Powerful Domestic Trust Strategies for International and Cross-Border Families

By:
Al W. King III, JD, LLM (tax law) and Jack R. Brister
Published Date:
May 1, 2018

There has been a powerful evolution taking place over the last decade of international families utilizing the United States for their trusts. Previously, the main reasons for an international family to establish a U.S. situs trust were if they owned U.S. property or if they had a U.S. green card or U.S. citizen family members. International clients continue to choose U.S. situs for those reasons; however, the international political and regulatory climate has created many new reasons for international families to seek out the United States as a trust situs.

Some of the more popular reasons why international families select U.S. trust situs and a U.S. trustee for both foreign and domestic trusts include:

  • improved U.S. trust, tax, asset protection and privacy (not secrecy) laws
  • blacklisting of offshore jurisdictions by their home country[i]
  • political stability and protection of the United States
  • forced heirship statute protection[ii]
  • the secrecy wall falling apart globally
  • ·ownership in U.S. residential or commercial property;
  • purchase of U.S. securities;
  • purchase of U.S. life insurance;
  • having family members in the United States
  • marriage by a U.S. citizen to a non-U.S. resident
  • coming to the U.S. to work or live (pre-immigration) as a foreign resident
  • the Common Reporting Standard (“CRS”)[iii]

Trusts established in popular modern trust jurisdictions (e.g., Alaska, Delaware, Nevada, New Hampshire, South Dakota, or Wyoming) can—if effectively designed and administered—provide international families flexibility and control while also limiting concerns over the personal liability of family, friends, advisors, and colleagues serving as co-trustees and fiduciaries. Additional concerns alleviated by these trusts include the concentration of assets or lack of diversification, fiduciary conflicts with business interests, improper due diligence and monitoring of assets, keeping trust matters quiet to beneficiaries, and environmental issues. Along with such flexibility, control, and administrative efficiency, modern trusts established in modern trust jurisdictions can also maximize tax, asset protection, and privacy advantages.[iv]

Below are some typical planning vehicles and considerations non-resident aliens (“NRAs”) are utilizing to take advantage of U.S. trust situs.[v]

Foreign Grantor Trust:

Many NRA grantors are establishing foreign grantor trusts (“FGTs”) with trustees in the United States for foreign beneficiaries and foreign property. Usually, the grantors choose one of the modern trust jurisdictions previously mentioned due to their trust protector, directed trust, privacy, tax, asset protection, and other modern trust statutes. An FGT is established as a “foreign” trust for U.S. tax purposes and is treated identically to an offshore trust, but it is administered by a U.S. trustee. (See Al W. King III and Jack R. Brister, “Powerful Domestic Trust Strategies for International & Cross-Border Families.”) Typically, the trust qualifies as an FGT if the grantor has the power to revoke the trust or if the grantor or the grantor’s spouse is the sole beneficiary of the trust. (See Whitaker.) Therefore, the FGT may be drafted as revocable or irrevocable, provided that if the trust is drafted as irrevocable, only the grantor or the grantor’s spouse may be named as a beneficiary..

Typically, this is a popular trust for NRAs with foreign beneficiaries and property who are seeking political stability, protection of property, and non-blacklisted countries. The NRA will be treated as owner of the trust under U.S. law if the trust is revocable or if the trust provides for the NRA or their spouse for their lifetimes. Any distributions from the FGT to U.S. beneficiaries will be deemed gifts and not income to the beneficiary. The FGTs can have U.S. as well as foreign beneficiaries. In cases where the trust is drafted as irrevocable, but the grantor has U.S. beneficiaries to whom he or she wishes to distribute gifts, the trust may make a distribution to the grantor or grantor’s spouse, and then from the grantor or grantor’s spouse to the U.S. beneficiaries. Upon their death, the trusts are distributed outright or in trust to their children, who can be either U.S. citizens or foreign citizens.  (See Al W. King III and Jack R. Brister, “Powerful Domestic Trust Strategies for International & Cross-Border Families.”)

