trust distributions to foreign beneficiaries: mastering...
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Trust Distributions to Foreign Beneficiaries:
Mastering Complex Planning and Calculation Challenges Navigating the Complicated Interplay of Foreign Withholdings, Treaty Benefits, DNI Calculations, and Trust Compliance
THURSDAY, JANUARY 5, 2017, 1:00-2:50 pm Eastern
FOR LIVE PROGRAM ONLY
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FOR LIVE PROGRAM ONLY
Jan. 5, 2017
Trust Distributions to Foreign Beneficiaries
Cynthia Brittain, Vice President and Senior Fiduciary Officer
Northern Trust, Santa Barbara, Calif.
Dianne C. Mehany, Member
Caplin & Drysdale, Washington, D.C.
John R. Strohmeyer
Crady Jewett & McCulley, Houston
Notice
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without limitation, the tax treatment or tax structure, or both, of any transaction
described in the associated materials we provide to you, including, but not limited to,
any tax opinions, memoranda, or other tax analyses contained in those materials.
The information contained herein is of a general nature and based on authorities that are
subject to change. Applicability of the information to specific situations should be
determined through consultation with your tax adviser.
5
Strafford Continuing Education
Webinars – January 5, 2017
A presentation for
U.S. Taxation of Foreign Trusts
Cynthia D. Brittain, J.D., LL.M., TEP Senior Vice President Regional Wealth Advisor, Northern Trust
© 2017 Northern Trust
6
Overview
Introduction: Why understanding trusts in the global context is important: And the moral of the story is….
Definition of a Trust – in the world of global relationships
Definition of a Foreign Trust (Foreign Grantor/Foreign Nongrantor)
Definition of U.S. Person versus Foreign Person
Israeli tax on Israeli Resident Beneficiaries who are U.S. Persons;
Case Study
7
And the Moral of the Story…why do you need to understand this stuff?
Outbound
• The California Revocable Trust Migration Story.
• Gifting to U.K.-based children through U.S. gift trusts.
• Gifting to Israeli-based children through U.S. gift trusts.
• Trust planning with California community property.
Inbound
• The California Revocable Trust for the Non-Resident, Non-Domiciled
individual’s inbound activities. (Inbound)
United Kingdom individuals
Canadian residents
Scenarios to demonstrate the difference between Inbound and Outbound Planning
and the treatment of trusts in different jurisdictions: The “why” of understanding trusts
in the cross border context.
Definition of a Trust – in the world of global relationships
9
Trust Classification
What is a Trust for U.S. Tax Purposes? And Why Does it Matter…
Lichtenstein Foundations?
Stiftungs? Usufructs?
Treuhand? Establishments?
Investment or Business Trusts?
10
Classifications (continued)
Ordinary Trusts -- 301.7701-4(a)
In general, the term “trust” as used in the Internal Revenue Code refers to an arrangement
created either by a will or by an inter vivos declaration whereby trustees take title to property
for the purpose of protecting or conserving it for the beneficiaries under the ordinary rules
applied in chancery or probate courts. Usually the beneficiaries of such a trust do no more
than accept the benefits thereof and are not the voluntary planners or creators of the trust
arrangement. However, the beneficiaries of such a trust may be the persons who create it and
it will be recognized as a trust under the Internal Revenue Code if it was created for the
purpose of protecting or conserving the trust property for beneficiaries who stand in the same
relation to the trust as they would if the trust had been created by others for them. Generally
speaking, an arrangement will be treated as a trust under the Internal Revenue Code if it can
be shown that the purpose of the arrangement is to vest in trustees responsibility for the
protection and conservation of property for beneficiaries who cannot share in the discharge of
this responsibility and, therefore, are not associates in a joint enterprise for the conduct of
business for profit.
11
Classifications (continued)
Business Trusts -- 301.7701-4(b)
There are other arrangements which are known as trusts because the legal title to property is
conveyed to trustees for the benefit of beneficiaries, but which are not classified as trusts for
purposes of the Internal Revenue Code because they are not simply arrangements to protect
or conserve the property for the beneficiaries. These trusts, which are often known as
business or commercial trusts, generally are created by the beneficiaries simply as a device to
carry on a profit-making business which normally would have been carried on through
business organizations that are classified as corporations or partnerships under the Internal
Revenue Code. However, the fact that the corpus of the trust is not supplied by the
beneficiaries is not sufficient reason in itself for classifying the arrangement as an ordinary
trust rather than as an association or partnership. The fact that any organization is technically
cast in the trust form, by conveying title to property to trustees for the benefit of persons
designated as beneficiaries, will not change the real character of the organization if the
organization is more properly classified as a business entity under Section 301.7701-2.
