Gratuitous Transfers to Foreign Trust Leads to Unintended Ownership

Gratuitous Transfers to Foreign Trust Leads to Unintended Ownership

Gratuitous Transfers to Foreign Trust and Ownership

While typically it is the grantor that settles the grantor trust — and is considered the owner of the trust they settle — it is possible for a third party to become an owner of a foreign grantor trust as well – and thus become subject to US Tax and Reporting. This can occur when a third party transfers assets into a foreign trust and becomes a partial owner of the trust. Stated another way, while the initial person who settles the grantor trust is the grantor, this is not necessarily the only grantor of the trust. If other individuals make contributions/transfers to the trust, they too can be considered a grantor – and subject to the grantor trust rules. Moreover, if a US person is considered a beneficiary of the foreign trust, this will further impact the ownership and those tax implications for the US person making transfers into a foreign grantor trust. Let’s take a brief look at how gratuitous transfers impact foreign trust ownership.

26 CFR 1.671-2(e)(2) Applicable principles

1. 1. 1. A gratuitous transfer is any transfer other than a transfer for fair market value. A transfer of property to a trust may be considered a gratuitous transfer without regard to whether the transfer is treated as a gift for gift tax purposes.

      2. For purposes of this paragraph (e), a transfer is for fair market value only to the extent of the value of property received from the trust, services rendered by the trust, or the right to use property of the trust.

         • For example, rents, royalties, interest, and compensation paid to a trust are transfers for fair market value only to the extent that the payments reflect an arm’s length price for the use of the property of, or for the services rendered by, the trust.

         • For purposes of this determination, an interest in the trust is not property received from the trust. In addition, a person will not be treated as making a transfer for fair market value merely because the transferor recognizes gain on the transaction. See, for example, section 684 regarding the recognition of gain on certain transfers to foreign trusts.

      3. For purposes of this paragraph (e), a gratuitous transfer does not include a distribution to a trust with respect to an interest held by such trust in either a trust described in paragraph (e)(3) of this section or an entity other than a trust. For example, a distribution to a trust by a corporation with respect to its stock described in section 301 is not a gratuitous transfer.

Form 3520-A Instructions

• • • “A grantor includes any person who creates a trust or directly or indirectly makes a gratuitous transfer of cash or other property to a trust. A grantor includes any person treated as the owner of any part of a foreign trust’s assets under sections 671 through 679, excluding section 678. Note.

    • If a partnership or corporation makes a gratuitous transfer to a trust, the partners or shareholders are generally treated as the grantors of the trust, unless the partnership or corporation made the transfer for a business purpose of the partnership or corporation.

    • If a trust makes a gratuitous transfer to another trust, the grantor of the transferor trust is treated as the grantor of the transferee trust, except that if a person with a general power of appointment over the transferor trust exercises that power in favor of another trust, such person is treated as the grantor of the transferee trust, even if the grantor of the transferor trust is treated as the owner of the transferor trust.”

Gratuitous vs Non-Gratuitous Transfers

When persons other than the initial grantor make transfers to a foreign trust, it is important for the person to assess beforehand whether making such a contribution may result in unintentional ownership of a foreign trust — which then leads to other issues such as the grantor tax rules, as well as reporting on Forms 3520 and 3520-A. In general, as long as the transfer is non-gratuitous, such as an exchange for Fair Market Value — the transferor does not necessarily become an owner of the foreign trust.

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