If you are a foreigner living in the United States that is creating a revocable trust as part of your estate plan, you will be faced with some difficult decisions, chief among them is who to appoint as your successor trustee. This role requires someone you trust. Naturally you might want to appoint a trusted friend of family member from your home country. Unfortunately, this can prove the be a costly mistake. Under U.S. law, a trust that appoints a non-US person as trustee will be recognized as a foreign trust, subject to burdensome and expensive disclosure, taxation, and withholding requirements:
· The foreign trust must receive its own tax identification number;
· The foreign trust must file annual returns (Form 3520-A or Form 1040-NR) and the failure to do so comes with harsh penalties;
· Foreign trust is subject to gain recognition upon the death of the U.S. owner or upon the U.S. owner becoming a nonresident alien for U.S. income tax purposes and may be subject to tax withholdings.
While it may not be an option to appointing your foreign friend or family member as trustee, you may be wondering if you could give these individuals some oversight over the trust, such as veto powers or the ability to supervise the trust and change trustees if need be. Unfortunately, such powers would trigger foreign trust status as discussed below.
A trust is classified as a foreign trust if it fails either the “court test” or the “control test.” The court test is met where a US court has primary supervision over the administration of the trust. If the trust is administered within the United States then the court test is satisfied, provided that the trust does not include a migration provision (designed to avoid US court jurisdiction by triggering foreign trust status upon the occurrence of an event). See, 26 CFR § 301.7701-7.
The “control test” requires that one or more U.S. persons have the authority to control to all substantial decisions of the trust and that no other person has the power to veto any of the substantial decisions. See, 26 CFR § 301.7701-7.
Substantial decisions include:
· Whether and when to distribute trust property (income or principal);
· The amount of any distributions;
· The selection of a beneficiary;
· Whether a receipt is allocable to income or principal;
· Whether to terminate the trust;
· Whether to compromise, arbitrate, or abandon claims of the trust;
· Whether to sue on behalf of the trust or to defend suits against the trust;
· Whether to remove, add, or replace a trustee;
· Investment decisions.
To preserve the domestic status of your trust, the ideal trustee is a citizen of the United States that resides in the United States. If you cannot identify such an individual to serve as your trustee, you might consider a US-resident that is not a US citizen. Be aware that naming a non-US citizen that is merely residing the United States can trigger foreign trust status where the individual moves from the United States. If you are unable to locate someone to serve as your trustee, you should consider appointing a professional fiduciary. Be aware you should also avoid naming anyone who is not a US citizen or US resident to hold any position that gives them control over the trust, as this could trigger foreign trust status under the control test as discussed above.