If you are a non-U.S. taxpayer looking to build a business or invest in the U.S., it’s essential that you plan carefully before you invest. Failing to plan before you invest may have catastrophic consequences for your family wealth. An irrevocable “Foreign Grantor Trust” may be an appropriate solution.

Key Features of an Irrevocable Foreign Grantor Trust

• Is an irrevocable trust created in a U.S. tax-friendly, private trust jurisdiction with no separate state-level income tax. Common choices include Wyoming, Nevada, Delaware, South Dakota, etc.

• Allows you to place assets into a private, protected structure established on the terms you select for any number of potential beneficiaries, often including you, your spouse or partner, children, other family members, or others.

• The trust is treated as you for U.S. income tax purposes, which has significant income tax advantages under the U.S. tax code. (For example, capital gains on the sale of U.S. securities are exempt for foreign grantor trusts.)

• Non-U.S. source income is not subject to U.S. income tax when earned but will be subject to U.S. income tax if distributed to a U.S. person.

• Is a “completed” gift for federal transfer tax purposes, meaning that all future growth on those assets is out of your U.S. taxable estate … and the increase in asset value can avoid estate tax for many generations.

• Allows you to maintain control over most investment decisions concerning the assets held in the trust and to remove and replace other decision makers concerning the administration of the trust.

• Is one of many potential strategies that can be combined into a comprehensive family wealth strategy set.

A deeper dive: 

An irrevocable foreign grantor trust is designed to be taxed as if it’s you, the trust creator, for U.S. federal tax purposes. You establish the trust in a “U.S. destination jurisdiction” and transfer property to the trust. The property is administered by the trustee in that jurisdiction for the benefit of the trust beneficiaries you choose – which may include yourself and your loved ones – under the laws of the selected jurisdiction. Depending on the jurisdiction selected, the design of the trust, the administration of the trust, and the source of the property placed in the trust, a foreign grantor trust has several key benefits.

Income Tax Opportunities

While the advantages of an irrevocable foreign grantor trust usually dramatically outweigh the disadvantages, you should understand both before proceeding with the strategy.

Irrevocable Foreign Grantor Trust Disadvantages:

1. U.S. source income is – and always will be – subject to U.S. income tax unless an exemption applies. Significantly, under the U.S. tax code, U.S. capital gains (other than for the sale of U.S. real estate) are not subject to U.S. tax if held by a non-U.S. (i.e., “foreign”) person or foreign grantor trust. The estate tax consequences are quite dire for a non-U.S. person with U.S. assets, as there is only a $60k exemption from estate tax – i.e., a non-U.S. person is generally subject to a 40% tax on the value of their U.S. assets above only $60k.
2. The trust must be administered by a trustee in the destination jurisdiction. This requires extra paperwork and adds annual expenses for trustee fees, typically in the range of $5,000 to $15,000 per year.

Irrevocable Foreign Grantor Trust Advantages:

1. Non-U.S.-sourced income held in a U.S. foreign grantor trust is not subject to U.S. income tax when earned. However, this income is subject to U.S. income tax if distributed to a U.S. person.
2. When structured properly, assets in a foreign grantor trust typically enjoy significant protection from your future creditors (and the creditors of other trust beneficiaries).
3. The Settlor of the trust (that’s you as the person establishing the trust) selects the Trustee and the individual or committee who is empowered to determine when and in what amounts to distribute property from the trust.
4. Foreign grantor trusts are usually very private. The trustee of the trust is responsible for preparing accountings and tax returns, and the Settlor of the trust and the beneficiaries are typically not disclosed other than to the trustee and tax authorities. They often provide a high level of “curiosity protection” by removing individual beneficiaries’ names from public view.
5. Unlike some other trust structures, you can direct who will make all investment decisions concerning trust property as the Investment Trust Adviser.
6. Even though the trust is “irrevocable,” it remains flexible. Advanced trust design techniques allow the trust to evolve as laws and circumstances change.

Irrevocable Foreign Grantor Trusts are advanced techniques. They are complex and powerful, and they aren’t right for everyone. But in the right circumstances they are compelling solutions to complement a more comprehensive tax efficient legacy plan.

