Nonresidents can use a U.S. trust as a safe, U.S.-based investment structure to hold foreign business and investment assets for the benefit of beneficiaries located outside the United States. This asset structuring approach offers several tax, estate, and security benefits.
Creating a U.S. trust: The control test and the court test
To be classified as a U.S. trust for tax purposes, a trust must satisfy two key tests: the control test and the court test. The control test requires that one or more U.S. persons have the authority to control all substantial decisions of the trust. The court test mandates that a court within the U.S. must be able to exercise primary supervision over the administration of the trust. This means the trust must be subject to the jurisdiction and authority of U.S. courts.
Avoiding U.S. tax on foreign source income
For nonresidents looking to leverage a U.S.-based structure to hold foreign assets, a non-grantor trust is generally the best option. A non-grantor trust is not revokable by the grantor and is treated as a separate taxable entity. It files its own tax return and pays taxes at the trust's tax rates. However, the trust is generally exempt from U.S. taxation on foreign source income generated by foreign assets and investments held by the trust.
Avoiding U.S. estate tax on foreign assets
In addition to being exempt from U.S. tax on foreign source income, the “foreign situs” (i.e., foreign located) assets of such a trust are exempt from U.S. estate tax. The U.S. estate tax treatment of assets held by a U.S. trust depends on whether they are considered U.S. situs assets or non-U.S. situs assets:
U.S. situs assets:
U.S. situs assets include real estate located in the U.S., tangible personal property located in the U.S., and stock of U.S. corporations. Nonresidents are subject to U.S. estate tax on U.S. situs assets.
The estate tax exemption for nonresidents is $60,000.
Non-U.S. situs assets:
- Non-U.S. situs assets are generally not subject to U.S. estate tax for nonresidents. Non-U.S. situs assets include foreign real estate, tangible personal property located outside the U.S., and stock of foreign corporations.
Leveraging U.S. law to protect foreign assets
A U.S. trust can leverage U.S. law to protect foreign assets in the following manner:
- Asset protection: U.S. trusts can provide robust asset protection features, shielding assets from creditors and legal claims. This is particularly beneficial for foreign beneficiaries who may face legal challenges in their home countries.
- Legal certainty: U.S. trust law offers a high degree of legal certainty and stability, ensuring that the trust's terms are upheld and enforced. This can provide peace of mind for nonresidents and foreign beneficiaries.
- Tax planning: U.S. trusts can be structured to optimize tax planning, taking advantage of favorable tax treaties and regulations. This can help minimize tax liabilities and maximize the benefits of holding foreign assets through a U.S. trust.
Using a U.S. non-revokable trust with foreign beneficiaries as a U.S.-based investment structure to hold foreign business or investment assets can provide significant tax and estate planning benefits for nonresidents. By meeting the requirements of the control test and the court test, the trust can be classified as a U.S. trust for tax purposes. The trust should be exempt from U.S. tax on foreign source income generated by foreign assets, while also ensuring that foreign assets are excluded from U.S. estate tax. Proper planning and administration are crucial for maximizing these benefits while also ensuring compliance with applicable regulations.
Want to learn more? Get in touch with Mowery & Schoenfeld's international tax and advisory team today.