PERSPECTIVE3-5 min to read

Solving problems for US beneficiaries of foreign trusts

Schroders’ specialist US team is seeing an increase in queries about US persons and foreign trusts. So, alongside our in-house experts, we assembled a panel of top advisors to address key questions on foreign trusts including IRS reporting obligations and tax.



Janette Saxer
Portfolio Director

American individuals living outside the US are increasingly aware of the complex tax and reporting requirements they need to fulfil. But what about foreign trusts and their beneficiaries? Schroders’ Wealth US is hearing more frequently from trustees and advisors in relation to their work with trusts where there are US beneficiaries. In some cases they are aware that there may be a problem, but they are not sure what it is, or how to address it. In other cases, they are looking to find an investment manager who understands their reporting and tax requirements.

To unravel some of the issues and point toward possible solutions we called on expert help from several leading firms, including Rawlinson & Hunter (Jersey) and Crestbridge.

Identifying whether there are Americans implicated in the trust

A trust is a straightforward vehicle for holding assets or cash. A non-US or “foreign” trust becomes of interest to the US tax authorities where either the owners or beneficiaries are American citizens or – to be more technically correct – they are “US persons”. But it isn’t always obvious that this is the case.

“One of the biggest problems we find is that trustees aren’t aware there are US persons involved,” says Paul Hunter, Head of Family Office Services at Crestbridge’s Jersey office. He says US legislation introduced over a decade ago – which puts the onus on worldwide financial institutions to identify US clients and ensure they fulfil their obligations to US authorities continues to trip up trustees and beneficiaries. “We’re still feeling the impact of FATCA legislation, in that there’s the issue of discovering a US connection, which can happen almost by accident,” Paul says. “Say a trust beneficiary was born in the US but has been living most of their life in Saudi. Until a question is asked, or the information exchanged, trustees may not know there is an issue.”

Typical scenarios which might signal warnings of a US connection or “accidental Americans” could include:

  • The beneficiary has lived all of their life outside of the US, but was born there
  • The beneficiary was a UK or other national who moved to the US to study, and has remained there
  • The beneficiary was born to a US parent but never lived there
  • A non-US settlor [the person who established the trust] dies, and the next generation of beneficiaries include US persons

Trustees will stay in regular communication with clients and hence be aware of potential or future US connections which would impact the structure, says Katrina Williams of Jersey-based trustees, Rawlinson & Hunter. “The common scenarios are, marrying a US citizen, or going overseas to study, as well as being aware and planning for opportunities to expatriate,” she says. “A pivotal moment is the death of the non-US settlor [the original contributor of assets to the trust], at which point a foreign trust can become non-grantor (see Is the foreign trust “grantor” or “non-grantor, below), and a different set of rules will apply, impacting the planning opportunities and reporting requirements, and where the beneficial class includes US persons. Planning should be undertaken in advance of such events, to ensure the optimal position for the next generation, including investment strategy and reporting rules.”

Is the foreign trust “grantor” or “non-grantor”?

In the eyes of the US’ Internal Revenue Service (IRS) there are two sorts of foreign trust. One is a “grantor” trust, the other is “non-grantor”.  “Careful review is necessary by the trustee as to whether a foreign trust is considered “grantor” or “non-grantor”," says Katrina, noting different rules for the classification apply depending on whether a US or non-US person settles the trust. Consideration needs to be given to whether the trust is fully revocable during the lifetime of the settlor, who has the powers to cause or block the revocation, and to whom amounts can be distributed, is this limited to the grantor or the spouse?

The “grantor” is the person who placed the original assets into the trust, and is treated, from a US tax perspective, as owning all assets from an income tax perspective. From the American taxman’s perspective, those assets are deemed to belong to the grantor, and the grantor will generally be liable for tax arising from those trust assets, even if the returns are in fact paid away to their children or other beneficiaries. Income and gains arising to a foreign grantor trust with a non-US settlor are therefore taxable to the non-US settlor depending on the jurisdiction, and not to US members of the discretionary beneficial class.

In the case of a foreign “non-grantor” trust, the US taxman is only interested if there are US beneficiaries. Distributions to a US person will be taxed, and in a disadvantaged way, in which case the beneficiaries will need to meet authorities’ requirements and pay the tax due.

