Coming to America

Report
N O R T H E R N T R U S T GLOBAL FAMILY & PRIVATE INVESTMENT OFFICES
Coming to America: U.S. Trusts for Non-U.S. Persons
STEP BENELUX
25 June 2014
Daniel F. Lindley
Managing Director, Global Family Offices - EMEA
+44 (0) 207 982 3524
[email protected]
© 2014 Northern Trust Corporation
northerntrust.com
Table of Contents
An Introductory Outline
Scenario 1: The Generous Parent
Scenario 2: The Foreign Non-Grantor Trust
Scenario 3: The Foreign “U.S.” Trust
Delaware – leading trust jurisdiction in the U.S.
Concluding Thoughts
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An Introductory Outline
It is increasingly common for families to have cross-border
circumstances that give rise to a multitude of U.S. income, gift, estate
and generation-skipping transfer tax consequences, particularly when
trusts are involved.
N.B. –The term “U.S. person” has different meanings for U.S. income taxes and U.S. gift, estate and GST taxes.
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Modern Cross-Border Scenarios: The Generous Parent
Scenario 1: The Generous Parent
Parent is a Belgian citizen and resident. She would like to make a
substantial lifetime gift for the benefit of her daughter, a Belgian
citizen residing in the United States.

Should the parent make the gift outright or establish an irrevocable gift trust in the
United States?

If a trust, will U.S. gift taxes apply and will the trust be subject to future estate or
generation-skipping transfer taxes?

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How will the trust be taxed for U.S. income tax purposes?
Northern Trust Global Family & Private Investment Offices
How the Generous Parent Can Save U.S. Estate Taxes

Gift tax: Non-citizen non-domiciliaries are subject to U.S. gift, estate and generationskipping transfer tax on their U.S.-situs assets only. Intangible assets do not have a
U.S. situs for gift tax purposes (cash can be an intangible if delivered outside the
U.S.). If the gift from the Belgian parent consists of cash or securities, it will not be
subject to U.S. gift tax.

Estate Tax: U.S. citizens (wherever they live) and U.S. “residents” (regardless of
their citizenship) are subject to U.S. gift, estate and generation-skipping transfer
taxes on their worldwide assets. U.S. estate tax is imposed on all wealth transferred
directly from U.S. daughter upon her death.

Proper use of a U.S. trust will give the daughter economic benefit of the assets
(income, discretionary principal), but keep the assets out of daughter’s estate and
avoid subjecting foreign wealth to U.S. estate tax in future U.S. generations.
Practice tips:
(1) Beneficiary’s interest in trust must not include a power to appoint the trust assets to herself, her estate or her
creditors.
(2) Watch for tax consequences of the gift in the donor’s home country.
(3) Gifts from foreign persons to U.S. persons, including U.S. trusts, are subject to information reporting requirements .
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Trusts Save U.S. Transfer Taxes
A Delaware trust can continue indefinitely, without any fixed term. The economic benefit
of a Delaware dynasty trust, in comparison to an outright gift, is inescapable.
Delaware Dynasty Trust
Transfers in Trust To the Next Generation
Every 25 Years
Taxable Outright
Transfers To the Next Generation
Every 25 Years
Year 1
$1,000,000
$1,000,000
Year 25 Value
$16,289,000
$16,289,000
Transfer Tax
—
$6,450,200
Year 50 Value
$55,160,000
$33,865,000
Transfer Tax
—
$13,238,400
Year 75 Value
$184,900,000
$67,245,000
Transfer Tax
—
$26,900,000
Ending Value
$184,900,000
$40,345,000
Dynasty Benefit =
$144,555,000
Assumptions:
Federal estate tax rate: 40%*
Return on investment assets: 5%
No state income taxes.
No distributions from trust or consumption of principal or income by persons receiving outright transfers.
* 2014 highest marginal estate tax rate.
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Modern Cross-Border Scenarios: The Foreign Non-Grantor Trust
Scenario 2: The Foreign Non-Grantor Trust
Many years ago, grandparents in Europe established a foreign
trust for the ultimate benefit of their grandchildren, following their
deaths.
Grandchildren are U.S. citizens and residents. The surviving
grandparent has died and the grandchildren will now receive
distributions from the trust.
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
How will a distribution from a foreign trust to a U.S. beneficiary be taxed?

