U.S. Taxation of Foreign Estates, Trusts and Beneficiaries (Portfolio 6500)

Tax Management Portfolio, U.S. Taxation of Foreign Estates, Trusts and Beneficiaries, explains in detail the federal income, estate and gift taxation of foreign trusts and estates and their grantors and beneficiaries. An entity is subject to U.S. income taxation as a foreign trust or estate if it is classified as a foreign trust or estate, respectively, for U.S. tax purposes.

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In order to prevent perceived abuses, foreign trusts, their grantors and beneficiaries are subject to a number of special provisions of the Internal Revenue Code. Section 679 taxes a U.S. grantor of a foreign trust that has a U.S. beneficiary as the deemed owner of the trust. Section 684 causes a U.S. grantor to recognize gain on the transfer of appreciated property to a foreign trust. Section 672(f) denies grantor trust status to the extent that it would cause a trust to be taxed as owned by a non-U.S. person, and makes any U.S. beneficiaries of such a trust taxable as the deemed owners.

The U.S. beneficiaries of a nongrantor foreign trust are generally taxable on the currently distributed income of the trust in the same manner as the beneficiaries of domestic trusts. Taxation of U.S. and foreign beneficiaries on accumulation distributions from a foreign trust, however, is different. Since the undistributed capital gains of a foreign trust are part of distributable net income, a distribution of those gains in subsequent years will be taxable to the beneficiaries. In addition, all accumulation distributions are subject to an interest charge.

Absent treaty obligations, U.S. estate taxes are imposed upon U.S. property of a foreign decedent. Although most of the usual deductions are allowed, the marital deduction is not unless the surviving spouse is a U.S. citizen. The foreign estate is also subject to a greatly reduced unified credit. The foreign estate is generally subject to the same income tax rules as a nonresident alien individual, but with an additional deduction for distributions to beneficiaries.


U.S. Taxation of Foreign Estates, Trusts and Beneficiaries was authored by the following experts.
Howard M. Zaritsky, Esq.

Howard M. Zaritsky, B.A., Emory University (1970); J.D., Stetson University College of Law (1973); LL.M. (Taxation), Georgetown University Law Center (1976); Consulting Counsel; member, Virginia State Bar; BNA Tax Management Advisory Board on Estates, Gifts and Trusts; University of Miami (Heckerling) Estate Planning Institute Advisory Committee; author or co-author, numerous articles and several treatises, including: Tax Planning for Family Wealth Transfers, Generation-Skipping Transfer Taxes: Analysis with Forms (with Carol Harrington & Lloyd Leva Plaine); Structuring Buy-Sell Agreements (with Farhad Aghdami & Mary Ann Mancini); Structuring Estate Freezes After Chapter 14 (with Ron Aucutt); Federal Income Taxation of Estates and Trusts (with Robert Danforth & Norman Lane); Tax Planning With Life Insurance (with Stephan Leimberg) — all published by Warren, Gorham & Lamont/RIA Group; tax editor,Probate Practice Reporter; Fellow, the American College of Trust and Estate Counsel and American College of Tax Counsel; former Chair, Virginia Bar Association Section on Wills, Trusts & Estates; lecturer, numerous Tax and Estate Planning Institutes, including Institutes of the University of Miami (Heckerling Institute), New York University, Georgetown University, Duke University, and the University of Southern California.

Howard D. Rosen, Esq.

Howard D. Rosen, B.B.A., University of Miami (1969, Magna Cum Laude); J.D., University of Miami (1973, Summa Cum Laude); Shareholder, Law Firm of Donlevy-Rosen & Rosen, P.A.; member, Editorial Board, University of Miami Law Review; Certified Public Accountant, Florida; member, Florida Bar; member, Tax and International Law Sections of the Florida Bar; Adjunct Professor of Law, University of Miami School of Law (1990– ); guest lecturer, University of Miami School of Business Administration; Chairman, Asset Protection Committee of the American Association of Attorney - Certified Public Accountants (2004–present); co-author, 810-2nd T.M., Asset Protection Planning; member, Board of Governors of the Florida Institute of Certified Public Accountants (1997–1999), BNA Tax Management's Advisory Board on Estates, Gifts and Trusts (1994–present), Board of Advisors of the Southpac Offshore Planning Institute (SOPI), Asset Protection Planning Committee of the Real Property, Probate and Trust Law Section of the ABA, Florida Institute of Certified Public Accountants; past president and Director, South Dade Chapter of the Florida Institute of Public Accountants; nationally recognized lecturer on the subjects of asset protection, offshore trusts, taxation, and estate planning; author, numerous articles in professional and academic journals such as the University of Miami Law Review, Journal of Asset Protection, Asset Protection Journal, TAXES Magazine, Journal of Taxation of Investments, University of Miami Business Law Journal, Offshore Finance USA, CCH Financial and Estate Planning, BNA Tax Management's Estates, Gifts and Trusts Journal, Estate Planning, Taxation for Lawyers, Taxation for Accountants, International Tax Report, Small Business Taxation, and others; charter member, Planned Giving Advisory Council of the Baptist Hospital of Miami Foundation.

