-2.

96

A trust that is treated as having no grantor under I.R.C. §§ 673-679.

-6-


97

I.R.C. §§ 651 and 661.

98

Id.

99

Id.

100

I.R.C. §§ 651(b) and 661(a).

101

Id.

102

I.R.C. §§ 652(b) and 662(b).

103

I.R.C. § 643(a)(1).

104

I.R.C. § 643(a)(2).

105

I.R.C. § 643(a)(3).

106

I.R.C. § 643(a)(6).

107

I.R.C. § 643(a)(6)(C).

108

I.R.C. § 643(a)(6)(A).

109

I.R.C. § 643(a)(6)(B).

110

I.R.C. § 643(a)(4).

111

I.R.C. § 643(a)(6)(C); Treas. Reg. § 1.643(a)-6(a)(3)(iii).

112

If a foreign non-grantor trust recognizes both ordinary income and capital gains in the same taxable year and makes distributions to U.S. beneficiaries, those beneficiaries include a proportionate share of both the ordinary income and capital gains, based on the relative inclusion of each type of income in distributable net income. The beneficiaries include the distributed capital gains and their own computations of net long-term and short-term capital gains and losses to determine each of their respective tax liabilities. Treas. Reg. § 1.643(a)-5(b), Example 1. 113

I.R.C. §§ 652(b), 662(b) and 667(a).

114

I.R.C. §§ 651(a) and 662(a)(1).

115

I.R.C. § 662(a)(2).

116

See Appendix for a general outline of the primary tax returns that are required to be filed for a foreign grantor trust. 117

I.R.S. Notice 97-34, 1997-25 I.R.B. 22 (hereinafter referred to in footnotes as Notice 97-34). This Notice also includes reporting requirements for U.S. persons who receive large gifts from foreign persons under I.R.C. § 6039F. 118

I.R.C. § 6048(a)(1); Instructions for Form 3520, Who Must File, 1 (2004).

119

Instructions for Form 3520, When and Where to File, 1, 2 (2004).

120

I.R.C. § 6048(a)(3)(A)(i).

121

I.R.C. § 6048(a)(3)(A)(ii); Instructions for Form 3520, Definitions, 3 (2004); Treas. Reg. § 1.671-2(e)(2)(i).

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122

Treas. Reg. § 1.671-2(e)(5).

123

I.R.S. Notice 97-34, 1997-25 I.R.B. 22.

124

Treas. Reg. § 1.643(h)-1(a).

125

I.R.C. § 6048(a)(3)(A)(iii)(I).

126

I.R.C. § 6048(a)(3)(A)(iii)(II).

127

I.R.C. § 6048(a)(3)(B)(i); Notice 97-34, Sec. III.; Form 3520, Part I, Schedule B, Line 13–Gratuitous Transfers, indirectly defines "gratuitous transfer" by asking "During the current tax year, did you make any transfer (directly or indirectly) to the trust and receive less than FMV, or no consideration at all, for the property transferred?"

128

I.R.C. § 6048(a)(3)(B), Notice 97-34, Sec. III. C.1.

129

I.R.C. §§ 6048(a)(3)(B)(i) and 679(a)(3). In addition, interests in the trust received by the transferor are also ignored. Notice 97-34, Sec. III. C.1. 130

Notice 97-34, Sec. III, C.2; Instructions for Form 3520, Definitions, 3 (2004).

131

Form 3520, Part I, Schedule A–Obligations of a Related Trust, and Schedule C–Qualified Obligations Outstanding in the Current Tax Year; Part III—Distributions to a U.S. Person from a Foreign Trust During the Current Tax Year. 132

Notice 97-34, Sec. III.

133

I.R.C. § 6048(a)(3)(B)(ii); Notice 97-34, Sec. III. E.

134

I.R.C. § 6048(a)(4)(A).

135

I.R.C. § 6048(a)(4)(B).

136

I.R.C. § 6048(a)(4)(C).

