Creating a US trust: The control test and the court test

To be classified as a US trust for tax purposes, a trust must satisfy two key tests: the control test and the court test.

The control test requires that one or more US persons have the authority to control all substantial decisions of the trust. The court test mandates that a court within the US must be able to exercise primary supervision over the administration of the trust. This means the trust must be subject to the jurisdiction and authority of US courts.

Avoiding US tax on foreign source income

For non-residents looking to leverage a US-based structure to hold foreign assets, a non-grantor trust is generally the best option. A non-grantor trust is not revokable by the grantor and is treated as a separate taxable entity. It files its own tax return and pays taxes at the trust's tax rates. However, the trust is generally exempt from US taxation on foreign source income generated by foreign assets and investments held by the trust.

Avoiding US estate tax on foreign assets

In addition to being exempt from US tax on foreign source income, the “foreign situs” (i.e. foreign located) assets of such a trust are exempt from US estate tax. The US estate tax treatment of assets held by a US trust depends on whether they are considered US situs assets or non-US situs assets:

US situs assets include real estate located in the US, tangible personal property located in the US, and stock of US corporations. Non-residents are subject to US estate tax on US situs assets. The estate tax exemption for non-residents is USD 60,000.
Non-US situs assets are generally not subject to US estate tax for non-residents. Non-US situs assets include foreign real estate, tangible personal property located outside the US, and stock of foreign corporations.

Leveraging US law to protect foreign assets

A US trust can leverage US law to protect foreign assets in the following manner:

Asset protection. US trusts can provide robust asset protection features, shielding assets from creditors and legal claims. This is particularly beneficial for foreign beneficiaries who may face legal challenges in their home countries.

Legal certainty. US trust law offers a high degree of legal certainty and stability, ensuring that the trust's terms are upheld and enforced. This can provide peace of mind for non-residents and foreign beneficiaries.

Tax planning. U.S. trusts can be structured to optimise tax planning, taking advantage of favourable tax treaties and regulations. This can help minimise tax liabilities and maximise the benefits of holding foreign assets through a US trust.

Conclusion

Using a US non-revokable trust with foreign beneficiaries as a US-based investment structure to hold foreign business or investment assets can provide significant tax and estate planning benefits for non-residents. By meeting the requirements of the control test and the court test, the trust can be classified as a US trust for tax purposes. The trust should be exempt from US tax on foreign source income generated by foreign assets, while ensuring that foreign assets are excluded from US estate tax. Proper planning and administration are crucial for maximising these benefits while also ensuring compliance with applicable regulations.

Fernando Lopez is an International Tax Services partner with Mowery & Schoenfeld, leading the service line. With a focus on helping his clients expand in the US and foreign markets, Fernando specialises in cross-border tax planning and structuring.

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