Trustees of Non-US Grantor Trusts ("NUSGT") may wish to invest in more than US based business and investment opportunities for a variety of reasons. Accordingly it is important for the Grantor, the Trustee and ultimately the beneficiaries of the NUSGT to understand the US tax treatment and compliance requirements of such entities in order to effectively manage investment returns and levels of taxation in the jurisdictions with taxing authority over the earnings of the entities. After all, one of the primary functions of the trustee is to effectively manage the assets for the benefit of the trust's beneficiaries and avoid waste.
Per se Corporations vs. Eligible Entities - Check the Box Regulations
In 1997, the Internal Revenue Service ("IRS") abandoned the complexity and unworkability of the so called Kitner Regulations and moved toward a simplified process of defining corporations formed under state corporate laws or equivalent laws of foreign jurisdictions as "per se corporations" and entities other than trusts as "eligible entities ."
Foreign Eligible Entities
Treas. Reg. ?301.7701-3(d) discusses special rules associated with foreign eligible entities ("FEE"). These rules discuss the concepts of relevance or deemed relevance of the classification of the entity for US tax purposes . Under these rules the date of an election or change in classification may affect a withholding agent's requirement to withhold or the owner of the FEE to provide certain information filings to the US tax authorities, e.g. the requirement to file a Form 5471 regarding Foreign Corporation Ownership or Form 8865 regarding ownership of Foreign Partnerships.
Investing under a Disregarded or Partnership Structure - Tax Credits and Treaty Benefits
NUSGTs often own interests in non-US per se corporations or eligible entities as subsidiaries to facilitate investment and to seek among or things the benefits and protections of a non-US jurisdiction, one or more double taxation treaties and asset protection. These subsidiary structures may be single or multimember and may be segregated along various lines such as by country, by industry or by investment type. To limit the complexity of this basic discussion we will focus solely on single or multi-member subsidiaries of an NUSGT that invest primarily in regularly traded securities outside of the United States.
Compliance Requirements for a Disregarded Entity Owning Non-US Investment Assets
If a NUSGT wholly owns a Nevis LLC which elects disregarded status under the check the box rules the US Grantor will be required to File Form 8938, Statement of Specified Foreign Financial Assets and perhaps FinCEN Form 114 (Formerly TD F 90-22.1 the FBAR form) in addition to Forms 3520 and 3520-A. The US Grantor will not be required to fill out the financial information on Form 8938 as that information may be duplicative of information required on forms 3520 and 3520-A, however, the number of 3520s and 3520-As must be reported on Form 8938.
Compliance Requirements for a Disregarded Entity Owning Non-US Investment Assets
There are thresholds for persons living within and without the United States. The Thresholds are also segregated by filing status. For example, an unmarried taxpayer living inside the United States has a reporting Threshold of $50,000 on the last day of the year and $75,000.00 at anytime during the year. While a Taxpayer meeting one of the residence tests and deemed to be living outside of the United States has a threshold of $200,000 on the last day of the year and $300,000 at any time during the year. Additional information on thresholds is available in Treas. Reg. ?1.6038D-2T.
Statute of Limitations Remains Open
In addition, a failure to file from 8938 means that the US Grantor's tax return will remain open until three years after the date of ultimately filing the Form 8938
Compliance Requirements for a Partnership Entity Owning Non-US Investment Assets
If an NUSGT owns an interest in a foreign eligible entity which elects partnership status, the Grantor must file a Form 8865, Return of US persons with Respect to Foreign Partnerships.
Ownership of per se Corporations and Eligible Entities Electing Association Status
As previously stated the regulations interpreting ?7701 provide a list of per se corporations that are considered corporations based on their characteristics under the laws of the countries where they may be formed. For example, in Latin America the Sociedad Anonima (S.A.) and Sociedad Anonima de Capital Variable (S.A. de C.V.) are considered per se Corporations. By contrast, A Soci?t? ? responsabilit? limit?e or S.a.r.L in Switzerland is similar to a limited liability partnership and thus an eligible entity. Also Nevis and other jurisdictions have limited liability companies which are also eligible entities which may elect disregarded, partnership or association status based on the facts and desire of the owner(s).
