My wife grew-up in a relatively small town in Maine. Her aunts, uncles, cousins, and grandparents all lived in the same town. Her parents’ aunts, uncles, cousins, and grandparents also lived in the same town. However, her generation was the first to “leave town.” I dragged her to California; her brother lives in New Hampshire; and she has cousins who live in Vermont and Illinois. Many families have similar stories as the world is much more global than it used to be. In fact, it is quite common today to have friends and family who live in a different country. While having contacts all over the world can be a benefit, it can also create a potential estate planning trap.
Most comprehensive estate plans are centered around a revocable living trust. The trust provides that the Grantors (the “Trust Makers”) serve as the initial Trustees (“Trust Managers”) and name other individuals or entities as Successor Trustees in the event of the Grantors’ incapacity or death. It is common to name family members and friends as Successor Trustees. However, if a trust names a non-U.S. Citizen or a U.S. Citizen who resides in another country as a Successor Trustee, the trust could be considered a “foreign trust” by the IRS, resulting in adverse tax consequences.
Adverse tax consequences of a foreign trust can include recognition of capital gains for transferring certain assets to the trust even if they have not been sold; mandatory withholding by the IRS; and certain federal reporting requirements. These consequences can result in a significant depletion of the trust estate contrary to the Grantor’s intent. To avoid classification as a foreign trust, the trust must meet two tests: the “court test” and the “control test.”
The “court test” is met if a court located within the 50 states or the District of Columbia has primary supervision over the administration of the trust. As long as the Trust is administered within the United States and does not contain a “migration provision” – a provision that transfers the administration to another country upon the occurrence of an event – then the “court test is satisfied.” If the Trustee is a resident of another country – even if the Trustee is a U.S. Citizen – there could be questions as to whether the administration of the trust is actually taking place in the United States.
The “control test” requires that a “U.S. Person,” which could be a non-U.S. Citizen who is a resident of the United States or a U.S. Citizen who is not a resident of the United States, has the authority to control to “all substantial decisions of the trust.” Naming non-U.S. residents who are not U.S. Citizens as a Trustee can fail this test.
When establishing a living trust, care should be taken if the trust involves any parties who are either non-U.S. residents or non-U.S. Citizens. Special language might be required to ensure that the United States courts have jurisdiction over the administration of the trust and that the trust is controlled by a “U.S. person.” It might also be prudent to avoid naming any non-U.S. resident or non-U.S. Citizen as a Trustee or to hold any other trust position that involves control over the trust. If you cannot think of any friends or family members who reside in the United States to act in such a role, you might want to consider appointing an American professional private fiduciary or a U.S. corporation to fulfill such roles.
KRASA LAW, Inc. is located at 704-D Forest Avenue, Pacific Grove, California 93950 and Kyle may be reached at 831-920-0205.
Disclaimer: This article is for general information only. Reading this article does not establish an attorney/client relationship. Before acting on any of the information presented in this article, you should consult a competent attorney who is licensed to practice law in your community.