12
Classifications (continued)
Investment Trusts -- 301.7701-4(c)(1)
An “investment” trust will not be classified as a trust if there is a power under the trust
agreement to vary the investment of the certificate holders. See Commissioner v. North
American Bond Trust, 122 F. 2d 545 (2d Cir. 1941), cert. denied, 314 U.S. 701 (1942). An
investment trust with a single class of ownership interests, representing undivided beneficial
interests in the assets of the trust, will be classified as a trust if there is no power under the
trust agreement to vary the investment of the certificate holders. An investment trust with
multiple classes of ownership interests ordinarily will be classified as a business entity under
Section 301.7701-2; however, an investment trust with multiple classes of ownership interests,
in which there is no power under the trust agreement to vary the investment of the certificate
holders, will be classified as a trust if the trust is formed to facilitate direct investment in the
assets of the trust and the existence of multiple classes of ownership interests is incidental to
that purpose.
13
Classifications (continued)
301.7701-4(c)(2), Example 4. Business Interest versus Trust Classification.
Corporation N purchases a portfolio of bonds and transfers the bonds to a bank under a trust
agreement. At the same time, the trustee delivers to N certificates evidencing interests in the
bonds. These certificates are sold to public investors. Each certificate represents the right to
receive a particular payment with respect to a specific bond. Under section 1286, stripped
coupons and stripped bonds are treated as separate bonds for federal income tax purposes.
Although the interest of each certificate holder is different from that of each other certificate
holder, and the trust thus has multiple classes of ownership, the multiple classes simply
provide each certificate holder with a direct interest in what is treated under section 1286 as a
separate bond. Given the similarity of the interests acquired by the certificate holders to the
interests that could be acquired by direct investment, the multiple classes of trust interests
merely facilitate direct investment in the assets held by the trust. Accordingly, the trust is
classified as a trust.
14
Why is Trust Classification Important?
Usufruct --
In Public Letter Ruling – 9121035 (91 TNT 116-47 (February
25, 1991), the IRS characterized a usufruct under German law (a Civil
Law country) as a foreign non-grantor trust.
Stiftung -- Great Analysis of trust factors…
In Estate of O.T. Swan, 24 T.C. 803 (1981, acq. 1981-2 C.B.
1., the Tax Court determined that stiftungs should be treated as trusts
for U.S. tax purposes.
The family wanted the stiftung to be treated as a trust
because U.S. children were inheriting German assets.
Liechtenstein Anstalt
A trust analysis provided that the anstalt was a trust. (AM
2009-012).
Foreign Trusts -- To Satisfy the Unique Needs of Nonresident, Non-domiciled Individuals and Their Families
16
NRAs Have Unique Needs
Political uncertainty in the client’s home
country may be causing currency instability.
Institutions in the home country may lack
sufficient financial strength.
Home country conditions may increase client
desire for privacy.
Home country market may not offer sufficient
asset diversification.
Desire access to U.S. markets directly.
NRA needs may include:
Stability:
Safety:
Privacy:
Diversification:
Access:
17
Common Reporting Standard – Broader than FATCA
• G20 Leaders at their meeting in September 2013 fully endorsed the OECD proposal for a truly global
model for automatic exchange of information and invited the OECD, working with G20 countries, to
develop such a new single standard for automatic exchange of information, including the technical
modalities, to better fight tax evasion and ensure tax compliance.
• The Standard, developed in response to the G20 request and approved by the OECD Council on 15
July 2014, calls on jurisdictions to obtain information from their financial institutions and automatically
exchange that information with other jurisdictions on an annual basis. It sets out the financial account
information to be exchanged, the financial institutions required to report, the different types of accounts
and taxpayers covered, as well as common due diligence procedures to be followed by financial
institutions.
• To fight tax evasion, 99 countries have agreed to automatically exchange information, including most
western nations (except the USA), BRICS and tax havens. Accounts include banking, custodial,
securities and investment funds. These may be held by individuals or entities, including companies,
partnerships, trusts and foundations. Politically motivated and flawed legislation has been rushed
through with no cost-benefit analysis invading individual privacy and national sovereignty, resulting in
global data theft, blackmail and political oppression. At least two countries may become major
beneficiaries as havens for global capital.
Foreign Trusts -- Defined
19
When is a Trust a Foreign Trust?
• A Trust is deemed to be foreign unless both of the following
are satisfied:
Court Test
Control Test
• Curing an inadvertent change
• Beware IRC §684(c)
Definitions found in IRC §7701(a)(30)(E), (a)(31)
20
Is the Foreign Trust a Nongrantor or Grantor Trust?