Commonly, the NRA establishes a foreign trust in the United States with a U.S. trustee to hold shares of the non-U.S. entity. This entity is utilized to hold both foreign or U.S. situs property. If there are no U.S. situs assets, then there are no U.S. income, gift, and estate taxes. The non-U.S. entity acts as an estate tax blocker for U.S. situs assets. The non-U.S. entity can also hold U.S. situs assets producing income, resulting in the 30% withholding taxes or treaty rates to be withheld at the entity level.  Both federal and state capital gains are generally saved, as well as U.S. estate taxes with the non-U.S. entity holding U.S. situs assets such as publicly traded securities.  Alternatively, disregarded domestic LLCs are also utilized for this structure and owned by the FGT but might result in U.S. estate taxes. (See Al W. King III and Jack R. Brister, “Powerful Domestic Trust Strategies for International & Cross-Border Families.”)

At the death of grantor, the FGT will convert to a Foreign Non-Grantor Trust (“FNGT”). The trust can remain an FNGT and make distributions to the remaining foreign beneficiaries (i.e., spouse, children). Alternatives would be to transfer outright or in trust to foreign children or provide the foreign beneficiaries a limited power of appointment so as to provide them flexibility to transfer assets to other vehicles that suit their specific circumstances (e.g., home country law). If the trust converts to an FNGT and has U.S. beneficiaries, distribution options to avoid the negative tax consequences of the FNGT for the U.S. beneficiaries (for further discussion see below) include

  • making distributions of income and realized capital gains annually to avoid accumulated earning issues
  • making a distribution to a U.S. Resident Trust
  • re-domesticating the FNGT to a domestic trust
  • terminating the FNG, which pours over upon death of grantor to a U.S. Dynasty Trust
  • providing the beneficiaries a limited power of appointment to distribute. (See Al W. King III and Jack R. Brister, “Powerful Domestic Trust Strategies for International & Cross-Border Families.”)

Foreign Non-Grantor Trust:

In certain instances, NRAs might find it beneficial to have the trust drafted as an irrevocable FNGT for added asset protection purposes or other home country benefits.  The structure and benefits are similar to the FGT discussed above.  Much like the FGT, the FNGT is a popular trust for NRAs with foreign beneficiaries and property who are looking for political stability or protection of property, or to avoid the blacklisting issues of many of the offshore trust jurisdictions. The FNGT is also best for NRAs who are not anticipating current U.S. beneficiaries, as the trust is deemed far less desirable with U.S. beneficiaries due to administrative complexities, burdensome tax compliance, and potential negative tax consequences. (See Whitaker.) For example, one of the major disadvantages of the FNGT is the treatment of undistributed net income (“UNI”) paid to U.S. beneficiaries. UNI paid to U.S. beneficiaries is generally subject to U.S. income tax and incurs the following negative consequences:

  • Capital gains realized by the trust in prior years that constituted part of the trust’s distributed net income are treated as ordinary income and taxed at rates up to 37%.
  • An interest charge is imposed on the tax due by the beneficiary on the UNI from the date the income was originally earned by the trust.
  • The “throwback” rules apply, so income might be taxed at the beneficiary’s tax bracket for the years in which income was accumulated. (see Whitaker)

There is also extensive tax reporting required of the U.S. beneficiaries.  (See Whitaker) Hence, the structure is typically reserved for foreign families without any U.S. beneficiaries.

NRA Dynasty Trust:

As discussed, if a foreign citizen dies leaving assets in an offshore trust to a U.S. beneficiary, there are burdensome tax and compliance issues.  As an alternative, establishing an NRA Dynasty Trust[vi] while the foreign parents or grandparents are alive provides a very favorable option for an international family. These NRA Dynasty Trusts are usually established in one of the modern trust jurisdictions. (See Al King III, “Domestic Trust Situs Opportunities for International Families?”)

