Before we discuss the differences between a foreign grantor trust and a foreign non grantor trust, it’s important to discuss the rather unique way US law handles trusts.
Under some circumstances, a trust can simultaneously be both “foreign” and “domestic.”
For purposes of asset protection and legal ownership of assets, a “foreign trust” is simply a trust that is formed outside of someone’s home jurisdiction.
For example, an American creates a “foreign” (meaning, non-US) trust for legal purposes upon settling a trust in Nevis or the Cook Islands.
However, US tax law is rather tricky. Just because a trust is foreign for legal purposes doesn’t mean it is foreign for tax purposes. There is a unique way to determine whether a trust is foreign for tax purposes.
The IRS relies on the “Court Test” and the “Control Test” to determine if a trust is domestic or foreign for tax purposes.
Court Test – A US court can exercise primary supervision over trust administration.
- Essentially, this means that a trust is 100% under the jurisdiction of a US court.
Control Test – US persons control all substantial trust decisions.
- Essentially, this means that the trustee is a US person.
If both tests are met, then a trust is “domestic” for tax purposes.
All other trusts are foreign for tax purposes.
By failing the Court Test and/or the Control Test, it is possible for non-US persons to settle a trust Wyoming that is foreign for tax purposes.
There are two types of foreign trusts – foreign grantor trusts and foreign non grantor trusts.
Foreign grantor trusts can be created by US grantors or nonresident alien grantors.
US Grantor
A foreign grantor trust is created when a US grantor makes a gratuitous transfer to a foreign trust with one or more US beneficiaries or potential US beneficiaries.
The IRS is very strict with its definition of “potential US beneficiaries.”
Any potential of a US beneficiary, however remote, is enough to force a classification as a foreign grantor trust.
Nonresident Alien Grantor
In limited circumstances, a nonresident alien grantor may form a foreign grantor trust.
For example, a foreign grantor trust is created if the trust instrument contains a provision stating that distributions can only be made to the grantor or the grantor’s spouse during the grantor’s lifetime.
A nonresident alien is someone who is not a US citizen and does not meet the green card rest or the substantial presence test.
Green Card Test – Aliens who are immigrants are resident aliens of the US for tax purposes, under the condition that they spend at least one day in the US.
Substantial Presence Test – there are two tests within the substantial presence test.
First, there is the 31 day test – you must be present in the US for at least 31 days during the relevant year.
Second, there is the 183 day test which is rather complicated.
Each day in the current year counts as one full day.
Every day in the first preceding year is multiplied by 1/3.
Each day in the second preceding year is multiplied by 1/6.
These figures are then added together. If the sum equals or exceeds 183 days, you have passed the 183-day test.
Here is an example.
Suppose that Matias spent…
130 days in the US during 2020 x 1 = 130 adjusted days
120 days in 2019 x 1/3 = 40 adjusted days
180 days in 2018 x 1/6 = 30 adjusted days
We must now add these together.
130 + 40 + 30 = 200 adjusted days.
200 exceeds 183.
Therefore, Matias meets the substantial presence test.
So, what is a foreign non grantor trust?
All foreign trusts that are not foreign grantor trusts.
It’s very important to understand your foreign trust’s classification to maximize tax benefits and to ensure tax compliance.
You can read more about the taxation of foreign trusts (both a foreign grantor trust and a foreign non grantor trust) by clicking here.
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