How this works in practice can become complicated. For example, where the beneficial class includes a mixture of US and non-US beneficiaries, a US beneficiary might not be deemed to own all of the trust’s assets requiring reporting. Planning opportunities arise.

In the case of non-grantor trusts, planning opportunities are available to optimise the position through careful management of how and when the income or capital returns are paid out of the trust (see Managing income distributions from a foreign trust, below).

Is the trust’s investment strategy appropriate for US beneficiaries?

Once trustees become aware of a US connection, they need to realise the implications of the investments held within the trust.

The IRS views many non-US investment funds (such as those which in the UK are called unit trusts or open-ended investment companies) as non-qualifying holdings, meaning taxes levied on returns can be high.

The non-qualifying holdings are known as PFICs (or passive foreign investment companies).

If you hold investments in a trust not considered US-friendly, they will fall at the beneficiary level. This means from a tax perspective they are attributed to the beneficiary. That can be penal.

One way to avoid this – a process which Schroders Wealth US has developed over many years – is to create bespoke portfolios investing in individual equities, bonds and US registered investments.

Whatever the right solution for any particular trust, it is likely to require detailed knowledge of the IRS’s position on various asset classes and the potential consequences of owning them.

Katrina says: “Trustees will seek specialist US advice in relation to specific asset classes.  Whilst  tax may not be the determiner of the chosen investment solution, trustees will want to understand the specific US tax and reporting implications of holding different types of investments, and ensure the appropriate investment portfolio restrictions are in place if determined to be appropriate.”

Managing income distributions – and negotiating “UNI” and “DNI”

When it comes to calculating US tax liabilities generated within foreign non-grantor trusts where there are US beneficiaries, complex rules apply. Advice is necessary to apply the rules to each specific trust structure to ensure the optimum outcome.

Capital gains and income arising within a tax year are called “distributable net income”, or DNI.

Income or gains arising within a year but not distributed become “UNI” (undistributed net income). If not distributed, this amasses over years and becomes subject to  “throwback” rules where income and gains from earlier tax years attract higher rates of tax, both in terms of penalties and application of different character of the income, increasing over time, which can result in tax rates up to 100% of the value of the distribution.

Income and capital gains within the year retain their character if distributed in that year, but the rules applying to UNI often mean more tax is due overall. Managing future distributions becomes very important in this scenario.

Paul Hunter adds that this longer-term planning should also involve a consideration of the next generation, and how they might be implicated.

Reporting requirements relating to foreign trusts

Once you’ve determined that a non-US trust does indeed have obligations to report or pay tax to US authorities, the next step is to understand what is required in order to comply. Tax may not be due, but in many scenarios annual returns will still need to be filed.

The responsibility generally lands with the US grantor and/or US beneficiary. Penalties for not filing as required can be significant.

“The obligation falls to the US person involved,” says Paul. “All income received from a foreign trust is reportable. But when people are asked by the IRS whether they are in receipt of this, it is amazing how often people tick "no". Trustees have to help.”

Katrina adds: “Calculations of income and gains for US purposes are done on a different basis to for UK purposes. Trustees will require US-specific reporting packs from investment managers, and often work with US accountants to compute the detailed figures, within a tight timeframe of 65 days post-year-end. The fact is that, however sophisticated you are, you need detailed experience for some of this work. The knowledge required is highly specific.”

But what happens in the “accidental American” scenario, where the trust or its beneficiaries discover a US connection and have been inadvertently non-compliant up to that point? Again, it is likely that highly specialised advice will be needed, both in terms of making the disclosure to the IRS and in preparing the history of trust returns.

How Schroders Wealth Management can help

Having worked for years with US expats, trusts and trustees where there are US compliance requirements, we have a clear understanding of the likely scenarios and pitfalls clients will face. We also know the solutions likely to be available to them.

We work closely with specialist advisors and trustees, such as Rawlinson & Hunter (Jersey) and Crestbridge, to become part of the solution that will see trustees and trust beneficiaries achieve their investment goals in a way that is compliant and tax-efficient.



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Janette Saxer
Portfolio Director


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