If properly done, an NRA foreign citizen parent or grandparent can transfer an unlimited amount of assets onshore into an NRA Dynasty Trust without any gift, death, or generation-skipping taxes.  They are not subject to the $11.2 million gift and generation-skipping transfer tax exemption limits of a U.S. citizen or Green Card holder. (See I.R.C. sections 2501(a)(3) and  2511(b).) The unlimited gift exemption generally only applies if NRAs are gifting non-U.S. situs assets. Furthermore, assets are not subject to state income tax if the trust is established in a modern trust jurisdiction without income tax (i.e., Alaska, Delaware, Nevada, New Hampshire, South Dakota, or Wyoming).  The trust can also continue forever or for a very long time for the benefit of U.S. beneficiaries, as well as provide asset protection and many other trust, privacy, and tax benefits.

Generally, cash is the most popular option to fund the NRA Dynasty Trust. U.S. insurance bought on either the NRA grantor’s life or on the lives of the U.S. beneficiaries is also a popular investment for these trusts. If properly structured, the life insurance wrapper can convert the trust to a zero-tax dynasty trust both for federal and state income as well as for capital gains purposes. Trust distributions are also not taxed because they’re in the form of non-taxable life insurance policy loans. This is particularly powerful when utilizing a modern trust jurisdiction that also has a low state-insurance premium tax[vii] such as Alaska, Delaware, or South Dakota. (See Al W. King III and Jack R. Brister, “Powerful Domestic Trust Strategies for International & Cross-Border Families.”)

Another common scenario is when one NRA parent dies and the second NRA parent decides to move to the United States to be with the U.S. beneficiary children and becomes a Green Card holder or U.S citizen. The surviving NRA parent may look to gift assets to a self-settled[viii] NRA dynasty trust or change the situs of a foreign trust to the United States prior to moving there while he or she still has unlimited estate, gift, and GST tax exemptions for non-U.S. situs assets. By using a self-settled dynasty trust, the NRA can also be a permissible discretionary beneficiary of the trust.

Stand-By Dynasty Trust:

The Stand-By/Pour-Over Dynasty Trust is a strategy for foreign citizens with U.S. beneficiaries who have established offshore trusts in offshore jurisdictions. The Stand-By Dynasty Trust lessens burdensome income tax filing requirements for the U.S. beneficiaries and the negative U.S. income tax rules on distributions of accumulated income.  Upon the grantor’s death, the foreign trust “pours over” the offshore trust assets to an existing (nominally funded) stand-by domestic Dynasty Trust for the benefit of U.S. beneficiaries. This trust can also be for the benefit of foreign beneficiaries.  Typically, such trusts are cost-effective as they are nominally funded (i.e., with $10) during the NRA’s lifetime and therefore require only a one-time fee until fully funded upon the pour-over. (See Al W. King III and Jack R. Brister, “Powerful Domestic Trust Strategies for International & Cross-Border Families.”)

Pre-immigration Planning With Self-Settled Trusts:

Substantial planning opportunities exist for NRAs who anticipate immigration to the United States (e.g., an NRA corporate executive transferring for work purposes). Typically, before moving to the United States, the NRA grantor would use the unlimited gift, estate, and GST tax exemptions to fund a pre-immigration non-grantor irrevocable trust in a self-settled domestic trust jurisdiction. Because the trust is self-settled, the NRA grantor would generally name himself or herself as a permissible discretionary beneficiary, so he or she can benefit from the trust. Life insurance provides a favorable funding option for these pre-immigration trusts. (See Al King III, “Domestic Trust Situs Opportunities for International Families?”)

Prior to immigration to the United States, the NRA makes a gift to the irrevocable self-settled trust with himself or herself as a permissible discretionary beneficiary.  If properly structured and administered, these trusts will generally avoid gift, estate, and generation-skipping taxation. These trusts are also typically structured as non-grantor dynasty trusts, thereby shielding the trust from estate, gift, and GST tax for future generations.