137

I.R.C. § 6048(b)(1)(A). The information prescribed by the Internal Revenue Service is included with Form 3520A and the required attached statements. See also Notice 97-34. 138

Instructions for Form 3520-A, When and Where To File, 1 (2004).

139

Instructions for Form 3520-A, 1 (2004); Form 2758 is titled "Application for Extension of Time To File Certain Excise, Income, Information, and Other Returns." 140

Instructions for Form 3520-A, When and Where To File, 1 (2004).

141

I.R.C. § 6048(b)(2)(A).

142

I.R.C. § 6048(b)(2)(A).

143

I.R.C. §§ 6048(b)(2)(B)(i) and 6048(b)(2)(B)(ii).

144

The law firm or the attorney who represents the client who establishes a foreign trust may serve as the limited agent for service of process. However, tax practitioners are concerned that any applicable attorney-client privilege may be waived when the law firm or attorney who drafts the trust or represents the client serves as the limited agent

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for service of process. Due to this concern, the law firm or the attorney who represents the client may recommend another attorney who practices in the international trust areas to serve as the limited agent for service of process. Also, the law firm or attorney may form a separate entity to serve as the agent for service of process. 145

I.R.C. § 6048(b)(2)(B).

146

Notice 97-34, Sec. IV. B.; Instructions for Form 3520-A, Part I—General Information, 2, 3 (2004).

147

Required by 31 U.S.C. § 5314.

148

Instructions for TD F 90-22.1, General Definitions, 1. Exceptions to filing the TD F 90-22.1 include the following: (i) if the foreign bank account is in a U.S. military banking facility or a U.S. military finance facility operated by a U.S. institution designated by the U.S. government to serve U.S. government installations abroad; and (ii) under certain circumstances, to employees of commercial banks and to employees and officers of large public domestic corporations, if the individual has no personal financial interest in the account. 149

Instructions for TD F 90-22.1, General Definitions, 1.

150

Instructions for TD F 90-22.1, General Definitions, 1.

151

Instructions for TD F 90-22.1, General Definitions, 1.

152

Instructions for TD F 90-22.1, General Definitions, 1.

153

Treasury Regulation §§ 1.1441-1 through 1.1441-9.

154

Treas. Reg. § 1.1441-1(e)(5)(ii).

155

I.R.C. § 6048(a)(1). Instructions for Form 3520, Who Must File, 1 (2004).

156

Instructions for Form 3520, When and Where To File, 1 (2004).

157

I.R.C. § 6048(a)(3)(A)(i).

158

I.R.C. § 6048(a)(3)(A)(ii).

159

See Treas. Reg. §§ 25.2511-2(b) and (j).

160

Form 3520, Part I, Transfers by U.S. Persons to a Foreign Trust During the Current Tax Year, Line 7a, asks "Will any person (other than the U.S. transferor or the foreign trust) be treated as the owner of the transferred assets after the transfer?" If the answer is "yes," the following information must be provided: (i) name of other foreign trust owners, if any; (ii) address; (iii) country of residence; (iv) identification number, if any; and (v) relevant I.R.C. Section. 161

I.R.C. § 6048(a)(4)(A).

162

I.R.C. § 6048(a)(4)(B).

163

I.R.C. § 684(a).

164

I.R.C. § 684(b).

165

I.R.C. §§ 673-678. Also, the trust includes no U.S. beneficiary until one taxable year after the deaths of the grantor and his spouse under I.R.C. §§ 679(b) and 672(e)(1).

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166

I.R.C. §§ 673-678. In addition, a foreign non-grantor trust includes no U.S. beneficiaries under I.R.C. § 679.

167

However, question 26 of this Form asks: "Does the filer have a financial interest in this account?" It then states that if the answer is No, that boxes 27-35 are to be completed. Instructions for the TD F 90-22.1, Item 26, states "United States Persons with Authority over but No Financial Interest In an Account–Except as provided in the following paragraph, you must state the name, address, and identifying number of each owner of an account over which you had authority but if you complete items 27-35 for more than one account of the same owner, you need identify the owner only once. If you complete items 27-35 for one or more accounts in which no United States person had a financial interest, you may state on the first line of this item, in lieu of supplying Information about the owner, 'No U.S. person had any financial interest in the foreign accounts.' This statement must be based upon the actual belief of the person filling this form after he or she had taken reasonable-measures to ensure its correctness." 168

Instructions for TD F 90-22.1, General Definitions, 3.

