When Are Foreign Trust FMV Distributions Taxable in the US?
The income tax rules involving foreign trust distributions are complicated, to say the least. In general, when a beneficiary receives a distribution from a non-grantor foreign trust, they are taxed for US tax purposes, and not the grantor. This is different than a foreign grantor trust in which the grantor US person is taxable on the income even if it is distributed to beneficiaries. But what happens in a situation in which the foreign trust distributes property/cash in exchange for services or acquires trust assets — how is the trust taxed? Let’s take an introductory look at what happens when a foreign trust makes certain distributions for either services or payment.
Providing Services to a Foreign Trust
For example, a trust hires a US person to perform some type of forensic accounting or other consulting services for the foreign trust. The trust distributes $10,000 to the individual for the work performed. If the value of the trust distribution is equal to the value of the services provided and there is no trust distribution.
But, what if the consultant offered $8,000 worth of services but received $10,000 from the trust distribution?
In this type of situation, the foreign trust has made a $2,000 distribution. The idea is the services provided were less money than the amount distributed from the trust and so the additional amount distributed to the consultant would be considered a distribution from the trust.
Foreign Trust Acquires Assets
In another common situation, if a person unrelated to the trust sells an asset to the trust, there may also be considered a trust distribution depending on the value of the asset and how much is distributed. For example, the trust acquires an asset with an FMV of $1M. The trust pays $1.2M for the acquisition of the Asset because the trust really wants the asset and is aware that even though the asset’s FMV is $1M, it is going to pay $1.2M to secure the acquisition of the asset. In this type of situation, the trust has made a $200K distribution.
Beware of Trust Income Tax Traps
When it comes to foreign trusts, it can become much more complicated from an income tax perspective when the distributions are made for a value that exceeds the FMV of the asset or services it received. It is important the trust consider the FMV and foreign trust income/distribution rules so that the trust can assess income and deductions; balance the books accordingly, and take any necessary trust deduction when making payments that exceed the FMV of what was received.
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