 After immigration, if the grantor—as a permissible beneficiary—needs assets, they can be distributed by an independent trustee on a discretionary basis.  If properly structured, the assets may also be excluded from one’s estate as well as protected from creditors and lawsuits. Note, however, that if the NRA becomes a U.S. person within five years of the transfer to the trust, the trust will be deemed a grantor trust for income tax purposes. (See Al W. King III and Jack R. Brister, “Powerful Domestic Trust Strategies for International & Cross-Border Families.”) Nonetheless, the grantor will still have the benefits of transfer tax savings, asset protection, privacy, flexibility, and control.

Real Estate:

Many NRAs purchase real estate in the United States for themselves or their families. U.S. real estate is frequently purchased in a U.S. dynasty trust or an offshore entity to avoid U.S. estate taxes. The domestic dynasty trust also generally avoids any possible imputed rental income for use of the property by the beneficiaries, although the NRA grantor might have to pay rent if he also uses the real estate. An NRA who purchases U.S. real estate outright, versus in trust, only has a $60,000 of U.S. estate tax exemption for U.S. situs property. There is a 40% estate tax rate at the $1 million dollar level. Consequently, the NRA should generally purchase the real estate in trust or alternatively purchase U.S. life insurance to pay for the estate taxes owed on the real estate at the NRA’s death. Life insurance is generally an estate tax-exempt U.S. asset for NRAs; nonetheless, the U.S. insurance carriers might require that it be purchased in a domestic trust to provide additional nexus to the United States. (See Al King III, “Domestic Trust Situs Opportunities for International Families?”)

Qualified Domestic Trust (QDOT):

Another frequently used trust for a U.S. citizen spouse married to an NRA spouse is the qualified domestic trust (QDOT). Generally, there’s a 100% marital deduction for assets passing from an NRA spouse to a U.S. citizen spouse at death. There isn’t, however, a 100% estate tax marital deduction if the surviving spouse isn’t a U.S. citizen—unless the assets pass to a QDOT. (See Al King III, “Domestic Trust Situs Opportunities for International Families?”) A QDOT ensures that either upon the distribution of principal from the trust during the spouse’s lifetime or at the spouse’s death, the trust principal will be subject to U.S. federal estate tax as if it were included in the estate of the transferor spouse. A QDOT can be established by the transferor spouse, by the transferee spouse, or by the executor of the transferor spouse. Only property that passes from the deceased spouse to a QDOT—or that passes to the surviving spouse and is then irrevocably transferred or assigned to the QDOT—will qualify for the estate tax marital deduction.[ix]

 Foreign Trust Change of Situs:

NRAs might have existing offshore trusts that they wish to transfer to the United States for the previously mentioned reasons. Generally, a foreign (offshore/non-U.S. law) trust can change trust situs to the United States. This is often accomplished by utilizing a domestic corporate trustee in one of the modern trust jurisdictions. The domestic trustee typically reviews both the existing trust as well as a newly drafted domestic trust. Thereafter, the domestic trustee (or offshore trustee) declares the new U.S. trust with the purpose of the new trust as part of the declaration. The foreign trustee then pays over trust assets with a deed of distribution to the new domestic trust.  This may also be accomplished via a decant. It is important to note that there might be potential tax issues (e.g., UNI, accumulations distributions, and throwback rules) with either method of changing the situs of an offshore foreign trust to U.S. situs. If, however, there are U.S. beneficiaries of a foreign trust that does not change situs before the death of the foreign grantor, the U.S. tax and tax reporting obligations are extremely burdensome. (See Al W. King III and Jack R. Brister, “Powerful Domestic Trust Strategies for International & Cross-Border Families.”)

