Identifying the difference between a far-off grantor trust and non-foreign grantor trust are often a frightening task if the aim is to form informed decisions to understand which one among them most accurately fits your needs.
In most cases, they share some similar features making it even harder to spot which is which.
However, before we explore this subject matter in hand, one needs to know why the trust is made in the first place also as being conversant in some basic terms around the topic in question.
So, first things first, why is trust created?
Basically, trusts are created for several reasons. The foremost important reason is that they are created as a definite legal entity to guard the grantor’s assets, wealth, or property and any income generated from that asset for safekeeping for the beneficiaries receiving them.
A trust is made to transfer wealth from the owner (grantor) to the beneficiary (usually an heir) but evading tax reporting on the wealth or asset transferred.
1. Grantor or Settlor
A Grantor may be a person who initiates or creates a trust to transfer wealth or property to the intended owner called a beneficiary. However, counting on the sort of grantor trust prepared, the grantor may or may not retain power and control over the administration or management of the trust.
Also, counting on the status of the grantor if he’s alive or not, the grantor (owner of the trust) has the following characteristics:
- Grantors have the facility to appoint trustees also as successor trustees who will oversee the operations and management of the trust.
- A grantor can revoke a trust.
- Grantors can modify or amend a revocable trust to meet their satisfaction.
- A grantor can choose a beneficiary of their trust or appoint a replacement.
- A grantor can change the distribution income of a trust and control fund investments.
2. Trustee
A trustee is someone given the legal title of the trust by a grantor for the management and protection of the trust for the beneficiary.
3. Beneficiary
A beneficiary may be one that receives the income generated from the trust. A beneficiary is the intended owner of the trust but isn’t given full control and ownership of the trust just because the grantor doesn’t want the wealth or asset transferred to the beneficiary to fall into substantial tax reporting, or the beneficiary is yet to be trusted to require control of the trust.
Difference between a Foreign Grantor Trust and a Non-Foreign Grantor Trust
Now that we got the fundamentals out of the way, we shall analyze the difference between a far-off foreign grantor trust and a non-foreign grantor trust.
1. Foreign Grantor Trust
A far off Grantor Trust (F.G.T) is a sort of trust during which a non-U.S resident creates a trust for the advantage of beneficiaries living in the country.
A non-U.S resident is someone who isn’t a U.S citizen, isn’t a real identification holder and is additionally not considered as a U.S taxpayer.
A Foreign grantor trust also can be created by an individual who is a U.S citizen, has assets within the United States or overseas, and also forms a trust for United States residents (beneficiaries).
It is a type of revocable trust in which the grantor (owner) controls the trust on behalf of the beneficiary.
Basically, all trust that doesn’t meet the wants of both the court test and the control test is mentioned as Foreign Trusts.
(a) Court Test: A trust satisfies a court test provided:
- The trust agreement doesn’t specify that the trust should be created and administered outside the United States.
- The trust is indeed administered exclusively within the United States.
- The trust isn’t subject to a migration agreement from the U.S when a court within the United States tries to enforce primary supervision over the administration of the trust.
(b) Control Test: One or more U.S persons must have the facility, by vote or otherwise, to make informed decisions of the trust with no other person having that equal power to vary the choice or say otherwise (except for the grantor and therefore the beneficiary acting during a fiduciary position).
(c) Big/Substantial decisions: This suggests all decisions, aside from managerial decisions that a person is permitted to form under the terms of the trust agreement like the grantor. The owner of the trust will be the one to specify how the trust is formed, who to work with, and the way to control the trust. These substantial decisions previously laid out in the control test include everything concerning:
- Whether or not to appoint a successor trustee to replace a trustee who has either died, resigned or ceased to act as a trustee.
- The choice of a beneficiary and therefore the appointment of a replacement.
- Whether to protect the trust against a lawsuit or to sue on behalf of the trust.
- Whether to feature, replace, or remove a trustee from the trust.
- Whether to distribute an income.
- When to distribute an income.
- The quantity of income to be distributed.
- Whether to supply a receipt of the income distribution.
- Whether to compromise or abandon claims of the trust arrangement.
- Whether to end/terminate the trust.
With the revocable trust, the grantor who is also the owner of the asset or property creates the trust.
- The trustee oversees and administers the trust and,
- The beneficiary receives what comes from trust.
Under a far off grantor trust, there are some tax reporting rules to follow which are provided by the Internal Revenue Service.
TAX GUIDELINES TO REPORT AFAR OFF FOREIGN GRANTOR TRUST
1. The U.S Grantor
During the lifetime of the grantor, the United States grantor has the responsibility of reporting all the income and gains from the trust on his/her income tax, mainly Form 1041, and the U.S individual income tax return.