Grantor Trust: Definition
• U.S. Settlor – IRC §§ 671-679
Grantor trust status generally limited to U.S. citizens,
resident individuals, and domestic corporations
Foreign Grantor Trust: Definition
• Non-Citizen, non-resident settlor – IRC §672(f)
Foreign grantor trust status available only if:
Foreign settlor retains right to revest assets (i.e., a
revocable trust), OR
The Trust must distribute only to settlor or settlor’s
spouse during his or her lifetime.
• Foreign intermediaries may be disregarded (IRC §672(f)(5))
21
Is the Foreign Trust a Nongrantor or Grantor Trust?
Foreign Grantor Trust : Definition (cont.)
• U.S. Grantor Treated as Owner - IRC § 679
Trust is a foreign trust
Transferor is a U.S. Person (IRC § 7701(a)(30))
NRA transferor who becomes a U.S. resident within
5 years of the transfer
Trust has one or more U.S. beneficiaries; AND
Transferor makes a direct or indirect transfer of assets
to the trust
Exceptions for testamentary transfers, transfers for
FMV and transfers to charitable or employee trusts
Presumption that every foreign trust has a U.S.
Beneficiary…
Taxation and Reporting --
23
Federal Taxation and Reporting of Foreign Nongrantor Trust
Foreign Nongrantor Trust: Taxation and Reporting
Calendar Year End (IRC § 644)
Taxed as an NRA individual with modifications (IRC § 641(b))
Reports only U.S.-source FDAP income (30% withholding
or treaty rate) and ECI (at graduated rates)
Income taxed to trust, beneficiaries, or partly to each:
DNI includes worldwide income
DNI includes capital gains (net of losses) (IRC §
643(a)(6)(C))
Deductions for distributions to beneficiaries
Simple or Complex
24
Federal Taxation and Reporting of Foreign Nongrantor Trust
Foreign Nongrantor Trust: Taxation and Reporting (cont)
• File Form 1040NR, U.S. Non-resident Alien Income Tax Return
U.S.-source FDAP not properly withheld upon or if deemed
to be ETB in the U.S.
Due June 15 (if no office in the U.S.), 6 month extension
• EIN
• Pass-through of U.S. withholding taxes
• Form W-8 and U.S. withholding considerations
• Throwback rules for distribution to U.S. beneficiaries of
accumulated income (IRC §§ 666 and 667)
25
Federal Taxation and Reporting of Foreign Nongrantor Trust
Foreign Nongrantor Trust: Taxation and Reporting (cont)
• Provide Foreign Nongrantor Trust Beneficiary Statement
for distributions to U.S. Beneficiaries
• Appoint a U.S. Agent?
• Form W-8 and U.S. withholding considerations
• Form 8805, Foreign Partner’s Information Statement of
Section 1446 Withholding Tax, for a trust that is a
partner in a partnership that withheld tax under IRC §
1446 (ECI)
Provide to U.S. beneficiary a copy of Form 8805
from partnership and prepare Schedule T Form
8805.
26
Federal Taxation and Reporting -- U.S. Beneficiary of Foreign Nongrantor Trust
Foreign Nongrantor Trust – U.S. Beneficiary: Taxation and
Reporting
• Report taxable trust distributions on Form 1040
• Form 3520, Annual Return to Report Transactions with
Foreign Trusts and Receipt of Certain Foreign Gifts
Receives a distribution from a foreign trust
Direct or indirect loan of cash or marketable
securities of the uncompensated use of trust
property (exception for qualified obligations)
Attach Foreign Nongrantor Trust Beneficiary Statement
• Form 4970, Tax on Accumulation Distribution of Trusts
UNI distribution
27
Federal Taxation and Reporting -- U.S. Beneficiary of Foreign Nongrantor Trust
Foreign Nongrantor Trust – U.S. Beneficiary: Taxation and
Reporting (cont)
• FinCen Form 114, Report of Foreign Bank and Financial
Accounts
U.S. beneficiary with a greater than 50% present beneficial
interest n the trust’s assets or income
• Form 8938, Statement of Specified Foreign Financial Assets
An interest in a foreign trust or estate is a SFFA
• Consider need for Forms 5471, 8865, 8858, 8621, 926 (foreign
entities)
28
Federal Taxation and Reporting -- Foreign Beneficiary of Foreign Nongrantor Trust
Foreign Nongrantor Trust – Foreign Beneficiary: Taxation
and Reporting
• U.S. reporting may be required if distribution carries out a
portion of DNI that is U.S.-source FDAP or ECI
• File Form 1040NR, U.S. Nonresident Alien Income Tax
Return
U.S.-sourced FDAP income not properly withheld upon
or if deemed to be ETB in the U.S.