Table of Contents

Detailed Analysis

I. Introduction

II. Foreign Trusts: A Brief Historical Look

Introductory Material

A. Foreign Trusts Before 1962

B. The Revenue Act of 1962

C. The Tax Reform Act of 1976

D. The Revenue Reconciliation Act of 1990

E. The Small Business Job Protection Act of 1996 and the Taxpayer Relief Act of 1997

III. What Constitutes a Foreign Trust (§ 7701)

Introductory Material

A. Definition of a "Trust"

B. State Law Trusts That Are Not Trusts for Tax Purposes

1. Generally

2. Business Trusts

3. Investment Trusts

a. One-Class Investment Trusts

b. Multiple-Class Investment Trusts

4. Liquidating Trusts

5. "Sham" Trusts

C. What Makes a Trust "Foreign"

1. Pre-1997 Subjective Rule

2. Post-1996 Objective Rule - The U.S. Court and Control Tests

a. The U.S. Court Test

(1) Generally

(2) Trust Registration

(3) Testamentary Trusts

(4) Petition to a U.S. Court (Inter Vivos Trusts)

(5) Co-Supervision by U.S. and Foreign Courts

(6) Automatic Migration Clauses

(7) Supervision of Administration by Multiple Courts

b. The Control Test

(1) "Control"

(2) "Substantial Decisions"

(3) Safe Harbor for Certain Domestic Trusts


c. Elective Domestic Status

IV. Outbound Foreign Trusts (§ § 679 and 684)

Introductory Material

A. Grantor Trust Status of Foreign Trusts Created by and for a U.S. Person

1. Generally

2. The Transferor Must Be a "U.S. Person"

a. Foreign Transferors Who Become U.S. Persons

b. Transfers of Community Property

c. Expatriating U.S. Transferors

3. Required Transfer

a. Generally

b. The Testamentary Transfer Exception

c. Transfers for Fair Market Value

(1) Transfers Before February 7, 1995

(2) Transfers After February 6, 1995

(a) Generally

(b) Transfers for Partial Consideration

(c) Debt Obligations Generally

(d) Qualified Debt Obligations

(i) Changing the Terms

(ii) Principal Payment

d. Transfers to Charitable or Employee Benefit Trusts

e. Indirect Transfers

(1) Transfers from Grantor Trusts

(2) Indirect Transfers Through Intermediaries

(3) Constructive Transfer by Assumption or Satisfaction of Trust's Debt

(4) Constructive Transfer by Guarantee of Trust's Debt

(5) Transfers to Entities Owned by a Foreign Trust

f. Outbound Trust Migration as a Deemed Transfer

4. The Trust Must Be a "Foreign Trust"

5. The Trust Must Have a U.S. Beneficiary

a. Scope of Inquiry

b. Discretionary Beneficiaries

c. Beneficiaries Who Could Become U.S. Persons

d. Indirect U.S. Beneficiaries

e. Annual Determination and the Five-Year Rule

f. Effect of Acquiring a U.S. Beneficiary

g. Drafting for § 679

h. Conflict Between § § 679 and 678

i. Deemed Transfer on Grantor's Immigration

6. Outbound Migrations of Domestic Trusts

7. Amount of Trust Income Taxable to the Grantor Under § 679

B. Transfers by U.S. Persons of Appreciated Assets to Nongrantor Foreign Trusts

1. Transfers Before August 5, 1997

a. The Former § 1491 Excise Tax

b. A "Transfer" Under Former § 1491

c. The Statutory Exceptions

(1) The § 367 Exception

(2) The Recognition Election Exception: Former § 1057

2. Transfers After August 4, 1997

a. Indirect and Constructive Transfers

b. Transfers by Grantor Trusts

c. Transfers to a Foreign Grantor Trust

d. Transfer to a Charitable Trust

e. Transfer at Transferor's Death

f. Transfers for Fair Market Value

g. Transfers to Certain State-Law Trusts That Are Not Taxed as Trusts for Income Tax Purposes

