Considerations Before Establishing an Offshore Trust
Often international families have U.S. family members whom they want to include in their estate planning. A foreign grantor trust allows families to establish a long-term trust in the United States to benefit offshore family members.
In this blog, we’ll talk about the creation of U.S. trusts for U.S. beneficiaries by non-U.S. persons. We’ll provide an overview of revocable foreign grantor trusts and irrevocable U.S. domestic non-grantor trusts.
Keep in mind that while this overview will give you a greater understanding of foreign grantor trusts, you’ll still need to speak with a professional for your individual planning needs.
The Foreign Grantor Trust
When a person establishes a revocable foreign grantor trust in the U.S., the trust remains revocable until the settlor’s death. Upon the settlor’s death, the trust becomes an irrevocable U.S. trust which will still serve to benefit the U.S. beneficiary.
A foreign grantor trust is considered both a foreign trust and a grantor trust. Neither the trust nor the settlor is subject to U.S. income tax on non-U.S. trust income while the settlor is alive unless the trust holds U.S. situs assets at the settlor’s death.
Upon the death of the settlor, if the trust does not contain U.S. situs assets, it will not be eligible for U.S. estate tax, but it is still subject to tax from the trust’s home country.
For a trust to be considered a foreign trust, the settlor must have the power to revoke the trust. When this is the case, the trust is deemed to be foreign for U.S. tax purposes.
The trust also needs to be determined a grantor trust. It is a grantor trust if the grantor is also the settlor and the owner and is not subject to U.S. Federal income tax on non-U.S. sourced income.
Two Tests for U.S. Tax Purposes
U.S. tax implications for non-U.S. residents are far more limited than those for U.S. citizens. Foreign grantors need to be sure that their trusts fail the two tests that determine whether it’s a domestic or foreign trust.
The two tests include the court test and the control test. Passing either test means that the trust is considered domestic and is subject to U.S. Federal income tax standards rather than the more limited foreign tax standards.
The Court Test
A trust passes the court test when it can subject itself to the primary jurisdiction of a U.S. court. Trusts established under U.S. state law with a domestic trustee can usually pass the court test. Passing the court test would denote the trust as a domestic trust.
The Control Test
A trust passes the control test if one or more persons associated with the trust have the authority to exercise any control or have decision-making power over the trust. This could include beneficiaries, settlors, grantors, and more. A trust’s status can change at any point if there are changes to the people who have control over the trust. It’s vital to consult with a professional about the establishment of a foreign grantor trust and any ongoing changes.
What Happens When a Foreign Settlor Dies?
When a foreign settlor dies, the revocable foreign grantor trust they’ve established becomes irrevocable. When this happens, any U.S situs assets within the trust will be subject to U.S. estate tax. If non-U.S. holding entities exist within the trust and hold U.S. investment assets, it’s possible to restructure the trust to benefit U.S. beneficiaries.
After the death of the foreign settlor, the trust becomes a non-grantor trust making it a separate taxpayer. It is essential to ensure the trust now passes the control and the court test, making it a domestic trust.
Any income the trust now receives will be subject to U.S. Federal income tax, but it may not be subject to state income tax depending on the jurisdiction of the trust. Nevada carries no state income tax.
Which U.S. State is Best to Establish Your Trust
When you establish a revocable foreign grantor trust or an irrevocable U.S. domestic non-grantor trust, you must consider the state jurisdiction in which you’ll establish the trust. The trust laws in each state become vitally important as they will determine the taxation and governance of the trust.
Several U.S. states, including Nevada, have no state income tax. Nevada also has expanded flexibility when it comes to the administration of the trust and some of the most secure asset protection laws in the U.S. If you wish to extend the duration of the trust to benefit generations, Nevada also permits dynasty trusts up to 365 years.
There are many options for foreign families who wish to support U.S. beneficiaries. A foreign grantor trust in the U.S. can undoubtedly help families meet their wealth planning goals, but these trusts require much professional navigating. Alliance Trust Company of Nevada is happy to assist international families to navigate the complexities of estate planning in the U.S.