29
Federal Taxation and Reporting -- Foreign Grantor of Foreign Grantor Trust
Foreign Grantor Trust – Foreign Grantor: Taxation and Reporting
• Trust Files Form 1040NR, U.S. Nonresident Alien Income Tax
Return
Include “grantor trust language” and detail of income, gains,
and losses
Due June 15 (if no office in the U.S.), 6 month extension
• Foreign grantor files Form 1040NR to report trust’s U.S.-source
FDAP income (if not properly withheld upon) or if deemed to be
ETB in the U.S.
• Form W-8 and U.S. withholding considerations
31
Federal Taxation and Reporting -- U.S. Grantor of Foreign Grantor Trust
Foreign Grantor Trust – U.S. Grantor: Trust Taxation and
Reporting
• Trust Files Form 1040NR, U.S. Nonresident Alien Income Tax
Return
Include “grantor trust language” and detail of income, gains,
and losses
Due June 15 (if no office in the U.S.), 6 month extension
• Trust Files Form 3520-A Annual Information Return of Foreign
Trust with a U.S. Owner
Trustee must file an annual Form 3520-A to report U.S.
owner
• Foreign Grantor Trust Owner Statement
• Foreign Grantor Trust Beneficiary Statement
• Appoint a U.S. agent?
• Form W-8 and withholding considerations
32
Federal Taxation and Reporting -- U.S. Grantor of Foreign Grantor Trust
Foreign Grantor Trust - U.S. Grantor: Grantor Taxation and Reporting
• U.S. grantor includes trust income, gain and losses on Form 1040
• Form 3520, Annual Return to Report Transactions with Foreign
Trusts and Receipt of Certain Foreign Gifts
Attach Foreign Grantor Trust Owner Statement
• U.S. grantor is responsible for Trustee filing Form 3520-A and
providing owner and beneficiary statements
33
Federal Taxation and Reporting -- U.S. Grantor of Foreign Grantor Trust
Foreign Grantor Trust - U.S. Grantor: Grantor Taxation and
Reporting (cont)
• FinCen Form 114, Report of Foreign Bank and Financial
Accounts
U.S. grantor reports foreign accounts held by trust
• Form 8938, Statement of Specified Foreign Financial Assets
U.S. grantor considered to own an interest in any SFFA
held by the trust
• Consider need for Forms 5471, 8865, 8858, 8621, 926 (foreign
entities)
• U.S. withholding tax considerations
34
Federal Taxation and Reporting – U.S. Beneficiary of Foreign Grantor Trust
Foreign Grantor Trust –U.S. Beneficiary: Taxation and
Reporting
• Form 3520, Annual Return to Report Transactions
with Foreign Trusts and Receipt of Certain Foreign
Gifts U.S. beneficiary receives a distribution from a foreign
trust Direct or indirect loan of cash or marketable securities or
the uncompensated use of trust property (exception for
qualified obligations)
Attach Foreign Grantor Trust Beneficiary Statement
35
Federal Taxation and Reporting -- Foreign Beneficiary of Foreign Grantor Trust
Foreign Grantor Trust –Foreign Beneficiary: Taxation and
Reporting
• No U.S. taxation or reporting
36
California Taxation -- Grantor/Nongrantor Trusts
Grantor Trust Treatment in California
• Federal grantor trust status generally respected
• Except if only a grantor trust under § 679
Cal. Rev. & Tax Code § 17024.5(b)
Nongrantor Trust Treatment in California
• Subject to California tax if:
One or more of the fiduciaries is a California resident;
One or more of the “noncontingent beneficiaries” is a
California resident; or,
The trust has California sourced income.
Settlor residence is irrelevant
37
Current Client Issues with trusts…
What are the issues? Trusts are not always the panacea…
Israel taxes income distributions from foreign trusts made to Israeli resident beneficiaries
If relative trusts – choose 25% currently or 30% deferred;
This income already taxed in the US as a grantor trust;
What is income?
Can we get a foreign tax credit?
Israel, the UK, Canada – pose particular issues with trusts
These require special considerations
Mom, U.S., and Dad, NRA (US taxation)
Children (U.S. and Israel)
(Israel taxation)
38
Allocate
GST $5,430,000
$23,570,000 $12,800,000
This value passes free of estate tax
and GST Tax. We presume
$67,000,000 at death of Surviving
spouse. $67,000,000 estate tax free
to children.
This value at SS death is
$213MM. Subject to U.S.
Estate Tax=$85,200,000
(40,45,50) (40,45,50)
Recommendation – GST Planning and
Loan to NRA Spouse under § 7672.