169

I.R.C. § 684(b); Treas. Reg. § 1.684-3.

170

I.R.C. § 684(a); Treas. Reg. § 1.684-1(a)(1).

171

I.R.C. §§ 671-679.

172

Treas. Reg. § 1.684-1(a)(2).

173

See Kelley, Gassman, Gulecas, The Effect of Section 684 on The Death of The Grantor of a Foreign Grantor Trust, 4, 4, J. ASSET PROTECTION, 23-31 (1999); Dudley and Karp, Continued Use of Foreign Trusts in U.S. Tax Planning, TRUST & ESTATES, 36 (1998). Carlyn S. McCaffrey, Learning to Live With the New Foreign Nongrantor Trust Rules, in International Trust and Estate Planning, ALI-ABA course of Study Materials, September 24-25, 1998; Joel J. Karp, Strategies for Drafting Estate Planning Documents for International Clients, in ESTATE PLANNING FOR THE INTERNATIONAL CLIENT, 6.21-6.22 (Oct. 23, 1997) (available from The Florida Bar); Howard M. Zaritsky, 854-2nd T.M., U.S. Taxation of Foreign Estates, Trusts and Beneficiaries (Estate, Gift and Trust Series). 174

Treas. Reg. § 1.684-3.

175

I.R.C. §§ 2036, 2038.

176

I.R.C. § 2042.

177

Treas. Reg. § 1.684-4(b) states: "The transfer … should be deemed to occur immediately before, but on the same date that, the trust meets the definition of a foreign trust …" 178

I.R.C. § 684(c); Treas. Reg. §1.684-3.

179

It is presumed the U.S. person made a gratuitous transfer to the domestic trust under Treas. Reg. § 1.671-2(e)(1).

180

I.R.C. § 684(b); Treas. Reg. § 1.684(d), Example 1; Treas. Reg. § 1.684-3(a).

181

The foreign trust is a foreign grantor trust under I.R.C. § 679(a) because the trust has a U.S. beneficiary under I.R.C. § 679(c).

182

I.R.C. §§ 679(a) and (c).

183

Treas. Reg. § 1.684-4.

184

Treas. Reg. § 1.684-4(b) states: "The transfer … should be deemed to occur immediately before, but on the same

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date that, the trust meets the definition of a foreign trust …" 185

Treas. Reg. § 1.679-6(a) states: "if an individual … transfers property to a trust that is not a foreign trust, and such trust becomes a foreign trust [while the U.S. person is alive], the U.S. individual is treated as a U.S. transferor and is deemed to transfer the property to a foreign trust …" 186

Treas. Reg. § 1.684-3.

187

I.R.C. § 684(a). In addition, the foreign nongrantor trust has no U.S. beneficiary under I.R.C. § 679(c).

188

See Controversy Regarding Foreign Nongrantor Trust, supra.

189

Treas. Reg. § 1.684-3(c).

190

Appreciated property passing at death to the trustee of a foreign trust is not subject to income taxation under I.R.C. § 684(b) if a person, other than the deceased settlor, is treated as the "owner" for income tax purposes.

191

I.R.C. § 684(b).

192

I.R.C. § 684(b).

193

J. Richard Duke, Uses of Offshore Life Insurance in International Estate Planning, ASSET PROTECTION STRATEGIES: PLANNING WITH DOMESTIC AND OFFSHORE ENTITIES, chapter 14 (2002); J. Richard Duke, How to Use Partnerships and LLCs for Successful Wealth Protection Planning, in ANNUAL WEALTH PROTECTION CONFERENCE, (May 4, 2001) (available from The Florida Bar). 194

Treas. Reg. § 1.684-4(c).

