Why You Should be Careful Before Domesticating a Foreign Trust

Why You Should be Careful Before Domesticating a Foreign Trust

Be Careful Before Domesticating a Foreign Trust

In recent years, the Internal Revenue Service has significantly increased enforcement for matters involving both domestic and foreign trusts. When it comes to domestic trusts, the IRS has been going after taxpayers who may have a 643(b) type of trust along with taxpayers who may be falling for tax promotions involving Charitable Remainder Annuity Trusts (CRAT). Likewise, the Internal Revenue Service is also going after foreign trusts that they deem abusive, such as certain offshore asset protection trusts and other trusts that taxpayers may be improperly using to try to shield income from the United States. The IRS has sought to investigate taxpayers who may be pursuing fraudulent conveyances and other types of transfers to third parties overseas as well as irrevocable trusts that are developed abroad, in which the taxpayer does not properly report the information or the income because they are under the false premise that a foreign trust can escape us reporting. Focusing on foreign non-grantor trusts, sometimes taxpayers may decide that they want to domesticate the foreign trust and turn it into a U.S. trust, but that also comes with its share of headaches. Let’s look at a few key facts about domesticating a foreign trust.

Deemed Sales of Assets

The first thing to consider is whether domesticating the foreign trust into a U.S. trust will require the taxpayer to sell any assets as a result of specific deemed sales provisions within the trust or within the law of the jurisdiction where the trust was created. While oftentimes just transitioning a foreign trust to a U.S. trust may seem simple but requires extensive tax planning and other modifications which may deem the trust no longer beneficial to the owners and the beneficiaries.

Will there still be Foreign Assets in the Trust?

Even if a trust becomes a US trust, if there are still foreign assets in the trust there may still be substantial reporting requirements necessary to keep the trust in compliance. This may require the taxpayer to continue filing Forms 3520 and 3520-A when the domestic trust contains foreign assets. In addition, the income within the trust may be handled differently depending on which income is being generated from U.S. assets versus foreign assets and whether the income is all being distributed in the current year or being contained in the trust which could lead to other issues including the throwback rule, etcetera. In other words, unless the full trust is domesticated without any foreign assets, the squeeze may not be worth the juice.

Finding a U.S. Trustee

To comply with U.S. trust law, there must be U.S. trustees designated for the trust. This may prove to be difficult, depending on the trust owner’s relationship with U.S. persons and who they trust to serve as a trustee to what may be a six, seven, or eight-figure trust.

U.S. Law instead of Foreign Law

By domesticating the foreign trust, the trust will now primarily be subject to U.S. law instead of foreign law and this oftentimes can pose a big problem for the trust. That is because in general, the reason the taxpayer uses a foreign jurisdiction is because there are tax benefits to forming a trust in that specific country or are subject to a specific country’s law. To qualify under the court test, the trust will become subject to U.S. tax law instead of foreign tax law and this may not have a tax benefit and may cause a detriment to the owner/beneficiaries. It may also impact issues involving GST, Throwback Rule, etc.

What Happens under Foreign Law when Trust is Domesticated

Another important fact to consider is that by domesticating the trust, the trust will no longer be managed under foreign law, but that may come with its own set of headaches as well. In many countries, once a foreign trust is domesticated out of that country and into the United States or even a different country, it can lead to certain tag simplifications. That is because the foreign country does not want that trust to be domesticated and therefore if the taxpayer seeks to domesticate the trust, there can be penalties and taxes associated with doing so.

Late Filing Penalties May be Reduced or Avoided

For Taxpayers who did not timely file their FBAR and other international information-related reporting forms, the IRS has developed many different offshore amnesty programs to assist taxpayers with safely getting into compliance. These programs may reduce or even eliminate international reporting penalties.

Current Year vs Prior Year Non-Compliance

Once a taxpayer missed the tax and reporting (such as FBAR and FATCA) requirements for prior years, they will want to be careful before submitting their information to the IRS in the current year. That is because they may risk making a quiet disclosure if they just begin filing forward in the current year and/or mass filing previous year forms without doing so under one of the approved IRS offshore submission procedures. Before filing prior untimely foreign reporting forms, taxpayers should consider speaking with a Board-Certified Tax Law Specialist who specializes exclusively in these types of offshore disclosure matters.

Avoid False Offshore Disclosure Submissions (Willful vs Non-Willful)

In recent years, the IRS has increased the level of scrutiny for certain streamlined procedure submissions. When a person is non-willful, they have an excellent chance of making a successful submission to Streamlined Procedures. If they are willful, they would submit to the IRS Voluntary Disclosure Program instead. But, if a willful Taxpayer submits an intentionally false narrative under the Streamlined Procedures (and gets caught), they may become subject to significant fines and penalties

Need Help Finding an Experienced Offshore Tax Attorney?

When it comes to hiring an experienced international tax attorney to represent you for unreported foreign and offshore account reporting, it can become overwhelming for taxpayers trying to trek through all the false information and nonsense they will find in their online research. There are only a handful of attorneys worldwide who are Board-Certified Tax Specialists and who specialize exclusively in offshore disclosure and international tax amnesty reporting. 

This resource may help taxpayers seeking to hire offshore tax counsel: How to Hire an Offshore Disclosure Lawyer.

Golding & Golding: International Tax Law Specialists

Golding & Golding specializes exclusively in international tax, specifically IRS offshore disclosure

Contact our firm today for assistance.