If you would like to discuss whether an irrevocable foreign grantor trust will help you accomplish your family’s legacy planning goals, please reach out to your Client Ambassador to discuss.

This information is intended for general educational purposes only and should not be construed as legal or investment advice.

On July 10, 2023 California Governor Gavin Newsom approved Infrastructure and Budget Legislation. The bill, SB 131, relates to taxation and includes several amendments to the Government Code, Revenue and Taxation Code, and Welfare and Institutions Code and thus changes the law in California to cause income in INCOMPLETE non-grantor trusts to be counted as California income. Importantly, the new law is limited to non-grantor trusts that are “incomplete” for gift and estate tax purposes. The law does not apply to COMPLETED GIFT non-grantor trusts.

California clients with Incomplete Grantor Trusts: It’s time to replan. 

Here’s what you need to know. 

• Estates and trusts under the current Personal Income Tax Law are subject to taxation on their taxable income, similar to individuals. This is true under both state and federal tax law.  If a trust is classified as a “grantor trust,” where the grantor or another individual is treated as the owner of a portion of the trust, then the trust’s income, deductions, and tax credits are included in the grantor’s taxable income. The grantor will report the trust’s income on his or her personal income tax return and will be responsible for payment of tax liability.
• The proposed bill is RETROACTIVE taking effect on January 1, 2023, and would include the income of an “incomplete gift nongrantor trust” in the gross income of the grantor. This means that if the trust’s income would have been considered in the grantor’s taxable income had it been treated as a grantor trust, it will now be included in the grantor’s gross income.
• However, certain conditions can exempt a trust from this provision, such as the fiduciary making an irrevocable election to be taxed as a resident nongrantor trust, as specified in the bill.

Starting from January 1, 2023, the new Section 17082 is added to the Revenue and Taxation Code, which outlines the treatment of income from an incomplete gift nongrantor trust for qualified taxpayers.

More specifically…

• For taxable years beginning on or after January 1, 2023, the income of an incomplete gift nongrantor trust will be included in the gross income of a qualified taxpayer. The inclusion will be to the extent that the trust’s income would have been considered in the taxpayer’s taxable income if the extent of the trust were treated as a grantor trust under Section 17731.
• There is an exception to the income inclusion. The income of an incomplete gift nongrantor trust will not be included in a qualified taxpayer’s gross income if the following conditions are met: 

1. 1. The fiduciary of the trust files a timely original California Fiduciary Income Tax Return and makes an irrevocable election to be taxed as a resident nongrantor trust under Chapter 9 (starting from Section 17731). This election must be made using the prescribed form and manner by the Franchise Tax Board.
   2. The incomplete gift nongrantor trust is considered a nongrantor trust according to Chapter 9 (starting from Section 17731), which in essence follows the Federal rules.
   3. At least ninety percent of the distributable net income of the incomplete gift nongrantor trust, as per Chapter 9 (starting from Section 17731), is distributed or treated as being distributed to a charitable organization defined under Section 501(c)(3) of the Internal Revenue Code. This includes provisions like Section 17752 or 17731(a) within Chapter 9 (starting from Section 17731).

Definitions for the Infrastructure and Budget Legislation SB 131 Bill

“Incomplete gift nongrantor trust” refers to a trust that meets two conditions: (A) It doesn’t qualify as a grantor trust as defined by Subpart E of Part I of Subchapter J of Chapter 1 of Subtitle A of the Internal Revenue Code. (B) The transfer of assets to the trust by the qualified taxpayer is treated as an incomplete gift under Section 2511 of the Internal Revenue Code concerning transfers in general.

“Qualified taxpayer” means the grantor of an incomplete gift nongrantor trust.

“Resident nongrantor trust” means a trust that is not a grantor trust and where the tax applies to the entire taxable income of the trust based on the residency of the fiduciary or beneficiary as per Section 17742.

California clients: reach out to your Bespoke contact immediately to connect you with a trusted colleague. Those based in California who are interested in Incomplete Non-Grantor Trusts reach out to a Bespoke team member for more information.  

This information is intended for general educational purposes only and should not be construed as legal or investment advice.