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Under current U.S. tax law, a trust entity is not subject to U.S. income tax as a foreign trust if it is (1) classified as a trust, and (2) if its contacts with a foreign situs are sufficient, and (3) its contacts with the U.S. so insubstantial, as to render it a foreign entity. Title 26 USC 7701(a)(31) says that a foreign trust is one "the income of which from sources without the United States which is not effectively connected with the conduct of a trade or business within the United States, is not includable in gross income under Subpart A." In effect, to avoid U.S. income tax liability, the trust must take the appearance of a nonresident alien.
Since a trust is a separate legal entity, it can be used in estate planning to hold assets in suspense, in capitol gains tax planning to avoid time apportionment, in income tax planning to reduce the effective rate of tax, and by changing the residence to defer income tax and capitol gains tax, often for long periods of time. When the trust's grantor trust status makes the beneficiary's income tax free, retaining that status for as long as possible becomes important.
Note: Recent repeal of Rev-Rul 69-70 – which made income distributions to US beneficiaries of a foreign grantor trust not taxable – makes the use of foreign trusts less attractive. Current rules make foreign trust distributions taxable to the US beneficiaries.
Still, the use of a corporate foreign grantor for a foreign trust might provide certain advantages. Corporate grantors for domestic US trusts are recognized by the IRS and US courts have ruled on such arrangements – consequently, foreign trusts with corporate settlors would also be recognized by US courts, unless the IRS, tax code or treasury regulations promulgate new law precluding their use.
It is clear that a corporation may be the grantor and the owner of a trust. Thus, a foreign grantor could create a corporation which in turn would create a grantor trust. The death of the creating shareholder would terminate neither the corporation's separate existence nor the trust's grantor status.
The IRS uses 5 factors to determine the situs and nationality of a trust:
1. the country under whose laws the trust was created,
2. the situs of the trust's corpus,
3. the nationality and residence of the trustees (at least one-half must be foreign),
4. the situs of the trust's administration,
5. the nationality and residence of the Grantor/Settlor.
Foreign trusts should not have named US beneficiaries or US settlors
Tax Return 1040: U.S. beneficiaries should answer item 11(a) (YES) and item 12 (NO) on Schedule B, Part III which appears on the back of Form 1040. Checking (YES) (to 11) means the U.S. beneficiary may have to file Form T.D.F. 90-22-1 (but not with a Form 1040).
Reporting on Form T.D.F. 90-22-1: If the beneficiaries have a signature authority (which they can have) over the trust, but no "financial interest", defined as "a trust in which the U.S. person either has a present beneficial interest in more than 50% of the assets, or receives more than 50% of the current income" of the trust, then they will merely be required to tell the Treasury their name and U.S. address. No disclosure regarding the amount of income received is mandatory. To avoid beneficiaries having a "financial interest", the trust creator could limit the beneficial enjoyment of all beneficiaries to 50% or less.
Properly arranged foreign trusts do not have to be registered with either the U.S. government or the tax haven government, thus names of beneficiaries, trustees and grantor(s) are not a matter of public record, and might not be subject to disclosure on IRS forms 3520 or 3520-A.
A foreign corporation (or trust) that does not carry on a trade or business within the United States does not have to file a Federal Income Tax Return.
"The legal right of an individual to decrease ... or ALTOGETHER AVOID his/her taxes by means which the law permits cannot be doubted" Gregory v. Helvering, 293 U.S. 465
Guarantees against future taxes are provided by the offshore tax haven governments for periods of up to 50 years. Exempt trusts can receive guarantees of up to 100 years.
Pursuant to Internal Revenue Service guidance, be advised that any federal tax advice in this communication, including any attachments or enclosures, was not intended or written to be used, and it cannot be used, by any person or entity for the purpose of avoiding penalties imposed under the Internal Revenue Code.
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