The Labour 2024 Autumn Budget brought with it sweeping changes to the UK tax landscape, including the abolishment of the ‘non-dom regime’ and largely signalling the end of an era for the use of offshore trusts as core component of UK tax planning. As we step into the new UK tax year and many of these changes begin to take effect, it is prudent to remind ourselves of the core uses for trusts outside the realm of tax planning.
In particular, it is important to bear in mind the fundamental benefits of the succession planning and asset protection solutions that trusts continue to provide for individuals and families, and the valuable role they play in helping to navigate the evolving and complex area of dynastic wealth planning.
But what about our neighbours across the pond? For families with a US nexus, do offshore trust structures still have a place within effective wealth structuring and tax planning?
Wealth planning scenarios
Whether it is for largely unrivalled career opportunities, world-class education, excellent quality of life, the romanticism of the ‘American Dream’, or simply the weather, the draw of the USA is undeniable for some. A true melting pot and a country built on the strength of immigration; this is a trend that is unlikely to change any time soon.
For some, however, this presents a dilemma. Take for example, an ambitious 20-something-year-old, who has recently graduated from university and has decided to ‘move stateside’. How do diligent non-US high net worth (HNW) and ultra-high net worth (UHNW) families approach such scenarios from a wealth planning perspective?
Naturally, parents will wish to support and provide for their children – wherever they are in the world – but how is this best approached in the case of ‘Uncle Sam’?
Whether it represents the first toe in the water for a wealthy family, or it forms part of an existing comprehensive offshore wealth planning structure, Jersey law trust structures can help.
US taxation
First, however, we need to look at the high-level criteria for taxation in the US… As a non-US citizen, ‘alien’ individuals are considered resident for US income tax purposes in the following circumstances:
As a non-US citizen, ‘alien’ individuals are considered resident for US income tax purposes in the following circumstances:
- an election is made to be treated as US tax resident;
- the ‘substantial presence’ test is met; or
- they are deemed to be a ‘lawful permanent resident’ as a green card holder.
The rules for defining residency for US tax purposes are therefore fairly specific, with US citizens and US tax-resident alien individuals typically subject to US tax on their worldwide income.
Conversely, non-US resident individuals are ordinarily only subjected to US income tax on income derived from US-source and some forms of foreign-source income “effectively connected” with US trade or business, including bonuses, salary and other forms of compensation.
Trusts and the US
Next, we need to understand how trusts are viewed from a US tax perspective, starting with the designation of a grantor trust vs a non-grantor trust.
In the US, a grantor trust, as the name would suggest, is a trust established by a grantor (more commonly known as the settlor or donor), where the grantor retains, or reserves, particular powers over the trust fund. Such reserved powers include the power to revoke the trust fund – both in part and in its entirety – as well as typically the power to direct investments, the power to remove and appoint the trustee, the power to direct distributions of income and the appointment of capital to named beneficiaries, or classes thereof. It is important also that no other party has the power to block the grantor exercising their power to revoke.
Meanwhile, a non-grantor trust is in line with what we would normally interpret to be a traditional discretionary trust, where the settlor entirely relinquishes legal ownership and ultimate control of the trust assets.
These differences are crucial, with the revokable nature of a grantor trust rendering this transparent from a US tax perspective and the grantor potentially being liable to US tax, while a non-grantor trust is viewed as an entirely separate legal arrangement from the grantor.
Lastly, it is necessary to understand how a trust is determined to be a foreign trust for US tax purposes, which it is deemed to be, provided it does not meet either the ‘control test’ or the ‘court test’, as well as various other sub-rules associated with each:
- Control Test – met where one or more US persons have the ability, by way of vote or otherwise, to make all “substantial decisions” of the trust, with no other persons holding the right to veto such decisions.
- Court Test – met where any federal, state or local court within the US is able to exercise primary authority over all, or substantially all, of the administration of the trust.
A hands-on approach
Returning to the example of our jet-setting postgrad; a Jersey law, settlor reserved powers, revocable trust, settled by a non-US individual (i.e. a foreign grantor trust), to which their US-bound child is a beneficiary, allows that child, once US tax resident, to benefit in a highly US tax-efficient format.
In such scenarios, while the non-US grantor is taxable on certain US-source trust income, the distributions to the US resident beneficiary are non-taxable from a US (and state) gift, estate and income tax perspective, albeit the US persons benefitting will almost certainly have US tax reporting obligations to adhere to.
In instances where grantors are themselves resident in a low tax jurisdiction, or one that is tax neutral when it comes to overseas income, the use of a foreign grantor trust therefore represents a powerful wealth planning tool.
Careful drafting of trust instruments to facilitate the designation of the trust as a foreign grantor trust is key, which in the case of a Jersey law trust, requires a hands-on approach by both US tax advisors and Jersey counsel. Likewise, careful adherence by trustees to the nuances of foreign grantor trust instrument drafting is equally important.
So, what’s the catch?
In the same way that a foreign grantor trust is largely viewed by the IRS as being transparent during the grantor’s lifetime, the opposite occurs at the time the settlor passes away (i.e. it generally becomes viewed as a non-grantor trust).
There are US transfer tax advantages through the use of a trust by non-US persons to facilitate the passing of non-US situs assets to US beneficiaries, albeit it does not alleviate future transfer tax that may apply when those US beneficiaries pass their wealth to the next generation.
However, with a trust being viewed as a foreign grantor trust after the settlor’s passing, the landscape changes dramatically from a US income tax perspective. Complex throwback provisions come into play, with the IRS expecting that all distributable net income (or DNI) is distributed by the trustee within the US tax year in which it arises, with the IRS taxing US beneficiaries punitively upon the receipt of accumulated trust income arising from prior tax years, also known as undistributed net income (or UNI).
The alternatives
There are other alternatives available, for example, rather than continuing to have the trust designated as a foreign non-grantor trust after the settlor’s passing, the trust could be ‘onshored’ as a US domestic trust by intentionally seeking to meet either the ‘court test’ or ‘control test’ touched on previously.
Alternatively, rather than mandating the distribution of income to US beneficiaries within a given tax year, this could instead be tipped into a newly established US domestic trust each year.
In the same way that careful pre-establishment trust planning is required when considering the formation of a foreign grantor trust for US tax planning, an equally carefully planned exit strategy is therefore needed in anticipation of the settlor’s passing or loss of capacity.
So how can we help?
Offshore trust structures remain a viable and often very effective way for individuals and families to provide for US tax resident beneficiaries in a highly tax-efficient manner. Additionally, there are many core advantages offered by Jersey law trusts as part of well-advised wealth structuring.
Our Private Client and Family Office teams in Jersey have extensive experience supporting clients with the establishment and ongoing servicing of a verity of standalone and complex cross-border trust and wealth planning structures. Many of these structures include trusts designated from a US perspective as foreign grantor trusts to allow wealth creators, typically the family patriarchs and matriarchs, to support their children upon moving to the United States – either temporarily or more permanently.
Many of these structures involve the use of a private trust company (PTC) to act as trustee, with the Hawksford team being adept in the development and implementation of governance and reporting frameworks, as well as providing nextgen education, particularly where clients wish to have members of their family appointed to the board of the PTC.
Working closely with US advisors, we act as trusted partners for clients in the implementation of these often-complex structures, holding not only traditional discretionary investment portfolios, but more commonly a broad spectrum of financial assets, family businesses and luxury assets, constructed around the priorities of asset protection, succession planning, tax planning and confidentiality.
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