(35,40,45,50) (25,30,35)
$31,800,000
All become subject to US Estate Tax at Child’s Level
At Mom’s passing, this
amount can be double.
Taxed in children’s
estates
At Mom’s passing, this
amount can be double.
Taxed in children’s
estates.
Cross Border Scenario --- Mom is U.S. and Dad is NRA/Non-
Domiciled
The Mother’s SP Trust
Family Trust –
Unified Credit Amount
Outright to children in stages.
QDOT--
Outright to children in
stages.
Mom’s Gift Trust –
From her parents.
To GC in stages.
Mom’s Gift Trust –
From her parents.
To GC in stages.
39
Family Trust –
GST-Exempt
(Delaware Dynasty
Recommended)
QDOT –
Outright to children in
stages, or in trust for
asset protection
Mom’s Gift Trust -
- To children in
stages.
$12,800,000
$179MM outright.
(Only $13,570,000 invested
with $10MM note freeze)
US Est. Tax = $71,600,000
Versus
$23,570,000—invested
U.S. Est. Tax= $85,200,000
Keep in Trust for asset
protection.
The real savings shows in
the FGT planning.
These amounts stay in trust.
Wealth transfer grows estate tax
free; Ultimate distribution to
great-grandchildren estate tax
free.
Foreign Grantor Trust –
This is GST Exempt.
Use with estate freeze.
Dad should also consider.
1980 Children’s Trust
To children in stages
$31,800,000
Separate children’s
Trusts GST Exempt
(Delaware
Dynasty Trust)
$10mm invested US
estate tax free. During
Dad’s life, U.S. income
tax free. Provides greater
investment yield, except
to extent taxed in Israel.
After Mom’s passing,
this amount can more
than double.
Taxed in children’s
estate.
After Mom’s passing,
this amount can more
than double.
Taxed in children’s
estate
$23,570,000
• GST from Parents to Children --
$124MM
• GST from Children to
grandchildren - $7,270,000,000.
• Options with drop-off trust and
foreign grantor trust. Two
strategies in tandem.
1. GST from Parents to children --
$67,000,000
2. GST from Children to
grandchildren -- $318,363,602;
3. GST from Grandchildren to
GGC -- $1,918,571,243
4. GGC pass away --
$23,716,699,973 – planning
dynastically
Cross Border Recommendations (continued) Planning
$10mm Intra-spousal loan
The Mother’s SP Trust
$12,800,000 $31,800,000
Beware Foreign
Intermediary rules
Dianne C. Mehany
Citizenship – the “accidental citizen.” Consider the following scenario:
• Jack is born in the US in the 1930s. Moves to Canada at 25 and becomes a naturalized citizen.
• Jack and his Canadian wife Mary give birth to Anna in 1962 in Canada and Matthew in 1968 in
Canada.
• Anna is sent to boarding school in Vermont for two years. Then, trying to “find herself,” she
waitresses in New York City while trying to make it on Broadway. One year later she gives up and
moves back to Canada.
• Matthew spends four years in boarding school in Vermont, but attends university in Canada. After
graduation, he works for a hedge fund in New York City for three years before returning again to
Canada.
• Anna (unmarried) gives birth to Joe in 1995 in Canada.
• Jack and his (Canadian) wife, Susan, give birth to Kathryn in 1998 in Canada.
• Who is an American Citizen?
41
Residency – is your non-US citizen actually a US resident?
• Green card – does not matter whether “reside” in US or whether expired.
• Substantial Presence test (IRC 7701(b)(3))
• Spends 183 days, or more, in the US in any year.
• Spends 183 days under the “multiplier” in a three year period.
• 31 days in current year.
• Count entire day in current year, 1/3 day in immediately preceding
year, 1/6 day in second preceding year.
• Day count
• Any portion of a day in the US counts.
• Transit time does not count.
• Illness after enter US and unable to return home does not count.
What if enter US for medical treatment?
42
Exceptions to the substantial presence test
• Exempt Individuals (7701(b)(5)) • Closer connection and foreign tax home (7701(b)(3)(B))
• Must be in the US less than 183 days during the current year
• Must maintain a tax home in a foreign country • Cannot have taken affirmative action to become a lawful
permanent U.S. resident • Requirement to timely claim exception
• Treaty tie-breaker
43
• Generally, trust treated as taxable entity, but may pass through items of income
and deductions to beneficiaries
• Domestic Trusts
• The worldwide income of a US trust is taxable
• US trust has the deductions and credits available to a US individual (plus no AGI
limit on charitable deductions). Also receives distribution deduction for
beneficiary distributions.