However, the trust itself won’t be subject to tax reporting. This is because the trust is conducted as a grantor trust. Under this type of trust, the grantor has authority over the trust and is therefore referred to as the owner of the trust for income and inheritance tax purposes.
2. The Trustee
The trustee of a far-off grantor trust is required to file a Form 3520-A and an Annual tax return of Foreign Trust with the grantor to the IRS each and every year.
The trustee is required to file a document called a far-off grantor trust Owner Statement to the grantor of the trust and a far off Grantor Trust Beneficiary Statement to each and every single beneficiary who received some of the income distributed from the trust during the tax year.
On the opposite hand, should the trustee fail to file Form 3520 as needed, the grantor of the trust will receive penalties from the IRS.
The grantor can file the Form 3520-A on his/her own to avoid such penalties.
3. The U.S Owners
The United States individual is one that is taken into account as an owner of a far off trust who is required to fulfil a tax payment annually on the portion of the income he/she receives from the trust.
The U.S owner is additionally required to file a form 3520 per annum to report ownership of the foreign trust even if there was no transfer made to the trust that year.
4. NRA Grantor
For a Non-Resident Alien Foreign grantor trust Owner, the subsequent tax guidelines are required to be followed:
(a). The Trustee
The trustee is required to supply a far off grantor trust Beneficiary Statement to the U.S recipient (beneficiary) to report the quantity of the income distribution.
(b). The Non-U.S Owner
The non-U.S owner isn’t subject to U.S taxes on the trust distributed income unless the income source generated by the trust is connected with a business residing in the United States. If it does, the owner is required to file a Form 1040NR to report and pay the accrued tax of such income.
(c). The U.S Beneficiary
Whether the grantor is a United States resident or not, the U.S beneficiary who receives an income distribution from a far off grantor trust must file Form 3520 alongside his/her income form 1040.
A Foreign Grantor Beneficiary Statement would be attached to Form 3520 in the event a United States beneficiary receives a distributed income from the trust alongside the statement altogether. However, if this happens, no tax is to be paid on the income distribution from the foreign grantor trust by the beneficiary.
5. FBAR
A trust will file an FBAR when a far off grantor trust has an offshore account that’s tied to it, also as a Form 8938 for reporting offshore accounts.
Rev Procedure 2020-17: This basically refers to the reporting rules and requirements of a far off trust:
As provided by the Internal Revenue Service:
“This revenue tax reporting rules gives an exemption from the knowledge reporting requirements under section 6048 of the interior Revenue Code (IRC) surely U.S citizens and resident individuals regarding their transactions with, and ownership of, certain tax-favored foreign retirement trusts and certain tax-favoured foreign nonretirement savings trusts, as described in sections 5.03 and 5.04 of this revenue procedure (collectively, applicable tax-favoured foreign trusts).
Only a few select individuals described in section 5.02 of this revenue procedure (basic individuals in the United States who are compliant about their tax obligations associated with such trusts) may require this revenue procedure.
Besides, this revenue procedure establishes procedures for eligible individuals to request cancellation of penalties that are assessed or a refund of sanctions that are paid according to section 6677 for the individuals’ failure to suits the knowledge reporting requirements of section 6048 concerning an applicable tax-favored foreign trust.
Eligible individuals may request relief from section 6677 penalties, subjects to the restrictions of sections 6402 and 6511, per paragraph 6 of this revenue procedure.
2. Foreign Non-Grantor Trust
This is a kind of grantor trust that’s created within the country of residence, by the citizens and for U.S beneficiaries.
Basically, all trusts that satisfy the need of both the court test and the control test is taken into account as a non-foreign trust.
1. Court Test: This refers to any domestic court within the country of residence that’s ready to exercise primary supervision over the administration and formation of a trust. The principles are as follows:
- A trust will pass the court test if it’s registered with a U.S (domestic) court.
- The trust will meet the court test if the members of the trust are appointed as trustees of that trust by a court in the United States.
- The trust will satisfy the court test if the decision-makers or the beneficiaries made arrangements with the U.S court to become the first supervisor within the administration of the trust.
- The court test is going to be met if the trust document states that the judicial law of a foreign country governs the trust, but gives authority to a court within the United States the facility to exercise primary supervision over enforcing such law.
2. Migration plans: A trust will fail to satisfy the wants of a court test if the trust document states that any jurisdiction enforced by a court within the United States or an effort to supervise the administration of the trust would ultimately end in the migration of the trust from the country.
