TRUST

Cross-Border Wealth Succession:
The Necessity of Establishing U.S. Trusts

In today’s highly financially intensive era, beyond the accumulated wealth of many large families spanning generations, there are also those who achieve overnight wealth through business models or financial products. These fortunes often extend beyond a single country and are diversified across various asset types worldwide, such as equity in Taiwan, real estate in China, and financial funds in Hong Kong and Singapore. In this era of intense information exchange, both wealth creation and preservation are equally crucial. How to prudently avoid various risks such as marital legal risks, tax authority claims, and intergenerational property disputes during inheritance underscores the importance of family trusts, making them the preferred solution for high-wealth families in recent years.

However, in establishing family trusts, factors beyond the robustness of national legal systems and financial environments must also be considered. These include the nationalities and tax risks of both settlors and beneficiaries. For instance, compliance with FATCA for U.S. individuals and CRS exchange for non-U.S. individuals necessitates finding optimal solutions through layered structures for family wealth succession.

Trust & Estate Planning

Typical Trust Structure Analysis

Revocable Trust(Dynasty trust)
Holding Foreign Assets
Outside the United States An irrevocable dynasty trust
holding assets located
outside the United States.Tax Analysis of Offshore Trusts
with U.S. Beneficiaries

In general, for cross-border estate planning involving a revocable trust, non-U.S. citizens typically act as settlors, while U.S. citizen children serve as beneficiaries, forming a Foreign Grantor Trust established by a non-U.S. person within the United States. The main advantage of such a trust is that during the settlor’s lifetime, due to their non-U.S. citizenship, there are no U.S. income tax implications for the beneficiaries or the trust itself.

A common practice is to use the revocable trust to control an offshore company in a third country, and to open investment accounts in the United States under the company’s name. This structure not only avoids Common Reporting Standard (CRS) reporting issues but also exempts capital gains taxes when trading stocks. Upon the settlor’s death, the trust assets pass directly according to the predetermined trust agreement without the need for complicated probate procedures, and assets held by the offshore company in U.S. investments are not considered part of the settlor’s U.S. taxable estate.

A U.S. domestic non-grantor trust established in the United States for cross-border inheritance typically involves a non-U.S. citizen as the settlor, with a U.S. citizen individual or entity serving as trustee, and U.S. citizen children as beneficiaries. Due to its irrevocable nature, the trust assets are completely independent of the settlor, thereby potentially avoiding estate tax claims from other countries and safeguarding against future disputes such as inheritance, debts, and divorce settlements involving descendants.

A common approach involves the non-U.S. citizen initially gifting assets into the U.S. non-grantor trust, taking advantage of tax-free gift allowances, thereby establishing the assets in the United States. Subsequently, the trust may invest in U.S.-based real estate, stocks, bonds, and other assets. Principal assets placed in the trust after establishment are exempt from additional gift or estate taxes, while income can either be taxed within the trust or distributed to beneficiaries and reported on their personal income tax returns.

1.While the foreign grantor is alive, the trust maintains its status as a revocable trust, with no U.S. tax concerns.

While the settlor is alive, the trust remains a revocable trust (FGT) with income tax obligations falling on the settlor. U.S. citizen beneficiaries who receive distributions from the FGT must file Part III of Form 3520 by April 15 of the following year, indicating receipt of distributions from the FGT, and include the signed page five of Form 3520A from the trustee. There are no concerns regarding U.S. taxes.
Regarding FATCA and FBAR reporting, if distributions received in the current year exceed 50% of the total distributions, it must be disclosed on the forms.
From a U.S. tax perspective, under the revocable trust scenario, there are no concerns regarding U.S. income tax obligations, hence there is no mandatory requirement to keep accounts to differentiate between principal and income.

2.When the settlor passes away, the trust converts into a Foreign Non-Grantor Trust (FNGT), which is irrevocable and situated outside the United States. From that point forward, any generated income triggers U.S. tax responsibilities and calculations for Throwback Tax.

Current year income is fully distributed in the same year.
If in any given year the trust distributes all of its total income to beneficiaries, the FNGT Beneficiary Statement will clearly list the income types, distribution amounts, and account details for that year. Beneficiaries must consolidate this distributed income into their personal income tax return (Form 1040) and report it according to the progressive tax rates.
Income from the current year distributed in subsequent years requires computation of throwback tax and interest penalties.
If the total income of the trust for a particular year is not fully distributed to beneficiaries within that year, any undistributed net income (Undistributed Net Income) accumulates. When this undistributed income is distributed in future years, beneficiaries are required to pay income taxes on it. Additionally, according to IRS rules on Throwback Tax, beneficiaries must also pay punitive taxes and interest penalties. These amounts must be aggregated and reported on Form 1040 & Form 3520 Part III for the relevant tax year.

3.Practical Application of Standby Trust

To avoid potential U.S. taxation on accumulated net income, it is recommended to establish a U.S. domestic irrevocable trust (Standby Trust) and designate it as the beneficiary of an offshore trust. Upon the death of the settlor, immediately sell the assets held under the trust and transfer the trust principal as distributions to the U.S. domestic irrevocable trust designated for beneficiaries. Due to the step-up basis of assets upon the settlor’s death, any profits generated from the quick sale will be limited, and promptly distributed within the period, avoiding issues of accumulated income tax. Furthermore, distributions of principal from the U.S. domestic irrevocable trust to beneficiaries are tax-free. Income from the trust can be either retained and taxed in the trust’s current period or distributed to beneficiaries, who will report it on their individual tax returns. However, transferring funds from the offshore trust to the U.S. domestic irrevocable trust involves considerations such as liquidity from asset sales and issues related to foreign exchange controls.