195

Treas. Reg. § 1.679-6(a) provides "if an individual who is a U.S. person transfers property to a trust that is not a foreign trust, and such trust becomes a foreign trust while the U.S. person is alive, the U.S. individual is treated as a U.S. transferor and is deemed to transfer the property to a foreign trust on the day the domestic trust becomes a foreign trust." Thus, whether the transfer is taxable or not under I.R.C. § 684, the U.S. person making the taxable or nontaxable transfer is required to file Form 3520. 196

I.R.C. §§ 6048(a)(3)(A)(ii) and 6048(c)(2)(B)(i).

197

I.R.C. § 6048(c)(1)(A).

198

I.R.C. § 6048(c)(1)(B).

199

I.R.C. § 6048(c)(1)(C).

200

Instructions for Form 3520-A, Part III, Foreign Trust Balance Sheet, 4 (2004).

201

This is the attachment to Form 3520-A, copies of which are furnished to each U.S. beneficiary and filed with the Internal Revenue Service Center, Philadelphia, PA 19255, Instructions for Form 3520-A, When and Where To File, 1 (2004). Form 3520, Part III, Line 29, requires the attachment of the Foreign Grantor Trust Beneficiary Statement; otherwise, Form 3520, Part III, Schedule A–Default Calculation of Trust Distributions (Lines 31-38) must be completed by each U.S. beneficiary who is required to file. 202

Instructions for Form 3520, Part III, Distributions To a U.S. Person From a Foreign Trust During the Current Tax Year, 7, regarding Lines 29-30. 203

Unlike the "Foreign Grantor Trust Beneficiary Statement" that is an attachment to Form 3520-A (see previous

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two endnotes), because the trust here is a foreign non-grantor trust, no reference is made to this form under Form 3520-A. However, Form 3520, Part III—Distributions to a U.S. person From a Foreign Trust During the Current Tax Year, Line 30, asks: "Did you receive a Foreign Nongrantor Trust Beneficiary Statement from the foreign trust with respect to a distribution? If 'Yes' attach the statement and complete either Schedule A or Schedule B below (see page 7 of instructions). Also complete Schedule C if you enter an amount greater than zero on Line 37 or Line 41. If 'No' complete Schedule A with respect to that distribution. Also complete Schedule C if you enter an amount greater than zero on Line 37." Apparently, this form, prepared in accordance with the Instructions for Form 3520, Part II, U.S. Owner of a Foreign Trust, for Line 30, is to be attached to Form 3520 and furnished to each U.S. beneficiary; otherwise, Form 3520, Part III, Schedule A–Default Calculation of Trust Distributions (Lines 31-38) or Schedule B– Actual Calculation of Trust Distributions (Lines 39-47) must be completed by each U.S. beneficiary. 204

I.R.C. § 6048(c)(1); Instructions for Forms 3520 and 3520-A, Definitions, 2 and 1 respectively (2004).

205

Instructions for Forms 3520 and 3520-A, Definitions, 2 and 1 respectively (2004).

206

I.R.C. § 643(i).

207

Treas. Reg. §§ 1.446-2(d)(1), 1.1273-2, or 1.1274-2, whichever is applicable, defines the issue price.

208

I.R.C. § 643(i)(2)(B)(i); Instructions for Form 3520, Definitions, 3 (2004).

209

Instructions for Form 3520, Definitions, 3 (2004).

210

This extension is reported on Form 3520, Part I, Transfers by U.S. Persons to a Foreign Trust During the Current Tax Year, Schedule A—Obligations of a Related Trust, and Part III—Distributions to a U.S. Person From a Foreign Trust During the Current Tax Year.

211

Notice 97-34; Instructions for Form 3520, Definitions, 3 (2004).

212

Form 3520, Part I, Schedule A–Obligations of a Related Trust, and Schedule C–Qualified Obligations Outstanding in the Current Tax Year; Part III—Distributions to a U.S. Person from a Foreign Trust During the Current Tax Year. 213

I.R.C. § 643(h).