h. Outbound Trust Migration

i. Exchanges Under § 1032

C. Certain Foreign "Qualified Revocable Trusts"

V. Inbound Transfers (§ § 643(h), 651-652, 661-662, 665-668, 672(f), 679(a)(4), 871, 897, 1441)

Introductory Material

A. No Grantor Trust Status for Foreign Grantors

1. Background

2. U.S. Beneficiary as Grantor

3. Partial Ownership

4. Trusts Created by Certain Foreign Corporations

5. Certain Revocable Trusts

a. Generally

b. "Grantor" Defined

(1) "Gratuitous Transfer"

(2) Special Purpose Trusts

(3) Accommodation Grantors

c. 183-Day Rule

6. Irrevocable Trusts Benefiting Only the Grantor and/or the Grantor's Spouse

a. Generally

b. Distributions for Support

7. Compensatory Trusts

8. Effective Date Protection (Certain Trusts in Existence on September 19, 1995)

9. Recharacterization of Certain Gifts

a. Generally

b. Purported Gift Defined

c. Gift or Bequest Through a Partnership or Foreign Corporation

d. Charitable Contributions

e. Gift or Bequest Through Intermediary Trust

f. Discretion to Further Recharacterize

g. De Minimis Rule

10. Recharacterizing Beneficiary as Grantor of Inbound Trust

a. Generally

b. Different Taxable Years

c. Entity Characterization

d. Effective Date of Recharacterization Rules

11. Effective Date

B. Grantor Trust Status and Inbound Grantors

C. Income Taxation of U.S. Income of Nongrantor Foreign Trusts

1. The Distribution Deduction

a. Generally

b. Simple vs. Complex Trusts

c. Computation of DNI

(1) Worldwide Income

(2) Capital Gains

d. Distributions Through Intermediaries

(1) Generally

(2) When Distribution Through Intermediary Is Deemed Made

(3) The Grantor as Intermediary

(4) De Minimis Rule

(5) Effective Date

2. Taxation of Nongrantor Foreign Trusts on Different Types of Income

a. Generally

b. Income Effectively Connected with a U.S. Trade or Business

c. Fixed or Determinable Annual or Periodic Income

d. Capital Gains

e. Gains from the Sale of U.S. Real Property Interests

f. The Alternative Minimum Tax on Items of Tax Preference

D. Taxation of Current Distributions

1. Distributions to U.S. Beneficiaries

a. Loans to U.S. Beneficiaries and Grantors

(1) Generally

(2) Relevant Definitions

(3) Related Persons

(4) Tax-Exempt Grantors

(5) Qualified Obligations

b. Distributions Through Intermediaries

c. Credit for Foreign Taxes

(1) Nongrantor Foreign Trusts

(a) In General

(b) Beneficiary's Foreign Tax Credit with Respect to Accumulation Distributions

(c) Beneficiary's Foreign Tax Credit for Current Distributions

(2) Foreign Trusts Deemed Owned by U.S. Beneficiaries

d. Alternative Minimum Tax

2. Distributions to Foreign Beneficiaries

a. Foreign Source Income

b. U.S. Source Income

(1) Effectively Connected Income

(2) Fixed or Determinable Annual or Periodic Income

(3) Treaty Benefit Issues

(4) Credits for U.S. Taxes Paid by the Trust

3. Distributions to Former U.S. Citizens and Residents

E. Income Taxation of Accumulation Distributions from Foreign Trusts

1. Background

2. The Throwback Rule

a. "Accumulation Distribution" and "Undistributed Net Income"

b. The Character Rule

c. The Interest Charge

d. Credit for Foreign Taxes Paid by the Trust

e. Planning Distributions to Avoid the Throwback Rule and Interest Charge

F. Gains Recognized on Certain Pre-August 6, 1997 Sales and Exchanges

G. Beneficiaries Changing Nationality During the Taxable Year

VI. U.S. Wealth Transfer Taxes on Foreign Transfers to Foreign Trusts

Introductory Material

A. Gift Tax

B. Generation-Skipping Transfer Taxes

1. Direct Skip Transfers

2. Taxable Terminations and Distributions

C. Estate Tax

VII. Reporting Requirements for Foreign Trusts (§ § 6048, 6677)

Introductory Material

A. Outbound Transfers to and Interests in Foreign Trusts (Form 3520)

1. Generally

2. Reportable Events

a. "Grantor"

b. "Beneficiary"

c. "Obligation"