• Foreign Trust
• Only US source income taxable in US. This includes FDAP, ECI, and FIRPTA.
(Interest under 871(h) and (i) excluded.)
• Foreign trust may only receive deductions to the extent they serve to offset ECI.
Also receives distribution deduction for beneficiary distributions.
44
• Basically, trust taxed like an individual, with certain exceptions
• Basic exception is that trust allowed a deduction for certain distributions
it makes to beneficiaries.
• DNI (distributable net income) is a unique income tax concept.
• It functions as an accounting methodology by which worldwide
income and gains are carried out to U.S. beneficiaries.
• DNI not completely taxable to foreign beneficiaries. One must look
through to the character and source of income to determine taxability
for foreign beneficiaries.
45
• DNI (distributable net income) is a unique income tax concept.
• It is essentially fiduciary accounting income that is distributable to
beneficiaries, net of trust expenses and deductions.
• Fiduciary Accounting Income (Section 643(b)) is the amount of income
of the trust under the terms of the governing instrument and
applicable local law. Items of gross income constituting extraordinary
dividends or taxable stock dividends which the fiduciary, acting in good
faith, determines to be allocable to corpus under the terms of the
governing income and applicable local law shall not be considered
income.
46
• US Trust DNI is taxable income plus tax exempt income; however, it
excludes capital gains and losses.
• Special rule for capital gains under 1.643(a)-3, if discretion permitted
by trust document. Treatment of distributions to foreign beneficiaries
in this case?
• Foreign trust DNI is taxable income including capital gains and losses.
• If Foreign trust distributes DNI to US beneficiary, the US beneficiary
must pay US tax on share of DNI that represents foreign source income
(even though foreign trust only remitted tax on portion of DNI that
was US source income).
47
• To calculate DNI
• First identify items of gross income (by type)
• Apply deductions to specific gross income items
• Allocate DNI between beneficiaries
Division depends on whether trust is simple or complex
o Simple = attribute ratably amongst beneficiary distributions,
regardless of whether foreign or domestic
o Complex = allocate according to the terms of the trust document
48
• Tier System
• Permits separate classes of beneficiaries
• Some receive mandatory distributions (typically all consisting of DNI)
• Some are discretionary beneficiaries
If the amount of distribution required for Tier 1beneficiaries exceeds DNI,
then all DNI is allocated to the Tier 1 beneficiaries.
If, however, there remains DNI after Tier 1 beneficiaries receive their full
distributions, the remaining DNI is allocated proportionately among the
Tier 2 beneficiaries, based upon the amount of trust property received
by each
49
Benefit of tier system for foreign beneficiaries? To trust entity itself?
• Consider type of income generated by trust
Treatment of capital gains deduction
• Consider type of assets distributed to beneficiaries
Consequences of FIRPTA withholding
50
• Whereas US persons are expected to file Form 1040 to report distributions and
remit tax, foreign persons are not (unless requesting a refund).
• Trusts are required to withhold tax on DNI distributions to foreign beneficiaries;
therefore, the net distributable amount differs between US beneficiaries and
foreign beneficiaries
• Withhold on DNI, to the extent it represents
FDAP income
Distributions of ECI from publicly traded partnership
Certain contingent payments
• Certain classes of income are exempt from 1441 withholding, but still
reportable on Form 1042-S
• Distributions of corpus not taxed (nor reported on Form 1042-S).
51
Exemptions from Withholding
• Distributions of corpus not taxed (nor reported on Form 1042-S).
• Certain classes of income are exempt from 1441 withholding, but still
reportable on Form 1042-S
Interest on bank deposits (to the extent not ECI)
Accrued interest
Interest income not taxable pursuant to 871(h)(1) and (2)
o Isidro Martin-Montis Trust
o Relatively new reporting requirements for trust
52
Total withholding reported annually to foreign beneficiary on (copy of) Form
1042-S, due by March 15 of the following calendar year.
• Form denotes type of DNI, whether interest, dividends, capital gains
• Separate form required for each type of DNI if statutory withholding rate
varies (even if rate does not actually vary due to application of treaty
rates)
E.g., Trust distributes DNI consisting of dividends and interest to three
different foreign beneficiaries. How many Forms 1042-S required?
• Trusts files corresponding Form 1042-S with IRS, along with Forms 1042
and 1042-T
Penalties apply for not withholding as well as for non-filing of required
Forms
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• Withholding occurs at time of distribution to foreign beneficiaries
• “Entity” (i.e., the actual trust) bears responsibility for withholding. Reg.
1.1441-5.