214

See Grantor Defined, for a discussion of the definition of grantor, supra.

215

Treas. Reg. § 1.643(h)-1(f).

216

Treas. Reg. § 1.643(h)-1(a)(1).

217

Treas. Reg. § 1.679-3(c). Treas. Reg. § 1.679-3(c)(3) provides that where a transfer is treated as an indirect transfer, the intermediary generally is treated as an agent of the U.S. transferor and the property is treated as transferred to the foreign trust by the U.S. transferor in the year the property is transferred, or made available, by the intermediary to the foreign trust. 218

Treas. Reg. § 1.643(h)-1(b)(1). A gratuitous transfer is defined as any transfer other than a transfer for fair market value under Treas. Reg. § 1.671-2(e)(2). 219

Treas. Reg. § 1.643(h)-1(b)(2).

220

Treas. Reg. § 1.643(h)-1(d).

221

Treas. Reg. § 1.672(f)-1(a)(1).

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222

I.R.C. § 672(f)(1). Also, a grantor does not include a foreign person who is acting as an accommodation party for another person. Treas. Reg. § 1.671-2(e)(3).

223

I.R.C. § 672(f)(2).

224

I.R.C. §§ 665-667.

225

I.R.C. § 668.

226

Treas. Reg. § 1.672(f)-1(a).

227

I.R.C. § 672(f)(2)(A)(i); Treas. Reg. § 1.672(f)-3(a)(1).

228

Treas. Reg. § 1.672(f)-3(a)(2).

229

Treas. Reg. § 1.672(f)-3(a)(3).

230

I.R.C. § 672(f)(2)(A)(ii); Treas. Reg. § 1.672(f)-3(b).

231

A gratuitous transfer is defined as any transfer other than a transfer for fair market value under Treas. Reg. § 1.671-2(e)(2). 232

Treas. Reg. § 1.671-2(e).

233

Treas. Reg. § 1.672(f)-3(b)(2)(i).

234

Treas. Reg. § 1.672(f)-3(b)(2)(i).

235

Treas. Reg. § 1.643(h)-1(e).

236

Treas. Reg. § 1.672(f)-3(b)(2)(ii)(A).

237

Treas. Reg. § 1.672(f)-3(b)(2)(ii)(B)(1).

238

Treas. Reg. § 1.672(f)-3(b)(2)(ii)(B)(2).

239

Treas. Reg. § 1.672(f)-3(b)(2)(ii)(B)(3).

240

I.R.C. § 672(f)(2)(B); Treas. Reg. § 1.672(f)-3(c).

241

Treas. Reg. § 1.672(f)-2(a). However, if one of these entities makes a gratuitous transfer to a U.S. person or if such an entity is deemed to own a foreign trust under I.R.C. § 678 and makes a gratuitous transfer to a U.S. person, the entity is treated as a foreign corporation for purposes of authorizing the IRS to recharacterize purported gifts to donees under the rules of Treas. Reg. § 1.672(f)-4(c). 242

Treas. Reg. § 1.671-2(e)(6), Example 6.

243

Treas. Reg. § 1.671-2(e)(1).

244

Treas. Reg. § 1.671-2(e)(1).

245

Treas. Reg. § 1.671-2(e)(1).

246

Treas. Reg. § 1.671-2(e)(6), Example 4.

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247

See Exceptions at I.R.C. §§ 672(f)(2)(A) and (B). In the event a U.S. beneficiary is taxed on trust income and a foreign settlor is taxed by a foreign jurisdiction, the U.S. beneficiary is allowed to use the foreign tax credit attributable to the foreign taxes paid by the foreign settlor. I.R.C. §§ 901(b)(5) and 665(d)(2).

248

Taxable gifts are present interest gifts exceeding $11,000 per donee annually. I.R.C. §§ 2001(b), 2503(a) and (b)(1). 249

Treas. Reg. § 1.672(f)-4(d).