Would a U.S. domestic trust result in a better outcome?
Northern Trust Global Family & Private Investment Offices
Domesticating a Foreign Trust with U.S. Beneficiaries

When the non-U.S. grantor of a foreign trust dies leaving U.S. family members as
beneficiaries, the trust becomes a non-grantor trust. The family should consider
domesticating the foreign non-grantor trust to a U.S. domestic trust before it
accumulates undistributed net income.
A
foreign non-grantor trust is subject to unfavorable U.S. income tax rules on undistributed net
income.
 Distributions
from the foreign trust will likely carry out accumulated income that is subject to
income tax and an interest charge based on the average number of years of accumulation.
 Capital
gains and qualified dividends included in the accumulation will be treated as ordinary
income.
 U.S.
persons who receive distributions from foreign trusts are subject to additional reporting
obligations, with substantial penalties for noncompliance.
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Positioning for Domestication

Appoint U.S. trustee and other power holders for the foreign trust. Make sure foreign
persons connected with trust renounce all powers.
 Settlor
powers

Foreign co-trustee

Trust protector

Investment managers
Adopt U.S.-style trust agreement for domestic trust


Directed trust provisions for investment and distribution advisors

Delaware governing law

Choose U.S. courts for primary supervision

Negate Rule against Perpetuities

U.S. trustee accepts trust documents for new domestic trust

Post-domestication decanting
 Trustee
of domesticated foreign trust exercises discretion over principal to distribute all assets to
the new U.S. domestic trust.
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Flipping the switch: Foreign to Domestic

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Resulting trust should satisfy the court test and the control test to attain domestic
trust status.
 Delaware
Court of Chancery should be designated as primary court for trust supervision.
 Non-U.S.
persons should have no authority over substantial decisions.
Northern Trust Global Family & Private Investment Offices
Modern Cross-Border Scenarios: The Foreign “U.S.” Trust
Scenario 3: The Foreign “U.S.” Trust
Patriarch is the life income beneficiary of an irrevocable
Guernsey trust established by his father some years ago. At
patriarch's death, his children will be entitled to the principal of
the trust.
Patriarch wants to defer indefinitely mandatory principal
distributions.
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
Can a U.S trust offer greater flexibility?

What are the U.S. income tax consequences with a U.S. trust?
Northern Trust Global Family & Private Investment Offices
Moving a Foreign Trust to the U.S. for Significant Modifications

There may be circumstances in which a client wants to change the design of his or
her trust to address a particular need, but the laws of the current jurisdiction do not
permit the proposed change.
 The
client wants the trust to continue indefinitely so that the assets will not pass outright to the
beneficiaries at the client’s death and distributions will remain subject to the discretion of the
trustee.

The client wants to appoint investment advisors or distribution advisors for the trust, without
any involvement of the trustee in investment or distribution decisions.

The client would like to defer informing the beneficiaries of the existence of the trust or client
anticipates a potential challenge to the terms of the trust.

In these and other circumstances, a trust located in Delaware may be the answer.
Practice tip: This foreign trust is not suitable for U.S. beneficiaries because of U.S. income tax considerations.
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Northern Trust Global Family & Private Investment Offices
Moving a Foreign Trust to the U.S. without Exposure to U.S. Income Tax

Non-U.S. clients can maintain a trust with a U.S. trustee, governed by U.S. state law,
but ensure that the trust is treated as a foreign trust for U.S. income tax purposes. By
giving a non-U.S. person authority over any substantial decisions involving a trust, the
trust will fail the “control” test and qualify as a foreign trust.

“Substantial decisions” include:
 Whether and when to distribute income or principal


The amount of distributions

Whether to terminate a trust

Whether to remove, add or replace a trustee

Investment decisions
Only U.S. source income will be subject to U.S. income tax. Generally speaking, U.S.
source income includes interest from U.S. bonds and notes, dividends from U.S.
corporations, and proceeds and rents from U.S. properties. Capital gains on
intangible U.S. assets are not source income.
Practice tip: This foreign trust is not suitable for U.S. beneficiaries because of U.S. income tax considerations.
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Northern Trust Global Family & Private Investment Offices
Positioning for Domestication into a Foreign U.S. Trust

Appoint U.S. trustee and other power holders for the foreign trust. Make sure foreign
persons remain connected with trust.
 Settlor

powers

Foreign co-trustee

Trust protector

Investment managers
Adopt U.S.-style trust agreement for foreign trust

Directed trust provisions

Delaware governing law

Choose U.S. courts for primary supervision

Negate Rule against Perpetuities

U.S. trustee accepts trust documents for new foreign trust

Post-domestication decanting
 New
U.S. trustee of original foreign trust exercises discretion over principal to distribute all
assets to the new foreign trust.
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Northern Trust Global Family & Private Investment Offices
Delaware – leading trust jurisdiction in the U.S.
Delaware – a leading trust jurisdiction in the U.S.
As a premier trust jurisdiction, Delaware offers many advantages
for individuals, families, and businesses. Delaware's Court of
Chancery has more than 250 years of history developing legal
precedent in trust and corporate law, and holds a preeminent
position in developing this body of law in the United States.
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The Appeal of Delaware as a Trust Jurisdiction
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
Delaware repealed its rule against perpetuities in 1995, allowing trusts of unlimited
duration and greatly extending the period in which family assets will not be subject to
federal estate and generation-skipping transfer taxes.

