With the US being a ‘common law jurisdiction’, it’s no wonder many Americans may be confused about foundations (and no, we’re not talking about *charitable* foundations like the Bill and Melinda Gates Foundation). This is because foundations are a concept derived from a ‘civil law jurisdiction’. So what does that mean for families setting up foundations to protect their wealth…..or assets? What are the tax consequences?
With the ever-growing popularity of statutory foundations, it’s important to understand not only the benefits, but how they are set up, operate and whether your statutory foundation would be treated like a trust or corporation, where tax laws are concerned.
In this video, Founder and CEO of Esquire Group, Jimmy Sexton, LL.M., is joined by the brilliant tax mastermind, Virginia La Torre Jeker, J.D. and together they discuss statutory foundations, how they are similar to trusts, how and why the benefits often outweigh that of a trust, and how it is or can be taxed.
Statutory foundations are most commonly set up for similar purposes as a trust. The parties involved are also similar; (Trust/Foundation: settler/founder, beneficiary/qualified recipient, protector/guardian); however, while a trust is managed by a trustee, a foundation is managed by a governing body/council. This means the wealth and assets are held/owned in the name of the foundation (as opposed to being held/owned in the name of a trustee). Having assets in the name of a foundation (which is a legal entity) instead of a trustee adds an extra layer of protection for a foundation’s qualified recipients.
So if a statuary foundation is not a trust or a corporation, how is it taxed by the US?
A foreign foundation can be taxed as a foreign trust or a foreign corporation. Because of the complexities and expenses that come along with the foreign corporation tax treatment, if possible, it is generally best to have the foundation organizational documents correctly drafted in a way that allows it to be treated/taxed as a trust.
Note: A trust computes its tax based on its income and takes whatever deductions are available to it, including a deduction for distributions to beneficiaries. Therefore, a US trust will not pay tax on the amount distributed, rather the beneficiary who received the trust distribution pays the tax. The result is that income is only taxed once (one level taxation). A corporation, on the other hand, is taxed on its net income without a deduction for amounts distributed to shareholders. Therefore, when it pays a dividend to shareholders, the dividend is also taxed in the hands of the shareholders (double taxation).
So what is the difference between how a foundation is taxed when set up by a US founder vs a foreign founder?
Assuming US beneficiaries, when it is a foreign foundation set up by US founder(s), all income earned by the trust, will be taxed only to the US founder who is considered the grantor. The US beneficiary does not pay US tax on distributions (though there are still tax documents to be filed by the beneficiary).
When a foreign founder sets up the foundation, where there are US beneficiaries involved, the foreign founder (meeting certain requirements) will be treated as the tax owner for the income, but because they are a non-resident alien, they will not be taxed unless there is US income. Assuming all income is foreign income and the founder is a non-resident alien, there will be no US tax consequences to him. The US beneficiaries will be treated the same as if it had been set up by a US founder—no US tax on distriubtions (though there are still tax documents to be filed by the beneficiary).
Either way, with strategic tax, succession, estate and privacy planning, a statutory foundation is a valuable way to structure and protect wealth, with long-term benefits.