250

I.R.C. § 672(f)(4); Treas. Reg. § 1.672(f)-4(a).

251

Treas. Reg. §§ 1.672(f)-4(a)(1) and (2).

252

I.R.C. § 6039F provides that a U.S. person shall report the receipt during any taxable year of aggregate foreign gifts exceeding $11,273, as adjusted by I.R.C. § 6039F(d). The inflation adjusted amounts are: (i) for taxable years beginning in 1997, $10,276 (Rev. proc. 96-59, 1996-53 I.R.B. 17) (ii) for taxable years beginning in 1998, $10,557 (Rev. Proc. 97-57, 1997-52 I.R.B. 20); (iii) for 1999, $10,735 (Rev. Proc. 98-61, 1998-52 I.R.B. 18); (iv) for 2000, $10,931 (Rev. Proc. 99-42, 1999-46 I.R.B. 568); (v) for 2001, $11,273 (Rev. Proc. 2001-13, 2001-3 I.R.B. 337); (vi) for 2002, $11,642 (Rev. Proc. 2001-59, 2001-52 I.R.B. 623); (vii) for 2003, $11,827 (Rev. Proc. 2002-70, 2002-46 I.R.B. 845); (viii) for 2004, $ 12,097 (Rev. Proc. 2003-85, 2003-49 I.R.B. 1184). 253

Treas. Reg. § 1.672(f)-4(b)(2).

254

Treas. Reg. § 1.672(f)-4(b)(3).

255

Treas. Reg. §§ 1.672(f)-4(b)(4) and 1.672(f)-4(c).

256

I.R.C. § 668.

257

I.R.C. § 6048(c)(2).

258

Instructions for Form 3520, Part III, Schedule A–Default Calculation of Trust Distributions, 7-8, regarding Lines 33, 35 and 36 (2004). 259

Form 3520, Part III, Schedule A–Default Calculation of Trust Distributions, Line 37.

260

I.R.C. § 643(a).

261

Instructions for Form 3520, Part III, Distributions to a U.S. Person From a Foreign Trust During the Current Tax Year, Schedule A–Default Calculation of Trust Distributions, 6 (2004). 262

Instructions for Form 3520, Part III, Distributions to a U.S. Person From a Foreign Trust During the Current Tax Year, Schedule A–Default Calculation of Trust Distributions, 6 (2004). 263

I.R.C. §§ 679(c)(1)(A) and (B). The instructions for Forms 3520 and 3520-A, Definitions, 4 (2004), 2 (2004), respectively, state that "A U.S. beneficiary includes any person that could possible benefit (directly or indirectly) from the trust (including an amended trust) at any time, whether or not the person is named in the trust instrument as a beneficiary and whether or not the person can receive a distribution from the trust in the current year.

264

Treas. Reg. § 1.679-2(a), Example 5.

265

I.R.C. § 679(c)(2)(A).

266

I.R.C. § 679(c)(2)(B).

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267

I.R.C. § 679(c)(2)(C).

268

I.R.C. § 679(c)(3); Treas. Reg. § 1.679-2(a)(3).