US Tax Compliance for Entities Treated as Corporations
If a NUSGT forms or acquires an interest in a non-US entity treated as a corporation there are a number of compliance requirements facing the US Grantor. In additions to the Forms 3520 and 3520-A that are required for reporting the activities of the NUSGT. The Grantor will need to file Form 5471 for each non-US corporation owned in whole or in part by the Grantor subject to certain limitations.
Generally Form 8938 is not required to be filed if the US Grantor of the NUSGT is filing Forms 5471, 8865, 3520 and 3520-A
Foreign Tax Credits (FTCs)
NUSGTs must be very aware of the investment vehicles they choose and may need to operate through multiple subsidiaries in order to maximize their investment return and tax efficiency. Part of the reason for this is the mechanics of Tax Credits.
Credit Limitations Generally
The ?901 credit available to a grantor, the trust or a trust beneficiary is limited by the provisions of ?904 of the Code. ?904 limits the available credit to no more than the US tax on the non-US source income determined prior to the imposition of the non-US tax against the same source income. The ?904 credit limitation rules work in tandem with double taxation treaties. In those cases where the US tax on the non-US source income, pre-credit is higher than the non-US taxes paid, the non-US taxes are fully creditable against US taxes. Where the Non-US taxes are higher than the US taxes on the same income the credit is limited to the amount of the US tax subject to the carryover provisions of ?904(c) .
Separate Categories of Income
The ?904 limitations are used using the US source rules. These sourcing rules break down income for foreign tax credit ("FTC") limitation purposes into the following categories or baskets.
In addition ?904 limitations rules treat capital gains as a separate category of income for the determination of the available credit . Generally, non-US source income includes gains derived from the sale or exchange of capital assets or assets treated as capital assets (e.g. ?1231) only to the extent of non-US source capital gain net income .
IRC ?904(d)(2)(A)(i) defines passive income as income which would be considered foreign personal holding company income (FPHCI) under the controlled foreign corporation rules. Accordingly passive income under the FTC limitation rules is comprised of:
PFIC Income, Tax Credits and Distributions
NUSGTs by themselves or through flow through subsidiaries may invest in publicly traded funds and indexes outside of the United States that may be subject to the Passive Foreign Investment Company rules . NUSGTs must annually file Form 8621 to report their interest in a PFIC and make the election . There are several sets of rules to consider.
Form 8621, Information Return by a Shareholder of a Passive Foreign Investment Company or Qualified Electing Fund is filed by US persons that are direct or indirect shareholders of a PFIC. A separate Form 8621 must be filed for each PFIC. Indirect ownership is indicated where a US persons owns 50% or more of a US or foreign corporation that is not a PFIC but that owns directly or indirectly an interest in a PFIC. Any direct or indirect owner in a pass through entity which owns a direct or indirect or indirect interest in a PFIC may also be an indirect shareholder. A NUSGT would typically be an interest holder in a pass through entity and thus required to file its direct and indirect interests in PFICs.
If the NUSGT files Form 8621, Information Return by a Shareholder of a Passive Foreign Investment Company or Qualified Electing Fund, a Form 8938 is not required.
Passive Activity Income and Losses- Net Investment Income and Material Participation
Income and net gain derived in the ordinary course of business from an ordinarily passive trade or business in which the taxpayer materially participates may be able to escape the NII tax. In Frank Aragona Trust v. Commissioner , an individual created a grantor trust naming himself as trustee and transferred to the trust and acquired various interests in rental real property during his lifetime. The grantor passed away leaving the property in trust for his children who became the successor trustees. Some of the successor trustees worked full time in the management of the real property through a disregarded subsidiary.
Net Investment Income is reported on Form 8960. There does not appear to be any exclusion related to foreign source passive income (FADPI). As such Subpart F income must be included in the determination of the 3.8% tax on Net Investment Income.
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