Foreign Grantor Trusts: Non-US Trust Planning for US Family Members

Trusts are often used by successful families to provide for long term succession planning and centralized asset management. However, US tax rules can adversely impact US citizens, green card holders and income tax residents who do or even can benefit from income and capital gain in non-US trusts (and their underlying holding companies). Non-US patriarchs and matriarchs with US family members can though substantially improve the position for their US family members through the establishment of a so called ‘foreign grantor trust’ (hereinafter ‘FGT’).
A properly structured and administered FGT provides highly favorable US federal tax treatment for US family members including:
These benefits are particularly attractive when compared either to transferring assets outright to US family members or currently placing assets into a trust not qualifying for FGT status. Assets currently transferred to:
While in many circumstances it should be relatively straight forward to structure a trust to qualify for FGT status, there are a number of related but additional trust drafting and structuring considerations needing to be addressed:
Following the settlor’s passing, the FGT will automatically convert to ‘foreign non-grantor trust’ (hereinafter ‘FNGT’) status. At that point in time, leaving aside additional considerations with respect to trust assets classified as PFICs or CFCs, very generally speaking,
Rather than owning investment assets directly, non-US trusts will frequently choose to use a non-US holding company to own such assets. Further, as noted above, where it comes to US situs assets, it is generally the case that such assets should be held via a non-US holding company so as to eliminate US estate tax exposure that generally would otherwise apply to those US situs assets. The use of a holding company can though create income and gains tax complications for the US family member beneficiaries with respect to the settlor’s passing.
Depending on the overall facts and circumstances at the time of the settlor’s passing, if more than half of the holding company’s ownership is attributed through the trust to US family members, such holding company generally would be classified as a CFC thereby creating US tax and reporting considerations for the US family members with respect to income and gains arising within the holding company after the settlor’s passing.
Prior to 2018, it was generally the case that (following the settlor’s passing) ongoing CFC tax exposure to the US family members could be eliminated by filing a so called “check the box” election to treat the holding company as liquidated / disregarded for US tax purposes in a manner that did not create CFC tax exposure to the US family member beneficiaries while still protecting US situs assets held by the holding company from US estate tax exposure in connection with the settlor’s passing.
However, under current law, such “check the box” election could now itself generate CFC tax for the US family members (generally measured by reference to the amount of built-in gains in the holding company’s assets and the point in time during the year at which the settlor passed). Thus, if the holding company owns a mix of US and non-US situs assets, absent additional planning the tax cost of protecting the US situs assets from estate tax exposure generally will be a one off CFC tax exposure for the US family members following the settlor’s passing.
In instances where the holding company doesn’t own any US situs assets, it generally should be possible to make a check the box election in a manner that doesn’t cause CFC tax exposure for the US family members.
Assuming it’s not feasible to eliminate US situs assets, then consideration can be given to several strategies, all of which would improve the position in varying ways, including:
Where the trust (directly or indirectly) holds substantial interests in ‘trading’ or ‘operating companies’, further CFC considerations may apply.
Depending on the overall facts and circumstances following the settlor’s passing, if the trust holds PFICs (directly or via or with respect to holding companies) then the US family member beneficiaries might be subject to tax and compounding interest charges when such PFICs are disposed of or such PFICs themselves make distributions (potentially even if such amounts are not even currently distributed to the US family member beneficiaries). Generally speaking:
How best to deal with PFICs will depend on a number of factors including the mix and needs of US and non-US family members, whether the trust was structured to qualify for a basis step up, how the PFICs were held (e.g. if through a holding company, did it also own US situs asses) and how check the box planning is implemented in connection with the settlor’s passing.
We would be pleased to discuss how best to tailor a ‘foreign grantor trust’ structure to the particular facts and circumstances of individual families.
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