3. Nongratuitous Transfers

4. Transfers to Deferred Compensation and Charitable Trusts

5. Filing Dates

6. Penalties

a. "Gross Reportable Amount" Defined

b. Responsible Party

c. Reasonable Cause Exception

d. Deficiency Procedures

B. Deemed Owners of Foreign Grantor Trusts (Form 3520-A)

1. Filing Dates

2. Penalties

a. "Gross Reportable Amount"

b. Responsible Party

c. Reasonable Cause Exception

d. Deficiency Procedures

e. Appointment of U.S. Agent

C. U.S. Beneficiaries of Foreign Trusts

1. General Return Information

a. "Distribution" Defined


b. Charitable and Compensation Trusts

2. Beneficiary Statements

3. Filing Dates

4. Penalties

a. "Gross Reportable Amount" Defined

b. Responsible Party

c. Reasonable Cause Exception

d. Deficiency Procedures

D. Foreign Bank Accounts - Form TD F 90-22.1

E. U.S. Recipients of Foreign Gifts

1. Reportable Gifts

2. Dollar Limitations

a. Gifts by Foreign Estates and Individuals

b. Gifts from Foreign Corporations or Partnerships

c. Aggregation of Transfers

3. Data Required

4. Filing Dates

5. Penalties

a. Responsible Party

b. Reasonable Cause Exception

F. Form 56: Notice Concerning Fiduciary Relationship

G. Form 1040NR: Nonresident Alien Income Tax Return

H. Form 4970: Accumulation Distributions

I. FIRPTA Reports

J. Form 1042-S: Annual Withholding Tax Return for U.S. Source Income of Foreign Persons

VIII. Selecting the Situs of Foreign Trusts

Introductory Material

A. Substantive Trust Law Existence and Development

B. Tax Burden on the Trust

C. Currency and Currency Controls

D. Political and Economic Stability of the Situs Nation

E. Asset Protection Laws

F. Availability of Communications Facilities

G. Availability of Competent Trustees

H. Split Situs/Governing Law

IX. Changing the Situs of Foreign Trusts

Introductory Material

A. Methods of Relocating a Foreign Trust

B. Tax Consequences

1. Termination and Recreation as a Domestic Trust

a. Tax Consequences Under the Change-of-Form View

b. Tax Consequences Under the Split-Transaction View

2. Decanting

a. Tax Consequences Under the Change-of-Form View

b. Tax Consequences Under the Split-Transaction View

3. Changing Trustee and Situs of Administration

C. Changing the Situs of a Trust from One Foreign Country to Another

1. Tax Consequences of Termination and Recreation

a. Tax Treatment Under the Change-of-Form View

b. Tax Treatment Under the Split-Transaction View

2. Decanting a Trust from One Foreign Country to Another

X. Drafting, Executing, and Administering Foreign Trusts

Introductory Material

A. Drafting to Assure That the Trust Is a Foreign Entity

1. Violating the Control Test

2. Violating the U.S. Court Test

B. Unfavorable Situs and the Force Majeure Clause

C. Drafting the Trustee's Investment Powers

D. Distribution Provisions

E. Avoiding U.S. Beneficiaries

F. Selecting Assets to Fund the Trust

XI. Special Planning Uses of Foreign Trusts

Introductory Material

A. Trusts with U.S. Grantors and U.S. Beneficiaries

B. Trusts with Foreign Grantors

C. Trusts with U.S. Grantors and Foreign Beneficiaries

D. Foreign Asset Protection Trusts

1. Structure of the Asset Protection Trust

a. Distribution Authority

b. Right to Revoke

c. Right to Change Trustees

d. Trust Protector

2. Situs of the Trust

3. Creditors Rights Problems Under U.S. Law

4. Tax Issues

a. Grantor Trust Status and Gain Recognition Under § 684

b. Gift and Generation-Skipping Transfer Taxes