• Withholding rate generally 30% of the beneficiary’s allocable portion of
DNI
• Contrast with rate of tax available to US person – i.e., US person carries
forward character of income for purposes of calculating tax rate.
• Treaties may apply to reduce amount of withholding. Foreign
beneficiaries must submit Form W-8BEN to the trust.
• Gross amount of income subject to withholding may not be reduced
by any individual deductions.
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• The trust need not withhold if a foreign person obtains classification as a
qualified intermediary or authorized foreign agent
• Form W-8IMY required.
• Trust must retain copy
For qualification as a foreign agent
• Written agreement required
• Notification procedures adhered to
• Foreign agent makes books and records available to IRS for
examination
• Trust remains liable for tax in case of default by foreign agent
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______________________________________________
Disclaimer This communication does not provide legal advice, nor does it create an attorney-client relationship with you or any other reader. If you require legal guidance in any specific situation, you should engage a qualified lawyer for that purpose. Prior results do not guarantee a similar outcome. Attorney Advertising It is possible that under the laws, rules, or regulations of certain jurisdictions, this may be construed as an advertisement or solicitation. © 2016 Caplin & Drysdale, Chartered
All Rights Reserved.
Dianne C. Mehany Member Caplin & Drysdale, Chartered 202-862-5068 [email protected]
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Trust Distributions to Foreign Beneficiaries
John R. Strohmeyer
Distributions from Estates
Specific Bequest Exception
Separate Share Rule
Interest on Funding Pecuniary Bequests
Distribution of Property In Satisfaction of Pecuniary Bequest
Distribution of IRD to Satisfy Pecuniary Bequest
In-Kind Distributions are typically not taxable under Rev. Rule 69-486.
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U.S. Income Tax Treaty System
The U.S.A. is a party to 58 bilateral income tax treaties with 68 countries. The U.S.–U.S.S.R. income tax treaty remains in effect for
members of the Commonwealth of Independent States that have not negotiated and ratified new treaties.
The U.S.–China income tax treaty does not apply to Hong Kong.
Three additional treaties (Chile, Hungary, & Poland) and four protocols (Japan, Luxembourg, Spain, & Switzerland) have been signed but not approved by the Senate.
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U.S. Income Tax Treaties
Available at http://ow.ly/TGSdp
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U.S. Income Tax Treaty Partners
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Recent Tax Treaty Cases
Cole v. Comm’r., T.C. Summ. Op. 2016-22.
U.S. citizen caught by the U.S.-Israel Savings Clause.
Topsnik v. Comm’r., 146 T.C. No. 1 (2016).
You must be a resident to claim treaty benefits.
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Income Taxation of Nonresident Aliens
Effectively Connected Income (“ECI”) Net-basis taxation for business income
Gains from the Sale of Real Property—FIRPTA Subject to mandatory 15% withholding, and taxed as ECI
Certain taxpayers are subject to 10% withholding
Fixed, Determinable, Annual, or Periodical Income (“FDAP”) All income other than gains from sale of property or income excluded
from gross income
Dividends
Interest
Pensions and annuities
Alimony
Rent and Royalties
Gross-basis taxation subject to mandatory 30% withholding
Gains from the Sale of Non-Real Property—Not Taxed 64
Selected Treaty Articles
Article 2—Taxes Covered
Article 3—General Definitions
Article 4—Resident
Article 5—Permanent Establishment
Article 6—Income From Real Property
Article 7—Business Profits
Article 12—Royalties
Article 13—Gains
Article 22—Limitation on Benefits
Article 23—Relief From Double Taxation
Article 25—Mutual Agreement Procedure 65
2016 U.S. Model Treaty Updates
On February 17, 2016, Treasury released a new U.S. Model Income Tax Treaty. New Article 1 Paragraph 7—Exempt Permanent Establishments
New Article 3 Paragraph 1(l)—“Special Tax Regime”
Changes in Articles 10, 11, & 12—Payments to Expatriated Entities
Changes to Article 22—Limitation on Benefits
New Article 28—Subsequent Changes in Law
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Tax Treaty Comparison
Australia (effective Dec. 1, 1983, Protocol Jan. 1, 2004 )
Canada (effective Jan. 1, 1985, Protocols Jan. 1, 1996, Dec. 16, 1997, and Jan. 1, 2009)
Japan (effective Jan. 1, 2005)
Kazakhstan (effective Jan. 1,1996)
Mexico (effective Jan. 1, 1994, Protocols Oct. 26, 1995 and Jan. 1, 2004)
New Zealand (effective Nov. 2, 1983, Protocol Jan. 1, 2011)
South Africa (effective Jan. 1, 1998)
Tajikistan (U.S.-U.S.S.R. Income Tax Treaty) (effective Jan. 1, 1976)
Tunisia (effective Jan. 1, 1990)
United Kingdom (effective Jan. 1, 2004) 67
