Accidentally Forming a Foreign Trust Could Cost You
If you have a trust, your attorney likely asked you for the names of persons you could rely on to take control of your trust as successor trustee when you pass away. Most people quickly name their spouse, a child, a sibling, or a series of related persons to take over as their successor trustee, and the names of those chosen as successor trustees are inserted into the trust documents. For persons having family members who may not be citizens of the United States, however, care must be used in selecting successor trustees. The citizenship status of a successor trustees can have serious implications and can result in a trust becoming a foreign trust upon your death or thereafter, with significant tax consequences.
In the United States, all trusts are considered “foreign trusts” for tax purposes unless two requirements are met. The first requirement is known as the “court test.” This requires a United States court to have jurisdiction over the trust. Virtually every trust meets this test. To verify, one can typically just look toward the end of the document for a choice of law provision – something along the lines of “this trust shall be governed under the laws of the State of Michigan.”
The second requirement, however, is known as the “control test” and is much easier to fail. This test requires that one or more U.S. persons must always possess the authority to control all substantial decisions of the trust. In short, the person controlling the trust (the trustee) must be a United States citizen or the trust becomes a “foreign trust” under the law. Thus, if any of your successor trustees, or a trust protector in some cases, is not a United States citizen and they come to control the trust, the trust will become a foreign trust, since failing to meet either of the two tests results in the trust being deemed a foreign trust. This is true regardless of whether it was a U.S. trust upon formation – any trust can become a foreign trust as soon as one of the two tests is failed.
If your trust becomes a foreign trust upon your death, the taxes on trust assets increase dramatically. You do, however, have 12 months to correct an inadvertent trust residency change under the Internal Revenue Code Regulations, but this requires a change in control over the trust, i.e. a new trustee must be appointed, which is not always the easiest process. If your trust names a foreign citizen as a successor trustee, you should contact an estate planning attorney so appropriate changes can be made to ensure this doesn’t happen. If you would like to discuss this issue further or if you have any questions or concerns, feel free to call the Law Offices of Shifman & Carlson today at 248.406.0620.