UK domiciled US resident, US tax implications on being beneficiary of UK trust?

I am rewriting a Will for a UK-dom individual who lives in the UK with UK property. She has a son who lives in the US and is a Green Card holder, not a US citizen. He is going to be a potential beneficiary from a discretionary trust of residue when his mother dies. All okay so far…

Another adviser has suggested that this will trust would be regarded by the US as a Foreign Non-Grantor Trust as a result of the “throwback rules” and that if the son benefitted from the trust whilst residing in the US, the IRS may impose “penalty interest” on any distributions. I have no idea what this is about. Is this true?

Would the FACTA rules affect the operation of this UK trust? The other adviser is suggesting so.

Donald Reevely
Will You Ltd

Yes, your information is substantially correct. Unless steps are taken to make the trust US resident, it will be a foreign non-grantor trust and the “throwback” rules will subject income and especially gains to unfavourable rules and a penalty interest charge. This can be mitigated, however, by making any trust of which the son is a beneficiary a US resident trust (by designating a US court to have primary supervising jurisdiction over administration, and providing that all “substantial” decisions of the trust are controlled by US persons – at a minimum this usually means a majority of the trustees must be US citizens or residents).

If there are also beneficiaries in the UK, such a trust could also be UK resident by naming at least one UK resident trustee in order to avoid the corresponding problem here. Alternatively, it may be easiest to create a separate trust for the US beneficiary that is solely a US resident trust.

If the purpose of the discretionary trust is only to defer the details of the division of the estate until after the testator’s death but then to distribute the capital fairly early, then the non-US residence of the trust is not too significant – it mainly affects income and gains accumulated over multiple tax years. If, however, it is intended that the trust will continue for some time, then effective steps must be taken to mitigate US tax with respect to an otherwise “offshore” trust. Much of the details of the mitigating steps can be left to the discretion of trustees of a DT to implement, provided their discretion is broad enough. I would be happy to discuss this if you like.

And yes, there are FATCA implications, but the details depend on what you end up with.

Ian Watson
Three Stone

If the US resident son has signature authority on an LPA (or old EPA) the US resident son could already have FBAR filing obligations, so these should be mentioned for good order.

If the monies are going to be held in the trust for any length of time, it might be prudent from the outset to select US “tax friendly” investments, in other words avoiding PFICs.

David Treitel
American Tax Returns Ltd