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"Foreign Grantor Trusts": Non-US Persons Can Provide for Children Living in the US While Avoiding US Gift, Estate and Income Tax
By Dani N. Ruran on April 7, 2021Rather than gifting assets directly to a child (or other individual) living in the United States who is subject to US income tax (which would then subject the assets to US income tax), someone who is not a “United States Person” (not a US citizen or a US permanent resident/“Green Card” holder) may transfer assets to a “Foreign Grantor Trust” for the benefit of such child (or other individual). Doing so with appropriate assets can exempt the trust property from US (and state) gift, estate and income taxation while the trust continues to be a Foreign Grantor Trust. (Only “US source income” earned by the trust – for example, dividends from shares of US corporations – is subject to US income tax.)
A Foreign Grantor Trust is a trust in which either: (a) the Grantor reserves the right to revoke the trust alone or with the consent of a related party, or (b) the Grantor (and spouse, if any) is the sole trust beneficiary during the Grantor’s lifetime. (While typical trusts require a foreign Trustee in order to be considered a foreign trust for US income tax purposes, a Foreign Grantor Trust need not have a foreign Trustee.) Assuming the Grantor wants a child to be a beneficiary immediately, the Grantor would use trust type (a), above – that is, reserve the right to revoke the trust. By reserving the right to revoke the trust, the Grantor’s gifts to the trust – regardless of the type of asset – avoid US gift tax, and by reserving the Grantor’s right to distribute trust property to anyone during her lifetime, the trust assets qualify for a “step up” in basis at the Grantor’s death, for capital gains avoidance purposes, thus reducing potential capital gains tax on the gifts when they are sold after the Grantor’s death.
Different US gift and estate taxation rules apply to non-US Persons, as compared to US Persons. First, US Persons are currently entitled to an $11.7 million combined gift/estate tax exemption, while non-US Persons only have a $60,000 gift/estate tax exemption (unless modified by applicable treaty). Second, while US Persons are subject to such taxation on “worldwide assets,” (a) non-US Persons are subject to US gift tax only on gifts of real or tangible personal property located in the US, including gifts of US or foreign currency or cash within the US (gifts of shares of US corporations are not subject to the gift tax); and (b) non-US Persons are subject to US estate taxation only on US situs property (real or tangible property located in the US, but including shares of US corporations).
Therefore, typically, non-US Persons will transfer US bank accounts or shares of foreign corporations to such a trust (which are exempt from gift tax regardless of which type of Foreign Grantor Trust is used – type (a) or (b), described above). Then, interest on those accounts and dividends from such shares are not subject to US income tax during the Grantor’s lifetime, even if distributed to the US trust beneficiaries (instead they are treated as gifts from the Grantor requiring reporting to the IRS on Form 3520), and at the Grantor’s death, these accounts and shares are not subject to US estate tax.
As the best structure of such trusts and the best type of assets to be gifted to and held by such a trust depend on your personal situation, please contact us to learn how a Foreign Grantor Trust might help in your circumstances. FT
©2021. This material is intended to offer general information to clients and potential clients of the firm, which information is current to the best of our knowledge on the date indicated below. The information is general and should not be treated as specific legal advice applicable to a particular situation. Fletcher Tilton PC assumes no responsibility for any individual’s reliance on the information disseminated unless, of course, that reliance is as a result of the firm’s specific recommendation made to a client as part of our representation of the client. Please note that changes in the law occur and that information contained herein may need to be reverified from time to time to ensure it is still current. This information was last updated April 2021.
A Foreign Grantor Trust is a trust in which either: (a) the Grantor reserves the right to revoke the trust alone or with the consent of a related party, or (b) the Grantor (and spouse, if any) is the sole trust beneficiary during the Grantor’s lifetime. (While typical trusts require a foreign Trustee in order to be considered a foreign trust for US income tax purposes, a Foreign Grantor Trust need not have a foreign Trustee.) Assuming the Grantor wants a child to be a beneficiary immediately, the Grantor would use trust type (a), above – that is, reserve the right to revoke the trust. By reserving the right to revoke the trust, the Grantor’s gifts to the trust – regardless of the type of asset – avoid US gift tax, and by reserving the Grantor’s right to distribute trust property to anyone during her lifetime, the trust assets qualify for a “step up” in basis at the Grantor’s death, for capital gains avoidance purposes, thus reducing potential capital gains tax on the gifts when they are sold after the Grantor’s death.
Different US gift and estate taxation rules apply to non-US Persons, as compared to US Persons. First, US Persons are currently entitled to an $11.7 million combined gift/estate tax exemption, while non-US Persons only have a $60,000 gift/estate tax exemption (unless modified by applicable treaty). Second, while US Persons are subject to such taxation on “worldwide assets,” (a) non-US Persons are subject to US gift tax only on gifts of real or tangible personal property located in the US, including gifts of US or foreign currency or cash within the US (gifts of shares of US corporations are not subject to the gift tax); and (b) non-US Persons are subject to US estate taxation only on US situs property (real or tangible property located in the US, but including shares of US corporations).
Therefore, typically, non-US Persons will transfer US bank accounts or shares of foreign corporations to such a trust (which are exempt from gift tax regardless of which type of Foreign Grantor Trust is used – type (a) or (b), described above). Then, interest on those accounts and dividends from such shares are not subject to US income tax during the Grantor’s lifetime, even if distributed to the US trust beneficiaries (instead they are treated as gifts from the Grantor requiring reporting to the IRS on Form 3520), and at the Grantor’s death, these accounts and shares are not subject to US estate tax.
As the best structure of such trusts and the best type of assets to be gifted to and held by such a trust depend on your personal situation, please contact us to learn how a Foreign Grantor Trust might help in your circumstances. FT
©2021. This material is intended to offer general information to clients and potential clients of the firm, which information is current to the best of our knowledge on the date indicated below. The information is general and should not be treated as specific legal advice applicable to a particular situation. Fletcher Tilton PC assumes no responsibility for any individual’s reliance on the information disseminated unless, of course, that reliance is as a result of the firm’s specific recommendation made to a client as part of our representation of the client. Please note that changes in the law occur and that information contained herein may need to be reverified from time to time to ensure it is still current. This information was last updated April 2021.
