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Tax and reporting considerations of a foreign grantor trust

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Tax and reporting considerations of a foreign grantor trust

Detail of the United States Capitol building in Washington D.C., the meeting place for Congress, and the seat of the legislative branch of the federal government.

A grantor, for U.S. tax purposes, is any person that either creates a trust or directly or indirectly funds a trust. In order for a foreign trust to be treated as a grantor trust, the grantor must: 1) be alive, 2) be a United States person or become one within five years for funding the trust, and 3) any part of the income or corpus of the trust could be paid to a U.S. beneficiary. Thus, a grantor trust is any trust to the extent that the assets of the trust are treated as owned by a person other than the trust. However there are exceptions for certain revocable and irrevocable trusts.

A foriegn trust will be treated as a non-grantor trust where: 1) there is a live foreign grantor that is a nonresident for U.S. tax purposes, and 2) the trust is either revocable, for the sole benefit of the grantor or the grantor’s spouse, or compensatory.

A trust is treated as having a United States beneficiary for the taxable year unless, under the terms of the trust, no part of the income or corpus may be paid or accumulated during the taxable year for the benefit of a United States person or if the trust were terminated at any time during the taxable year. What’s more, The Foreign Account Tax Compliance Act (FATCA) expands the interpretation of who is deemed to be a U.S. beneficiary of a foreign trust. The Act treats a foreign trust as having a U.S. beneficiary if a current, future, or contingent beneficiary of the trust is a U.S. person. Distributions to such persons as well as loans of cash or marketable securities to them or others (i.e. a controlled foreign corporation (CFC) or a foreign partnership of which a U.S. person is a partner) are categorized as payments to a United States beneficiary.

Tax treatment for a foreign grantor trust is as follows. If there is a U.S. grantor than the grantor is treated as the owner of all trust income and taxed accordingly (taxed as a domestic trust). Conversely, if the grantor is a nonresident or foreign corporation, the trust is taxed under international income taxation rules. U.S. source investment income (but not capital gains, except real estate) is taxed at a flat 30% rate and income that is effectively with a U.S. trade or business is taxed at regular 35% U.S. rates. Nonetheless, treaty relief may be available based upon the grantor’s residence. As for reporting, a U.S. person who at any time during a taxable year is treated as the owner of any portion of a foreign trust under the grantor trust rules is responsible to ensure that the trust files a Form 3520A return setting forth a full and complete accounting of all trust activities and operations for the year and provides such information to any U.S. person that is treated as an owner or receives any distribution from the trust.