~ Immigration Tax Planning ~
Immigration Trusts
Trusts have long been used by well-advised potential immigrants to shelter a portion of their assets from U.S. tax jurisdiction. The basic idea is to place assets in trust prior to taking up U.S. residence, so that the immigrant is not subject to U.S. income tax on the income from the trust's assets, and so that the assets themselves are not subject to U.S. estate tax should the immigrant die while residing in the United States.
The
rules with respect to income tax and estate tax are quite different as
they apply to trusts. U.S. taxation of trusts depends in large part upon
the terms of the trust.
Income Taxation of Foreign Trusts in General
Certain trusts, generally irrevocable trusts as to which the settlor does not retain prohibited powers to control the disposition of the trust's assets, are taxed as separate entities. If such a trust is a foreign trust, it will pay U.S. income tax only on its U.S. source income. In that case, if the trust's assets are located outside the United States for tax purposes, the trust may not owe any U.S. tax on its income. This permits the trust to shelter income which might otherwise be subject to U.S. tax in the hands of a U.S. settlor. Recently enacted foreign trust legislation contains a definition of a foreign trust for tax purposes. This should make it easier to confirm that a particular trust will qualify as a foreign trust and will not be subject to U.S. tax on its income.
Grantor Trusts
However, not all foreign trusts qualify for this advantageous tax treatment. A U.S. person may be taxed on the income of a trust under the so-called "grantor trust" rules of Section 671-679 even if the person does not receive any distributions from the trust, or even if the person is not a beneficiary of the trust at all. The grantor trust rules are generally triggered because the settlor retains certain prohibited powers to control the disposition of the trusts assets. If the grantor trust rules apply, the settlor is taxed on the income from the trust's assets as if the settlor owned the assets personally, even though the settlor may not be able to obtain cash from the trust with which to pay the tax liability.
Section 679
Of greatest concern to the potential immigrant is Section 679. Section 679 treats the transferor as the owner of any property transferred to a foreign trust if the transferor is a U.S. person and the trust has any U.S. beneficiaries. In the past, the well-advised immigrant could avoid this provision relatively easily by funding the foreign trust prior to becoming a U.S. person. However, the recently enacted foreign trust legislation contains certain "look-back" provisions make this technique more difficult. Now, it is not enough to transfer the assets prior to becoming a U.S. resident, but rather the transfer must take place more than 5 years before becoming a U.S. resident if the transfer is to avoid the application of Section 679. This makes it more difficult, but not impossible, to structure the ownership of offshore assets so that the income from these assets will not be subject to U.S. income tax once the owner becomes a U.S. resident. These changes make it even more imperative for the high-net-worth individual to seek competent tax advice as far in advance of taking up U.S. residence as possible.
Trusts and Estate Tax
In addition to the potential benefits for income tax purposes, foreign trusts can also be of value to potential immigrants with respect to U.S. estate tax as well. The trusts are most useful when the person will not only take up U.S. residence, but will also have a U.S. domicile. In that case, the creation of a foreign trust may shelter assets from U.S. estate tax. While a U.S. domiciliary is subject to estate tax on all assets owned by the domiciliary at death, regardless of where they are located, the person is treated as not owning assets held by certain foreign trusts. Proper use of this technique can save tremendous amounts of U.S. estate tax, especially where the person has substantial assets located outside the United States.
Trusts and Gift Taxes
Foreign trusts can also be of help with respect to U.S. gift tax. A person who has U.S. domicile is generally subject to gift tax on all gifts in excess of certain annual limits, regardless of the location of the property given. On the other hand, distributions from a foreign trust may well not be subject to U.S. gift taxes, especially if the recipient is not a U.S. person and the property given is non-U.S. property. To the extent that the potential immigrant has relatives or favored charities that are located outside the United States, it is prudent to consider placing some assets in a foreign trust to avoid future gift taxes.
Timing of Transfers to Trust
The timing of any transfer to trust is very important. The transfer must be made prior to taking up U.S. residence, so that the transfer itself will not be subject to U.S. income tax or gift tax. Under the recently enacted foreign trust legislation, advance planning is even more crucial, because the law now treats most transfers to foreign trusts made within 5 years of taking U.S. residence as having been made on the first day of U.S. residence - which in many cases results in immediate imposition of either income or gift tax.
Nevertheless, in many cases it is still possible to create trust arrangements which will defer or eliminate U.S. income, estate and gift taxes on a substantial portion of a potential immigrant's worldwide assets. I am familiar with the remaining exceptions and can help you plan to come within their protection.