Assets of foreign grantor trust not includible in grantor's U.S. gross estate.
Today, an estimated $1 trillion of foreign trust funds represent asset protection trusts in the Bahamas, Belize, the Cayman Islands, the Cook Islands, Cyprus, Gibraltar, the Turks and Caicos Islands, Nevis, Mauritius, the British Virgin Islands and the Isle of Man.
In this regard, the IRS recently issued Letter Ruling 9332006 in connection with the income, excise, gift and estate tax consequences of the establishment and funding of a trust organized under the laws of a foreign country.
Settler A and Settler B are siblings and U.S. citizens. Each owns a percentage interest in a U.S. corporation (corporation C). C owns all of the voting common stock of corporation B, also a domestic corporation, B's nonvoting common shares are owned by a domestic limited partnership, which conducts no active business. Each settler directly owns a percentage of the interests in the partnership, as a limited partner. C is the sole general partner in the partnership.
The settlers created an irrevocable trust under the laws of foreign country X. The trust beneficiaries include the settlers, a living parent of the settlers who is a U.S. citizen, and the settlers, a living parent of the settlers who is
Either the trustee (an independent X corporation) with the consent of the protector (as explained), or the living parent of the settler as beneficiary may direct trust income or principal to be appointed to or for the benefit of any beneficiary, provided, however, that only the protector may make such appointments for the benefit of either settler or the parent beneficiary.
The term of the trust is 100 years unless terminated earlier under the sole discretion of the trustee. On termination, the trustee can appoint the trust's
assets to any or all of the then beneficiaries or, if there are no living beneficiaries, for charitable purposes.
The protector cannot be a person or entity related to or under the control of either settler.
Under the laws of X. neither a beneficiary nor any creditor of any beneficiary (including the settlers) may compel the trustee to distribute the trust's assets to or for their benefit at any time during the trust term. Transfers by the settlers of interests in the partnership to the trust are not in any way liable to be satisfied under any applicable fraudulent conveyance or other law.
Neither the trustee nor the settlers have any plans to hold trust assets anywhere other than in X. The settlers requested a ruling that:
1. The transfers of partnership interests to the trust were completed gifts for purposes of Sec. 2511 at the time of the transfer to the trust.
2. No portion of the trust would be includible in the estates of either A or B under Sec. 2033, 2036, 2037 or 2038.
3. The trust was a grantor trust within the meaning of Sec. 679.
4. Each portion of the trust treated as owned by a settler under Sec. 679 would, on that settler's death, cease to be so treated even if then trust beneficiaries included U.S. persons.
The Service first ruled that the transfers to the trust were completed gifts and the entire value of the interests in the partnership transferred to the trust by the settlers was subject to the U.S. Federal gift tax.
With respect to the second issue, the IRS ruled that the value of the interest in the partnership transferred by a settler to the trust would not be includible in that settler's gross estate.
The Service ruled that the trust would be treated as a grantor trust; each settler would, for the tax year in which the trust is funded and in each succeeding tax year during his life in which the trust continued to have a United States beneficiary, be treated as the owner of a portion of the trust income and corpus. Thus, each settler will be required to take into account, in computing his Federal income tax liability, his appropriate portion of the trust's items of income, deductions and credits.
Finally, the inter vivos trust was not treated as owned by the settler's estate.
Although not clearly indicated in the facts of the letter ruling, it is possible that the foreign grantor trust could be a foreign protection asset trust in a jurisdiction such as the Bahamas, Bermuda or the Cayman Islands. As indicated, the objective to the foreign asset protection trust is generally to protect the grantor's assets over a reasonable period of time from potential litigation, such as malpractice suits, etc., that could cause a significant loss to the typical grantor. However, most asset protection trusts would retain a reversionary interest (unlike the trust in the ruling). Although the ruling does not address U.S. excise tax, presumably this individual would avoid the 35% excise tax because the grantor is already being taxed under Sec. 679.
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|Author:||Zink, William J.|
|Publication:||The Tax Adviser|
|Date:||Feb 1, 1994|
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