When you’re moving to a new part of the world it’s certainly an exciting time, but for high net worth individuals there can be all sorts of complications. The secret is to get started on your pre-arrival planning as early as possible and work through any issues and complications well in advance. To introduce you to the key issues you and your advisors will have to tackle, take a look at the following 3-minute read.
Trusts Need to Work for Everyone Involved
Creating a trust is a way to move your assets across borders, but the way you do it, and the people who will benefit from it, are all important. US persons are subject to anti-deferral tax regimes which accelerate the person’s exposure to US taxation or charges an interest payment to make up for taxes having been delayed.
For these issues to be avoided or minimized, the trust must be structured in the correct way. It’s what will allow your beneficiaries to have easy access to funds, minimize their liabilities, and give you the peace of mind that you’re 100% compliant with complex cross-border issues. By creating a full list of the people you want to benefit, and taking into account their personal situation and financial structure, you can create a trust that works for everyone involved, rather than one that’s hastily assembled to move your assets.
Trusts Need to be Built for the Longterm
Rushing into creating an overly complicated trust is something that won’t create the long-term results you hoped for. You may find you quickly fall foul of accumulation distribution issues, which are nothing more than penalty charges applied to your US beneficiary when they want to make a withdrawal from the trust. With sufficient pre-planning and organization, they’re often readily avoidable with the right approach.
The key is to consider the distributed and undistributed net income of the trust, as well as the manner in which the distribution is ultimately reported. This will then acts at the starting point for the creation of a solution that works for everyone involved for the long-term.
Trust Must Always be Compliant
You only have to read the rolling news to see the number of high net worth individuals who fall foul of tax avoidance schemes. What seemed like a good idea at the time when explained by someone they regarded as an expert can quickly unravel and result in substantial penalties.
Whilst the goal of a trust is to minimize the US tax and reporting burden for its US beneficiaries, this needs to be done within the confines of a well-defined set of rules and regulations. There are a number of specific, technical terms you will start to hear at this point, such as CFC and PFIC regimes, accumulation issues, and 65-day elections. To give you a gentle introduction to the fine details, we’re going to take a quick look at one of the most common pieces of legalese you can expect to encounter.
Time to Get Technical: CFC AND PFIC Regimes Explained
What are they?
Any US beneficiaries of the Trust can be treated as indirectly owning shares of a CFC (Controlled Foreign Corporation) or PFIC (Passive Foreign Investment Company) which is itself owned by the Trust. The issue here is the income tax and reporting complications which could result for the beneficiary. In certain instances, they could be taxed on particular assets held by the Trust, even if it doesn’t distribute any income to the beneficiary. In the case where the Trust can be shown to qualify as a PFIC, the beneficiary may even be subject to a special tax regime in which the receipt of PFIC distribution can be recategorized as deferred income, which then gives rise to far higher tax liability.
How do I avoid the complications?
The key thing to know here is that any non-US company which is classified as a corporation for US tax purposes could be classified as a CFC or a PFIC for income tax purposes. Common examples would be non-US mutual funds and investment holding companies, which will in most cases be classed as corporations, and therefore subject to US tax.
If the trust was structured so it only invested in companies through non-US companies, such as limited partnerships, which can be classed as ‘pass-through’ entities, these problems can very often be avoided. This is an approach commonly taken by offshore funds who wish to accommodate US and non-US investors with little change in the overall portfolio of the fund.
What are my reporting obligations?
If a beneficiary is treated as the indirect owner of a CFC or PFIC owned by the Trust, they could be subject to a number of restrictive reporting obligations. They could be required to file a Form 5471 with the IRS on an annual basis, and when the CFC is next funded. Filing of a Form 8621 is required for PFIC indirect owners when certain transactions have been judged to take place. Failure to comply with either of the above can result in significant fines and penalties.
Whilst we hope this gives you a gentle introduction to the specifics involved, it also serves to illustrate the complexity that can ensue when high net worth individuals relocate to the US. The best approach is to always seek specialist advice at the earliest opportunity and to take a pragmatic, long-term approach that works for everyone involved.