269

Instructions for Form 3520 and 3520-A, Definitions, 4 (2004), 2 (2004), respectively, state "A foreign trust will be treated as having a U.S. beneficiary unless the terms of the trust instrument specifically prohibit any distribution of income or corpus to a U.S. person at any time, even after the death of the U.S. transferor, and the trust cannot be amended or revised to allow such a distribution." The italicized words in the foregoing sentence indicate the position of the IRS with respect to the provisions of I.R.C. § 679(b). Some practitioners take the position that the subject italicized words are contrary to the meaning of I.R.C. § 679(b), using the foreign non-grantor trust as their example. If a foreign non-grantor trust is settled by a person ("grantor") which includes no U.S. beneficiaries and, at the death of the grantor, the trust specifically prohibits the designation of a U.S. beneficiary until one taxable year after the latter of the death of the grantor and grantor's spouse, any accumulations of income prior to death are not subjected to income taxation under the plain meaning of I.R.C. §§ 679(b) and 672(e)(1). The Treas. Reg. under I.R.C. § 679 support the foregoing position by the IRS. First, the Treas. Reg. under I.R.C. § 679 do not mention I.R.C. § 679(b), the provision primarily relied upon to ensure that a foreign non-grantor trust continues to be treated as a foreign non-grantor trust after the death of the settlor (and the settlor's spouse). Treas. Reg. § 1.679-2(a)(2) states that for purposes of determining whether a foreign trust has a U.S. beneficiary "income or corpus may be paid or accumulated to or for the benefit if a U.S. person during the taxable year of the U.S. transferor if during that year, directly or indirectly, income may be distributed to, or accumulated for the benefit of, a U.S. person, or corpus may be distributed to, or held for the future benefit of, a U.S. person. This determination is made without regard to whether income or corpus is actually distributed to a U.S. person during that year, and without regard to whether a U.S. person's interest in the trust income or corpus is contingent on a future event." The IRS ignores the legislation under I.R.C. § 684(b) by stating that a "future event" includes a U.S. person becoming a beneficiary more than one taxable year after the death of the settlor under I.R.C. § 684(b) and the settlor's spouse under I.R.C. § 672(e)(1). It appears that the IRS is attempting to write legislation by ignoring the legislation under I.R.C. § 684(b). Treas. Reg. § 1. 679-2(c)(1). 270

Treas. Reg. § 1.679-2(c)(1).

271

Instructions for Form 3520, Part IV, U.S. Recipients of Gifts or Bequests Received During the Current Tax Year From Foreign Persons, regarding Line 54 (2004) that states: "To calculate the threshold amount ($100,000) you must aggregate gifts from different foreign nonresident aliens and foreign estates if you know (or have reason to know) that those persons are related to each other (see definition of related person on page 3) or one is acting as a nominee or intermediary for the other. For example, if you received a gift of $75,000 from nonresident alien individual a and gift of $40,000 from nonresident alien individual b, and you know that a and b are related, you must answer 'Yes,' and complete columns (a) through (c) for each gift."

272

I.R.C. § 6039F provides that a U.S. person shall report the receipt during any taxable year of aggregate foreign gifts exceeding $10,000, as increased by the cost-of-living adjustment under I.R.C. § 6039F(d). For taxable years beginning in 1997, the adjusted amount is $10,276. Rev. Proc. 96-59, 1996-53 I.R.B. 17. For taxable years beginning in 1998, it is $10,557. Rev. Proc. 97-57, 1997-52 I.R.B. 20. For taxable years beginning in 1999, the adjusted amount is $10,735. Rev. Proc. 98-61, 1998-52 I.R.B. 18. For the year 2000, the amount is $10,931. Rev. Proc. 99-42, 1999-46 I.R.B. 568. The amount is $11,273 for the year 2001. Rev. Proc. 2001-13, 2001-3 I.R.B. 337. 273

Instructions for Form 3520, Part IV, U.S. Recipients of Gifts or Bequests Received During the Current Tax Year From Foreign Persons, regarding Line 55 (2004) states "During the current tax year, did you receive more than $12,097, that you treated as gifts from a foreign corporation or a foreign partnership? See instructions regarding related donors. If 'Yes,' complete columns (a) through (g) with respect to each such gift. "

274

Instructions for Form 3520, Part IV, U.S. Recipients of Gifts or Bequests Received During the Current Tax Year From Foreign Persons, regarding Line 55 (2004). See also Recharacterization of Purported Gifts, supra.

275

See Distribution Through Certain Foreign Trusts Through Nominees, supra.

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276

Instructions for Form 3520, Part IV, U.S. Recipients of Gifts or Bequests Received During the Current Tax Year From Foreign Persons, regarding Line 56 (2004).

277

Instructions for Form 3520, Part IV, U.S. Recipients of Gifts or Bequests Received During the Current Tax Year From Foreign Persons, regarding Line 54 (2004).

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U.S. Tax Compiance for Offshore Entities