How trusts fit a family office plan

A U.S. citizen scenario

Consider a U.S. citizen who is a beneficiary of a trust and is considering how that trust fits into a family office plan. The starting questions concern the trust’s classification and the citizen’s relationship to it. A U.S. person who owns a foreign trust or receives a distribution can have U.S. tax consequences and information reporting duties.^[1]

Evaluating a proposed transaction starts with the trust instrument and with who actually exercises decision-making authority. The family office label creates no tax exemption. The tax analysis must address the actual ownership relationship and any transaction with the trust under the applicable U.S. rules.^[1]

Classify the trust before choosing labels

A trust is domestic for U.S. tax purposes only when a U.S. court exercises primary supervision over its administration and one or more U.S. persons control all substantial decisions. These are the court test and control test. A trust that does not meet both tests is foreign.^[1]

The governing-law label alone does not complete this analysis. For the illustrative citizen, the questions are which court has supervisory authority and who can make the substantial decisions. The trust is classified as domestic or foreign only after the operative documents and the actual arrangements answer both of those questions.^[1]

Grantor or nongrantor treatment requires a separate ownership analysis. The IRS applies grantor trust rules to determine whether a U.S. person is treated as owning a foreign trust, with consequences distinct from those of a beneficiary receiving a distribution.^[1]

U.S. treatment of ownership and beneficiary payments

A U.S. person treated as the owner of a foreign trust generally pays U.S. income tax on the trust’s income. The IRS describes a Foreign Grantor Trust Owner Statement that identifies the income the owner reports on the owner’s U.S. income tax return. The analysis therefore cannot begin and end with cash received by the citizen.^[1]

A U.S. beneficiary receiving a distribution from a foreign nongrantor trust generally reports the beneficiary’s share of distributable net income. The relevant beneficiary statement helps establish the distribution’s tax treatment. Reporting rules still require attention when no statement arrives.^[1]

For the illustrative citizen, the planning question is whether the citizen is an owner, a beneficiary, or both. The answer determines which information must be obtained before preparing the return. A local exemption does not establish a U.S. exemption; the U.S. ownership and distribution rules require their own analysis.^[1]

Funding and the transfer of property

Funding a foreign trust can itself produce tax consequences. Section 679 generally treats a U.S. person transferring assets to a foreign trust with an actual or presumed U.S. beneficiary as an owner. Section 684 requires gain recognition on certain transfers of appreciated property by a U.S. person to a foreign nongrantor trust.^[1]

Gift tax is a separate inquiry. A transfer for less than full value can constitute a gift even when the transferor did not intend to make one. Funding therefore turns on the property transferred and the value received in exchange.^[2]

Estate tax also requires separate attention. A gross estate can include interests in trusts, so the presence of a trust does not settle the estate tax analysis. The interests a transferor retains drive the treatment, so they are identified and assessed before the transfer.^[3]

Reporting follows the relationship and the transaction

Form 3520 generally applies to specified transactions with foreign trusts and to U.S. ownership of them. Relevant events include funding a trust and receiving a distribution. A loan or the uncompensated use of trust property can also require reporting, so a cash distribution ledger alone may omit reportable activity.^[1]

A separate Form 3520 is required for transactions with each foreign trust. A U.S. owner must complete Part II even when no transactions occurred during the tax year. An inactive account therefore does not, by itself, resolve the owner’s filing obligations.^[4]

A U.S. owner must ensure that the foreign trust timely files a complete and accurate Form 3520-A and furnishes the required annual statements. FBAR and Form 8938 are separate reporting inquiries. Completing a foreign trust return does not resolve those other requirements.^[1]

Trust structures and service arrangements

A private trust company is a corporate trustee established to act for a specific trust or trusts. The trustee company's role does not establish the U.S. tax treatment of either the company or the trust.^[5]

A trust and a foundation are different structures with different U.S. consequences, so the two terms are not used interchangeably in a plan. Trusts and private foundations are separate Guernsey structures used for family wealth and succession arrangements. A foundation's status under Guernsey law does not establish how it is classified for U.S. tax purposes.^[6]

Each participant in a proposed arrangement holds a legal role. A licence covers particular activities, and endorsement is a separate matter. A service provider's title or regulatory description does not support a U.S. tax conclusion.

Personal status and filing procedures

The IRS explains that residence for gift tax purposes differs from residence for income tax purposes. Holding a green card is not conclusive evidence of U.S. domicile for estate and gift tax purposes.^[2]

Filing procedures also deserve separate attention. Form 3520-A is generally due on the fifteenth day of the third month after the foreign trust’s tax year ends. A substitute Form 3520-A attached to the U.S. owner’s Form 3520 follows the Form 3520 due date under the instructions. These are separate procedures, so each gets its own place on the filing calendar.^[4]

The trust’s classification and the citizen’s obligations are the starting points for the tax and reporting analysis, and questions about either stay open until the facts are settled.

Scope and status

Family office notice. A family office label does not establish an investment adviser exclusion, a tax exemption or a reporting exemption. The SEC exclusion needs all three conditions: only family clients, wholly family-owned and family-controlled, and no holding out to the public as an investment adviser. An office serving unrelated families generally must register or find another exemption, and state law may apply.

Questions and answers

Related pages

• How the IRS classifies trusts for U.S. tax purposes: U.S. trust classification for tax purposes: ordinary and investment trusts, U.S. person status, and the environmental remediation trust rule in the regulations.
• Grantor and nongrantor trust taxation | OffshoreTrusts.com: U.S. income tax rules distinguish grantor and nongrantor trusts for U.S. citizens. Sections 671 through 679 may assign ownership of all or part of a trust.
• Foreign trust reporting inside a family office: How a family office tracks foreign trust income reporting, Forms 3520 and 3520-A, FBAR and Form 8938, and who is responsible for each filing and its records.
• When Trust Transfers Are Completed Gifts: How dominion and control, reserved powers, and retained use, enjoyment, or income relate to completed gifts and estate inclusion for a U.S. citizen's trust.