Selecting Favorable Trust Situs in the U.S.:

Key trust laws to consider when selecting a trust situs state in the United States are privacy, beneficiary quiet,[x] self-settled, asset protection,[xi] forced heirship protection, trust protector,[xii] special purpose entities/trust protector companies,[xiii] ability to modify/reform,[xiv] dynasty trust statutes,[xv] income and premium taxes, directed trusts,[xvi] and private family trust companies.[xvii]The modern trust jurisdictions previously mentioned all have these modern trust, asset protection, tax, and privacy laws; consequently, such jurisdictions are typically the choice for wealthy international families choosing U.S. trust situs. (See Al W. King III and Jack R. Brister, “Powerful Domestic Trust Strategies for International & Cross-Border Families.”)


[i] Many offshore (non-U.S.) trust jurisdictions are blacklisted by many foreign countries via legislation or regulations. This blacklisting may result in negative treatment of offshore trusts.

[ii] The law of a foreign country may prohibit or may not recognize the concept of a trust and will in turn direct where assets will go at a person’s death. Many domestic modern trust jurisdictions have statutes specifically excluding these forced heirship claims.

[iii] Please note the United States is not a signatory to CRS, which is most foreign jurisdictions’ version of the U.S. Foreign Account Tax Compliance Act (“FATCA”); however, many foreign families are very concerned with privacy regarding their families and their assets under CRS.  Specifically, CRS is the Organization for Economic Cooperation and Development’s (“OECD”) emerging global standard for the automatic exchange of financial account information. CRS is a set of global standards for the annual exchange of financial information by financial institutions to tax authorities of the jurisdictions in which customers are residents for tax purposes. See Standard for Automatic Exchange of Financial Account Information in Tax Matters, OECD (2014).  CRS was inspired by the financial reporting requirements established by FATCA and currently has more than 100 jurisdictions committed.  Global Forum on Transparency and Exchange of Information for Tax Purposes, AEOI: Status of Commitments, OECD (November 2018).

[v] Al W. King III and Jack R. Brister, “Powerful Domestic Trust Strategies for International & Cross-Border Families,” New York State Society of Certified Public Accountants International Taxation Conference, New York, N.Y. (January 2018); G. Warren Whitaker, “U.S. Tax Planning for Non-U.S. Persons and Trusts: An Introductory Outline,” Al King III, “Domestic Trust Situs Opportunities for International Families?”, Trusts & Estates (September 2015).

[vi] Dynasty Trust: An unlimited or long-term duration generation-skipping trust benefiting families with tax, asset protection, privacy, and the promotion of family values, inter-generationally. These dynasty trusts may be third-party or self-settled. They can also be grantor or non-grantor.

[vii] Generally, state premium taxes are imposed on all life insurance premiums paid based upon where the applicant for the insurance policy is resident, domiciled, or sitused; however, the insured’s resident state will not generally levy a premium tax on the premium paid for the life insurance policy purchased and owned by a trust or a LLC which is administered or managed in a state with a low premium tax (e.g., Alaska, Delaware, and South Dakota). In that case, typically the trust or LLC located in a low premium tax state purchases the policy so as to utilize the low premium tax of such state.  

[viii] A self-settled trust is generally a discretionary irrevocable trust where the grantor/settlor is a permissible discretionary beneficiary. If properly structured and established in a state with such laws, creditors cannot reach the assets in the trust to satisfy the settlor’s legal obligations. Only 17 states have self-settled trust statutes; this includes all of the modern trust jurisdictions.

[ix] Summer Ayers LePree, “Pre-Immigration Planning for a Move to the U.S.” The Society of Trust and Estate Practitioners' International Estate Planning Institute in New York, NY (March 2016).

[x] Allows for trust information to remain confidential from beneficiaries until instructed otherwise by the grantor/advisor/trust protector, as opposed to the typical right to trust information/accounting provided to beneficiaries.

[xi] The modern trust jurisdictions typically provide for four levels of asset protection: (1) trust; (2) LLC with charging order protection as the sole remedy; (3) discretionary interest in trust is not a property right, (4) spendthrift clause.