Delaware does not impose a state fiduciary income tax on irrevocable trusts for
nonresident beneficiaries, which creates an opportunity for clients to avoid state
income taxes on accumulated trust income.

Delaware law explicitly allows trustees to take direction from investment and
distribution advisors, without liability for the advisors’ performance or decisions.

Delaware is a leading proponent of the concept of freedom of disposition, as
evidenced in its confidential treatment of trusts, its enforcement of no-contest
provisions, its novel pre-emptive notices and its broad decanting statute.

Delaware’s court system for resolving trust matters is second to none.

A client may establish a Delaware trust for his or her own benefit and, within defined
circumstances, use the trust to protect the assets against future creditor claims.
Northern Trust Global Family & Private Investment Offices
Fiduciary Income Tax Savings
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
In addition to U.S. income taxes, U.S. domestic trusts are subject to income tax in
many of the fifty states, with tax rates as high as 9% or more. Most states treat capital
gains as ordinary income.

Since 1971 Delaware has not imposed a fiduciary income tax on irrevocable trusts for
non-resident beneficiaries.

Absent a taxable connection or “nexus” with another state, capital gains and ordinary
income can accumulate in irrevocable Delaware trusts without incurring a state income
tax.
Northern Trust Global Family & Private Investment Offices
Direction Trusts
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
Since 1986 Delaware law has allowed trustees to take direction from advisors
(including investment advisors, distribution advisors and trust protectors), without
liability for their decisions or results.

Offshore jurisdictions do not absolve trustees of liability for following advisor directions,
so trustees have to review and consider “directed” investment activities and
distribution decisions.
Northern Trust Global Family & Private Investment Offices
The Direction Trust as an Enterprise Trust
Custody,
Reporting,
Accounting &
Beneficiary
Communications
Discretionary
Administration
Directed
Trustee
Discretionary
Committee
Special
Asset
Management
Special
Assets
Advisor
Values
Mission
Goals
Investment
Advisor
Tax Advisor
Trust
Protector
Trust Modification
Fiduciary Removal
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Tax Planning
& Compliance
Confidentiality

Delaware trusts are not subject to any public registration or filing requirements.

In the event of litigation, the Court of Chancery often seals the record of trust
proceedings on application.

Delaware law even permits a trustee to withhold knowledge of a trust’s existence from
future or discretionary beneficiaries for “a period of time,” if the trust deed so directs.
12 Del. C. § 3303(a).
 The
concept of a trust that remains “secret” from its beneficiaries for a period of time is
surprisingly attractive to clients who do not want unproductive descendants.
 The
trust deed for a “secret” trust must have someone – a trust protector, for example – who
can receive statements from the trustee and monitor the trustee’s conduct.
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Freedom of Disposition: No-Contest Clauses

Delaware law recognizes the validity of no-contest or in terrorem clauses in trusts and
wills. These provisions have the effect of forfeiting the interests of a beneficiary who
challenges the validity of a trust or will.

The general rule enforcing a forfeiture does not apply to:
A
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beneficiary who “substantially prevails” in challenging the instrument.
 An
agreement in settlement of a dispute among the beneficiaries.
 An
action to determine whether a proceeding triggers the no-contest provision.
 An
action for construction of the instrument.
Northern Trust Global Family & Private Investment Offices
Concluding Thoughts

There are a number of common circumstances in which it may be useful for a nonU.S. person to create a U.S trust.

Once a client has made the decision to establish a U.S trust, the selection of Delaware
as the specific situs is self-evident given its tax-neutral posture and its highly favorable
body of trust laws.

Since 2006 Northern Trust Corporation has maintained a separate subsidiary in
Delaware, The Northern Trust Company of Delaware, to provide fiduciary services to
clients and their families across the globe. As of 31 March, 2014, The Northern Trust
Company of Delaware administers trust assets in excess of US $16 Billion.
Practice tips: (1) In any cross-border trust planning of this nature, be sure to consider home country
consequences as well as treaty modifications of the applicable rules.
(2) Special rules cover U.S. expatriates. Proceed with caution if an expatriate is involved.
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Disclaimer
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March 2014
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