c. Withholding Taxes

E. Abusive Foreign Trusts

XII. Investments by a Foreign Trust

Introductory Material

A. Foreign Life Insurance Trusts

1. U.S. Estate Taxation

2. Transfer for Value Problems Under § 684

3. Income Taxation of U.S. Beneficiaries

B. Foreign Mutual Funds

XIII. Foreign Estates

Introductory Material

A. The Definitional Problem

1. "Estate" Defined

2. "Foreign" Defined

a. Income Tax

b. Estate Taxes

B. U.S. Estate Taxation of Foreign Estates

1. The Gross Estate

2. Deductions

3. Computation and Credits

4. Estate and Gift Tax Treaties

C. U.S. Income Taxation of Foreign Estates

1. Income Taxation of Estates Generally

2. Foreign Income of Foreign Estates

a. Taxation of the Estate and Foreign Beneficiaries

b. Taxation of U.S. Beneficiaries

3. U.S. Income of Foreign Estates

a. Taxation of the Estate and of Foreign Beneficiaries

(1) Determination of Trade or Business

(2) Capital Gains

(3) Fixed or Determinable Annual or Periodic Income

b. U.S. Beneficiaries

c. Transfers of Appreciated Assets to Foreign Estates

D. Returns Required of Foreign Estates

1. Fiduciary Income Tax Returns

2. Estate Tax Returns

3. FIRPTA Reports

4. Transfer Certificates

XIV. Collection and Enforcement

Introductory Material

A. Liability of a Foreign Fiduciary for U.S. Taxes

B. Extraterritorial Enforcement of IRS Levies by U.S. Courts

C. Extraterritorial Enforcement of IRS Assessments Through Foreign Courts

1. Enforcement of IRS Assessments Through Foreign Courts

2. Enforcement of U.S. Tax Laws Through Tax Treaties

Working Papers

Working Papers

Table of Worksheets

Worksheet 1 Staff of the Joint Committee on Taxation, 94th Cong., General Explanation of the Tax Reform Act of 1976, pp. 218-226 (1976) (Committee Print)

Worksheet 2 Staff of the Joint Committee on Taxation, 95th Cong., General Explanation of the Revenue Act of 1978, pp. 364-368 (1979) (Committee Print)

Worksheet 3 Conference Report on the Technical and Miscellaneous Revenue Act of 1988 (H.R. 4333), pp. 113-116

Worksheet 4 Conference Report to the Small Business Job Protection Act of 1996, H.R. Rep No 104-737, 104th Cong., 2nd Sess., pp. 330-338 (1996)

Worksheet 5 Conference Report to the Taxpayer Relief Act of 1997, H.R. Rep. No. 105-220, 105th Cong., 1st Sess., pp. 628-633 (1997)

Worksheet 6 Form TD F 90-22.1, Report of Foreign Bank and Financial Accounts

Worksheet 7 Preamble to REG-252487-96 (62 Fed. Reg. 30785-30789, 6/5/97), Inbound Grantor Trusts with Foreign Grantors

Worksheet 8 Preamble to REG-251703-96 (62 Fed. Reg. 30796-30798, 6/5/97), Residence of Trusts and Estates

Worksheet 9 Preamble to T.D. 8813 (64 Fed. Reg. 4967-4970, 2/2/99), Residence of Trusts and Estates

Worksheet 10 Preamble to REG-209038-89 (65 Fed. Reg. 48182-48190, 8/7/00), Foreign Trusts That Have U.S. Beneficiaries

Worksheet 11 Preamble to T.D. 8955 (66 Fed. Reg. 37886-37889, 7/20/01), Foreign Trusts That Have U.S. Beneficiaries

Worksheet 12 Preamble to REG 108522-00 (65 Fed. Reg. 48198-48201, 8/7/00), Recognition of Gain on Certain Transfers to Certain Foreign Trusts and Estates

Worksheet 13 Preamble to T.D. 8956 (66 Fed. Reg. 37897-37899, 7/20/01), Recognition of Gain on Certain Transfers to Certain Foreign Trusts and Estates

Worksheet 14 Selected Sample Foreign Trust Clauses (Force majeure clause, no U.S. beneficiary clause, rule against perpetuities clause, investment authority)



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