U.S. Income Tax Treaty Comparison
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Dividends (Article 10)
Tax Rate on Dividends Paid by U.S. Corporations No Treaty—30%
Model Treaty—5% if owner has 10% ownership, 15% otherwise
Australia—15%
Canada—15%
Japan—10%
Kazakhstan—10%
Mexico—10%
New Zealand—15%
South Africa—15%
Tajikistan—30%
Tunisia—15%
United Kingdom—15% 69
Interest (Article 11)
Tax Rate on Interest Income Paid by U.S. Obligors No Treaty—30%
Model Treaty—15%
Australia—10%
Canada—0%
Japan—10%
Kazakhstan—10%
Mexico—15%
New Zealand—10%
South Africa—0%
Tajikistan—0%
Tunisia—15%
United Kingdom—0%
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Pensions & Annuities (Article 17)
Tax rate on non-governmental pensions & annuities No Treaty—30%
Model Treaty—15%
Australia—0%
Canada—15%
Japan—0%
Kazakhstan—0%
Mexico—0%
New Zealand—0%
South Africa—15%
Tajikistan—30%
Tunisia—0%
United Kingdom—0%
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U.S. Estate & Gift Tax Treaties
Available at http://ow.ly/TLGKH
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Estate & Gift Tax Treaties
7 Situs-Type Treaties
Allocation taxation of assets to jurisdictions based on the situs of the assets.
Treaties with Australia, Finland, Greece, Ireland, Italy, Japan, Norway, South Africa, & Switzerland.
6 Domicile-Type Treaties
Allocate taxation of assets to jurisdictions based on the domicile of the taxpayer.
Treaties with Austria, Denmark, France, Germany, Netherlands, Sweden, & the United Kingdom.
Protocol Amending United States-Canada Income Tax Treaty.
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U.S. Estate & Gift Tax Treaty Partners
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Expatriation
U.S. citizens and long-term U.S. residents who cease to be permanent U.S. residents may be “Covered Expatriates.”
Three-prong test to not be a Covered Expatriate
Average annual net income tax bill for the five prior years ending before expatriation under $162,000 in 2017 (adjusted for inflation)
Net worth under $2,000,000 on date of expatriation (not adjusted for inflation)
Certify on Form 8854 that you’ve complied with all U.S. federal tax filing obligations for 5 years preceding date of expatriation
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Expatriation
Income tax on mark-to-market valuation of assets on the day before expatriation ($699,000 exemption in 2017)
Must report for 10 years. Topsnik v. Comm’r., 143 T.C. No. 12 (2014)—
If you fail to properly surrender your Green Card, then you haven’t left the U.S. tax system.
Special rules apply to distributions from applies only to nongrantor trusts only if the covered expatriate was a beneficiary of the trust on the day before the expatriation date.
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Nongrantor Trusts After Expatriation
Special rules for distribution of any property from a nongrantor trust to a covered expatriate under Code § 877A(f)
The trustee must withhold 30%of the taxable portion of the distribution.
Gain will be recognized on the distribution as if the distributed property were sold to the expatriate at its fair market value if the fair market value of the distributed property exceeds its adjusted basis in the hands of the trust.
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Nongrantor Trusts After Expatriation
The “taxable portion” of a distribution is that portion of the distribution that would be includible in the gross income of the covered expatriate if such expatriate continued to be subject to tax as a citizen or resident of the United States.
A “nongrantor trust” means the portion of any trust that the individual is not considered the owner of under subpart E of part I of subchapter J, with the determination made immediately before the expatriation date.
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Nongrantor Trusts After Expatriation
Special Rules apply to withholding
Any item subject to the withholding is subject to tax under Code § 871.
Any item subject to withholding is subject to withholding under Code § 1441.
Rules similar to the rules for withholding liability under Code §§ 1461—1464 .
Treaty Issues: The covered expatriate is treated as having waived any right to claim any reduction under any treaty with the United States.
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Crady, Jewett & McCulley, LLP 2727 Allen Parkway, Suite 1700
Houston, Texas 77019-2125 (713) 739-7007 telephone (713) 739-8403 facsimile
Tax Disclosure: Please note that this outline was written as support for a presentation for Strafford Webinar on January 5, 2017, and any statement in this outline (including attachments) is not written or intended to be used, and cannot be used, for the purpose of avoiding tax penalties. Any recipient should seek advice based on the recipient’s particular circumstances from an independent tax advisor.
Crady, Jewett & McCulley, LLP
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