The Use of Offshore Trusts

This is an area requiring great care and planning if there is a United States grantor or any possible US beneficiaries. Prior to certain US tax law changes, a US person was able to establish a trust in a foreign, tax-neutral jurisdiction that could generally accumulate income and capital gains without paying tax at the trust level. These would ultimately be taxed only at the time of distribution to US persons. The value of tax deferral and the time value of money was very significant. Imagine no tax being paid for twenty or thirty years while the assets in the trust continued to grow and grow. Comparable tax deferral was not available with the use of US trusts, since a US trust is itself, a separate taxpaying entity. The law was thus changed to make the use of foreign trusts created by US grantors with a US beneficiary (or even the possibility of a US beneficiary) highly inadvisable.

A US grantor who establishes a foreign trust with a US beneficiary will himself generally be taxed directly on the trust’s income (including capital gains) even if the trust makes no distributions to anyone! It is very important to note that when a foreign trust is funded by a US person, the trust will automatically be treated as having a US beneficiary unless the trust document specifically prohibits all US persons, including the US grantor, from benefiting from the trust at any point in time. Without this critical language in the trust instrument, a foreign trust created by a US person will be taxed as discussed, that is, the US grantor will pay tax each year on all the income earned by the trust regardless of whether or to whom, trust distributions were made. Read More