[xii] The trust protector generally has many important personal or fiduciary powers, which increase trust administration efficiency. Typically, those powers include the ability to remove or replace trustees/fiduciaries, veto or direct trust distributions, add or remove beneficiaries (or appoint someone to do this), change situs and the governing law of the trust, veto or direct investment decisions, consent to exercise power of appointment, amend the trust as to the administrative and dispositive provisions, approve trustee accounts, and terminate the trust.

[xiii] Special Purpose Entities (“SPE”) are entities that house the trust protector as well as the investment and distribution committees or advisors of a directed trust. They generally work with a qualified trustee sitused in the SPE state. Only South Dakota and New Hampshire have specific statutes providing for such an entity. Other states (e.g., Delaware, Nevada, and Wyoming) have a similar entity typically referred to as a trust protector company.

[xiv] Most irrevocable trusts transferred to a modern trust jurisdiction can be reformed or modified depending upon the reasons and results, either judicially or non-judicially and via decanting. Generally for administrative and tax purposes versus changing beneficial interests.

[xv] Certain states, such as Alaska, Delaware, New Hampshire, and South Dakota, allow for a trust to last for unlimited duration (relying on  Estate of Murphy v. Commissioner 71 T.C. 671 (1979), in which the IRS acquiesced to the method utilized to abolish the Rule Against Perpetuities). Other states allow for a term-of-years, such as Florida (360 years), Nevada (365 years), and Wyoming (1000 years).

[xvi] Structures commonly utilized by NRAs discussed above are typically drafted as directed trusts specifically. A directed trust allows individuals, who establish a trust with an administrative trustee in the directed trust state, to appoint a trust advisor or investment committee, who in turn can select an outside investment advisor(s) or manager(s) to manage the trust’s investments. Multiple advisors may be chosen based upon different asset classes/diversification. This allows a family to utilize and deploy a broad and sophisticated Harvard or Yale endowment-type asset allocation, which they might not otherwise be able to do with most states’ delegated trust statutes as a result of laws, risks, time, and costs. Moreover, it allows the directed trust to hold both financial and non-financial assets (i.e., offshore companies, business interests, real estate, LLCs, FLPs, timberland, direct private equity, and more).   

[xvii] A PFTC is generally an LLC or corporate entity that is typically 100% owned by the family and qualified to do business in the PFTC jurisdiction, usually after acceptance by the jurisĀ­diction’s Division of Banking. The PFTC then typically works with the family office, often located in the client’s resident jurisdiction, via a service agreement to provide related services, such as investment advisory and management and asset allocation, as well as illiquid asset, real estate, and private equity management. PFTCs can be either regulated or unregulated. The type of PFTC selected may also depend upon a family’s net worth and desires.


Al W. King III, JD, LLM (tax law) is the co-founder and co-chairman of South Dakota Trust Company LLC (SDTC). SDTC is a national trust boutique serving wealthy families all over the world with currently more than $45 billion in assets under administration. Mr. King is based in New York City. Previously, he was managing director and national director of estate planning for Citigroup and the co-founder and vice chairman of Citicorp Trust South Dakota.  He is the co-vice chairman of the editorial board for Trusts & Estates magazine. He has been inducted into NAEPC’s Estate Planning Hall of Fame, has served on their Board of Directors, and is a former chair of their foundation advisory board.

 

Jack Brister has more than 25 years of experience.  He specializes in U.S. tax planning and compliance for non-U.S. families with international wealth and asset protection structures which include non-U.S. trusts, estates and civil law foundations that have a U.S. connection; and non-U.S. companies wanting to do business in the U.S. Jack also specializes in non-U.S. persons investing in U.S. real property, and other U.S. assets, pre-immigration planning, U.S. expatriation matters, U.S. persons in receipt of gifts and inheritances from non-U.S. persons, non-U.S. account and asset reporting, offshore voluntary disclosures, FATCA registration and compliance (W-8BEN-E and Form 8966) and executives working and living abroad. Jack has been widely published, in addition to speaking at numerous international engagements and he has also been named a Citywealth Top 100 U.S. Wealth Advisor.

 
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